Zillow responds to criticism of business model

Share price stabilizes in wake of scathing research report

Editor’s note: This story has been updated with closing prices for shares of Zillow, Trulia and Move Inc. for Wednesday, Sept. 26. The story has also been corrected to note that an offering of Zillow shares that closed Sept. 24 was a follow-on offering dilutive to existing shareholders, not a secondary offering of previously issued shares.

Real estate portal Zillow Inc.’s share price stabilized today after going on a roller coaster ride that was apparently prompted by publication of a research report slamming the company’s business model and stock trades by managers.

The 18-page report by Citron Researchdescribed by the Associated Press as a "short seller’s research firm" –  presented a detailed criticism of Zillow’s business model, questioning the company’s reliance on selling leads to real estate agents and brokers.

Web 2.0 companies like Open Table, LinkedIn and Facebook are predicated on smart management and publication of information interactively that "can scale tremendously" with fixed costs, the report said.

But Zillow "generates virtually all of its revenue from U.S. real estate agents," the report noted. "And it does so the old fashioned way: By cold-calling them on the telephone."

According to Zillow’s last quarterly report to investors, the company had 22,696 paying "Premier Agent" subscribers at the end of June, up 70 percent from a year ago.

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But the report notes that growth in Premier Agent subscribers has slowed, and claimed Zillow "is buying revenues with an intense telesales effort. Put in its simplest terms, they spent an additional $3.8 million on sales expense last quarter, and only generated $4.8 million in new revenues."

Selling leads to real estate agents "is a dead-end business," the report asserted, citing Zillow’s recent moves to offer customer relationship management tools and enter "other businesses such as rentals, that have little to no synergy with their current business" as evidence.

The Citron Research report also focused on sales of stock by a few of Zillow’s managers during the company’s recent follow-on offering, which netted the company $156.7 million after expenses.

Despite the Citron Research report’s unprofessional qualities — it borrows heavily from reports published by other analysts, and Zillow CEO Spencer Rascoff’s name is misspelled in two different places — its release coincided with a drop in the price of Zillow shares Tuesday.

Shares in Zillow were trading at $41.45 at Tuesday’s close, down 6.7 percent. Nearly 8 million shares traded hands — about eight times the normal volume, and the busiest day on record since the company went public in July 2012.

Zillow’s stock price stabilized today, with rebounding to a high of $41.79 for the day before closing at $40.37, down 2.6 percent for the day and 13.8 percent from their 52-week high.

The Citron Research report may also have inflicted some collateral damage on the share price of Zillow rivals Trulia and Move Inc. Shares in Trulia closed at $20.78 today, down 6.6 percent for the day and 21.8 percent from an all-time high of $26.57. Shares in Realtor.com operator Move Inc. were down 2.6 percent today, to $8.21, an 18.3 percent decline from a 52-week high of $10.06.

Chad Bartley, a research analyst with Pacific Crest Securities, thinks the report’s main thesis — that Zillow’s stock is vastly overpriced — is wrong. Citing the company’s aggressive growth outlook and a vast, untapped customer base, he thinks the company’s current valuation in the $40s is reasonable.

Bartley said it would be good if Zillow published its "churn" rate, the rate of customer turnover.

A company spokeswoman today addressed some of the questions raised by Citron Research, including the potential for future growth in sales of leads to real estate agents and brokers.

"In many, many ZIP codes, we have waiting lists for our Premier Agent subscriptions," said Zillow spokeswoman Katie Curnutte.

Zillow management did sell shares in the follow-on offering, Curnutte said, but the amount sold represented only a small percentage of the total amount the sellers owned.

Zillow co-founders Rich Barton and Lloyd Frink each sold 250,000 (50,000 of Frink’s amount was sold by the Frink Descendants’ Trust) shares of class A common stock for $36.50 per share. They still own 4.89 million and 4.22 million shares of Class A common stock, respectively, and remain the company’s largest shareholders.

A trust related to board member Erik Blachford also sold 100,000 shares of Class A Common stock and retained 176,624 shares. No other individuals sold stock in Zillow’s follow-on offering.

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