Back in late July, Zillow made a $3.5 billion all stock bid for rival Trulia. Since announcing the deal on July 28th, closing it last month, Zillow’s stock is down 33% from the all time highs made amidst the deal euphoria. By the time of the closing, Trulia’s market value was half of the announced deal, and the combined companies now sport a market cap of just $6 billion.
I won’t suggest that Zillow using its massively inflated stock price to take out a large competitor was a bad move from a strategic standpoint, but the combined company (now trading at 8x expected 2015 sales) could remain valuation challenged for some time as the combined Zillow/Trulia is no different than what they were before, which is primarily businesses that sell online ads. While they’ve been at the forefront of a huge secular trend in the real estate market these are the exact sort of business models that will be taken to the woodshed when investors become more risk adverse.
I have no position in the stock. I traded it once last year when the stock was in nearly the same spot (read here) but it lacks liquidity and the options on the stock are wide. It trades as if it has 30% short interest, because it does. For those with a directional view, options prices are fairly reasonable, with 30 day at the money implied volatility (blue below) about 45% vs the 30 day realized vol (how much the has actually moved, white below at 60%):
Oh, and one more thing. The 3 year chart of Zillow is at an inflection point, with the stock recently failing at the uptrend that had been in place since the 2012 lows of nearly $20, and now threatening important psychological support at $100:
So while I can’t argue with Zillow’s use of their ridiculous stock price to buy a competitor and ensure a less challenging future, I see a business model like theirs, which already under-performs in the current market environment, as one of the first casualties when sentiment turns towards high valuation stocks/sectors the way it has for other internet service stocks that rely on ad sales like Pandora and Yelp.