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The Economist MBA Case Competition 2014
Muddy Waters Investment Competition
Analysis on the Zillow Trulia Merger
Authors Michael Jonas, Juan Guillermo Rintha, Philipp Soechtig
Full-Time MBA Class of 2015
WHU – Otto Beisheim School of Management
Submitted November 3, 2014
© WHU – Otto Beisheim School of Management, www.whu.edu Page 2
Table of Contents
1. Introduction to online real estate market .............................................................................. 4
2. Case Questions ..................................................................................................................... 5
a) Which company is getting the better deal and why? ........................................................ 5
b) Does the structure of the deal make sense for each company? ......................................... 8
c) What will the futures likely be for each company on a standalone basis if the
transaction fails to close? .................................................................................................. 8
d) Based on the companies’ present combined market valuations, what assumptions
about their future would you have to make in order to buy stock in the combined
company? ........................................................................................................................ 12
e) What trades, if any, would you recommend around this transaction and why? ............. 16
3. Wrap-up .............................................................................................................................. 19
© WHU – Otto Beisheim School of Management, www.whu.edu Page 3
Table of Exhibits
Exhibit 1: Share of visitors ......................................................................................................... 5
Exhibit 2: Future revenues/EBITDA vs. market capitalization ................................................. 6
Exhibit 3: Adj. EBITDA and synergies 2016 ............................................................................. 7
Exhibit 4: M&A deals capped to certain market share ............................................................ 11
Exhibit 5: Market position highly correlated with level of profitability .................................. 13
Exhibit 6: Share prices mainly influenced by three major drivers ........................................... 14
Exhibit 7: Significan premiums at technology M&As ............................................................. 17
Exhibit 8: Benefit from online trend ........................................................................................ 18
© WHU – Otto Beisheim School of Management, www.whu.edu Page 4
1. Introduction to online real estate market
The fundamental structure of the American real estate market has not
radically changed in last decade, even after the housing bubble that took
place around seven years ago (CNN, Money & Main St., 2009). The
traditional and largely fragmented way has always facilitated interactions
between the agents, who personally show the properties, and the final
residents, aiming to acquire a new home. However, new virtual
mechanisms prior to those interactions are now widely used and
appreciated by the last mentioned (CNN, Zillow buys Trulia for $3.5
billion, 2014).
The online platforms in this market now store properties from diverse parts
of the country that are uploaded by the real estate agents, and display them
to thousands of people that rate them with their computers and mobile
devices. The largest ones are Zillow and Trulia, followed by others like
Realtor.com, Yahoo! Homes, Homes.com, Redfin, among others. They
provide not only information about houses to buy and to rent, but also
complementary services such as housing valuation, moving-in advice,
mortgage options, interior designer lists, and the like.
The business model of the platforms mostly relies on few streams. For
example, Trulia’s revenue largely depends on the mortgages that are
traded online, the advertisement on its site and the number of properties it
shows. The listings of properties are uploaded by the agents who pay the
platform to publish their information on its website and mobile apps.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 5
However, these payments towards Zillow and Trulia represent less than
4% of the total advertisement expenditure that the real estate market invest
(CNN, Zillow buys Trulia for $3.5 billion, 2014). On the other hand, the
platforms have relatively low fixed costs, making the marginal variable
ones (mostly the development of the platform) almost negligible (Refkin).
2. Case Questions
a) Which company is getting the better deal and why?
The merger of Zillow and Trulia seems to be the best that opportunity in
the online real estate market. It can be seen as the beginning of market
consolidation and will create the biggest player by far in the market with
market share of visitors of 24% (inman, 2014) or 3.5 times the second
largest player (see Exhibit 1). This gives market power to the combined
player and will help to negotiate higher fees with agents. On the cost side,
significant cost avoidance can be reached due to economies of scale.
Exhibit 1 Slide 7 © WHU – Otto Beisheim School of Management, www.whu.edu
This deal creates a strong market leader 1.
Source: http://www.inman.com, Team analysis
Share of visitors
December 2013
Opportunity analysis
Market consolidation starts now � First mover advantage is important � Rumors about Trulia trying to acquire Move
(Realtor.com)
Zebra will be by far the biggest player � Dominate the market � Avoid competition with larger ones Other M&A opportunities were even less attractive � Highest synergy potential between Zillow
and Trulia � Acceptable range of visitors overlap
© WHU – Otto Beisheim School of Management, www.whu.edu Page 6
To find out who gets more of the deal, the contributions of each company
stand alone were analyzed and compared to the share of ownership in the
combined company. The data were taken from the management forecast
on stand alone basis in the SEC form S-4 (SEC, 2014), published by Zebra
HoldCo. In Exhibit 2 it can be seen that Zillow contributes roughly 60% of
revenues and 64% of EBITDA from 2014 till 2017 and Trulia earns 40%
revenues or respectively 36% of EBITDA in the same time horizon.
Exhibit 2
Looking at the market capitalization at the last day before the merger was
announced Zillow contributes 70% of the combined market capitalization.
