MorningWord 8/11/14: Make Me Move – Zillow ($Z)

by Dan August 11, 2014 9:49 am • Commentary

Zillow is a stock that we have not understood for most of its 500% gains from its December 2012 lows.  We surely understand momentum, and this stock has had that.  We definitely understand why valuation does NOT matter, until it does, which makes trying to short high valuation stocks that have unusual momentum behind them in a raging bull market a fool’s errand. We tried that and gave up (read here).  So maybe, just maybe, it is a turn in sentiment based on some sort of questionable corporate act that could signal the all clear on the short side.  Two weeks ago, Zillow made an all stock $3.5 billion bid for their largest rival Trulia (TRLA).  My thoughts at the time (MorningWord 7/28/14: Gettin While the Gettin is Good):

Zillow….. KNOWS that their stock price is ridiculous, up nearly 100% so far in 2014 and trading at 26x trailing sales that are expected to grow 57% this year and 36% next. What’s nuts is that Zillow must think that TRLA is cheap as they are expected to have $253 million in sales this year vs Zillow’s $311 million, yet coming into today Zillow’s stock commanded a market cap of 3 times that of TRLA.

I have long been in the camp that this market cycle will not end until we get our share of M&A that makes even the bravest of bulls think twice.  We have had our share so far this year in Tech, Telecom and Media, some successful some not:  Facebook’s $19 billion bid for no revenue WhatsApp and AT&T’s $49 billion bid for DTV, and the now- scuttled $80 billion bid for TWX from FOXA and Sprint’s failed bid for T-Mobile.

Back in late December I opined:

it’s not sky high public market valuations of high-flying tech stocks that mark a bubble, or the valuations, or quantities of unprofitable hot tech IPOs that come to market. It is usually some combination of such activity over a period of time that defies logic, but then topped off with the mother of all ridiculous M&A activity! This could be coming to a theater near you in 2014.

Which brings me to a fairly important market idiom, “No One Rings the Bell at the Top” and reminds me of the now infamous commentary by Fed Chair Yellen last month relating to some equity valuations, from WSJ, per her Monetary Report to Congress on July 15th:

“Valuation metrics in some sectors do appear substantially stretched–particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year

So you get the point.  But it wouldn’t be any real fun if we did not have a few brave souls willing to rain on the bull market parade and attempt a top call every so often.  Look no further than Barron’s.  On this week’s cover, Zillow was highlighted with the article suggesting that Zillow shares could fall by a half:

Merging real estate Websites Zillow and Trulia isn’t the sure winner bulls contend. Time to put a “For Sale” sign on the stocks.

I am not going to go into the nitty gritty, but it is a perfectly well-thought-out bearish argument of why the money losing entities (in GAAP terms) might never grow into their valuations.  But again, remember, we are in a market that for the moment does not care about such things.

Barron's August 9th, 2014
Barron’s August 9th, 2014

Timing will be everything for those who agree with Barron’s.  We are clearly in their camp.  I would add one more thing – I was a bit astounded by a tweet by Zillow CEO Spencer Rascoff on July 30th, two days after making the TRLA bid.  In that tweet, he was taking a victory lap for his advice back in May to Twitter employees not to sell their stock:



Doesn’t this guy have bigger fish to fry??  I agree with Barron’s on this – I’ll bet my left pinkie tip that this combined entity will be worth only what Zillow is worth now at some point in the next year or so. But the question is from where does it stop going up? Your guess is as good as mine. Rather press this one when the momentum is broken than try to pick a top.