The share of enterprise value of Zillow was at 71%, due to higher cash and
lower debt than Trulia. The unweighted average shows that Zillow only
contributes 62% but gets 67% of ownership. Nevertheless, a valid
argument would be that the capital market takes the market consensus of
the forecast into account and values Zillow higher and implicitly values
Slide 8 © WHU – Otto Beisheim School of Management, www.whu.edu
Future revenues/EBITDA vs. market capitalization
Sources: Zebra Holdco SEC form S-4, Team analysis
Revenue ($m) 2014 328
2015 516
2016 738
2017 971
Adjusted EBITDA ($m) 2014 53
2015 121
2016 208
2017 296
Market capitalization ($m) 6,400
Enterprise value ($m) 6,858
Visitors (m) 81.1
Attention on Google (index) 100.0
Number of agents (000) 56.8 Average revenue per user ($) 320.0
266
365
485
634
29
72
121
190
2,773
2,758
51.6
26.0
73.9
206.0
Zillow Trulia
Unweighted average
Ownership 67% 33%
62% 38%
1.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 7
the risk of Trulia’s future revenues and profits higher. Therefore, only
based on this analysis it cannot be said who made the better deal.
Furthermore, it has been analyzed how the forecasted operating synergies
were distributed among the shareholder of the combined company. The
data is based on the synergies of 2016, the first year with a significant
synergy effect. The total EBITDA consists of the contribution of both
companies stand alone and the synergies. It will be distributed to 67% to
former Zillow shares and 33% to former Trulia shares. Assumed that the
base of the distribution is the stand alone EBITDA, the difference to the
share of 67% respectively 33% is the part of the synergy allocated to each
former company. It can be seen that Zillow get 71% of the synergies
compared to a share of ownership of 67%. Trulia gets 29% of synergies
distributed to a 33% share of ownership. Exhibit 3 shows that Zillow gets
4%-pt. more ownership than synergies.
Exhibit 3 Slide 9 © WHU – Otto Beisheim School of Management, www.whu.edu
Zillow gets slightly higher share of synergies
Sources: Zebra Holdco SEC form S-4, Team analysis
Adj. EBITDA and synergies 2016
$m, according to management forecast
Zillow Trulia 1+1=2 Operating Synergies
1+1=3 Zillow’s synergy share
Trulia’s synergy share
29% of synergies
71% of synergies
208
121
329
320
649
435
214
227
208
121
93 33%
67%
Ownership
1.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 8
Taking that into account it seems that Zillow gets a slightly better deal
than Trulia.
b) Does the structure of the deal make sense for each
company?
The deal was structured as a 100% share deal. Trulia’s shareholder will get
0.444 shares of the combined company for each share. No further cash
premium will be paid. Based on the share prices of the last day before the
public announcement of the merger agreement Trulia’s shareholder will
receive a premium of 25%. The volume of the total deal amounts to
$3.5bn. The debt of Trulia will not be repaid.
Looking at the structure of the deal, it stands out that there is no cash
involved and the combined company is not levered any further. Looking
ahead that seems to be reasonable for two reasons. Firstly, cash is needed
to facilitate the organic growth of each company. In particular, building
stronger brands, develop the US online real estate market in terms of better
service to agents and buyer/renters as well as realizing the operating
synergies and do successful post merger integration. The second reason is
the ongoing market consolidation. The combined company will need to
take an active part in that and needs firepower to execute M&A deals
quickly. The process of issuing new shares can be too long to succeed in
acquiring companies, which are interesting to more than one player of the
market, especially when cash premiums come into play after the first offer
and another capital raise is needed.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 9
Both companies will operate under a holding company called Zebra
Holdco Inc. Both trademarks will remain in the market. That makes sense
to not lose the visitors visiting both sites. Nevertheless, it is likely that
certain departments will be shared to realize the estimated cost synergies.
Especially in the IT development and maintenance economies of scale can
be gained. The back-end of both platforms can be joined. Furthermore, all
administrative functions like HR or Investors Relations can be merged.
Looking it marketing costs, it can be argued, that both trademarks will
remain and there are no advantages of the merger. However, due to the
fact that the biggest competitor is gone, there is less need to advertise
against each other. Zillow and Trulia will focus und slightly different
market segments and thereby use their resources more efficient.
Considering the no cash deal and the organizational structure of both
companies, the overall deal structure makes sense and fits to the strategy
of the combined company.
c) What will the futures likely be for each company on a
standalone basis if the transaction fails to close?
Both companies, Zillow and Trulia have already entered into an
Agreement and Plan of Merger (“Merger Agreement”) (Zillow, 2014) and
thereby committed to pursue the merger of both companies. Considering
the termination regulations of this Merger Agreement, there is still the
possibility that the planned merger will fail to close.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 10
Analyzing all termination options in the Merger Agreement, such as
“mutual written consent (…)”, “if the Initial Effective Time shall not have
occurred (…)”, the case of the other’s companies’ “Board
Recommendation Change (…)”, the main risks can be seen in external
influences. There are chances that Trulia’s stakeholders do not approve the
deal and that an US Governmental Authority classifies this merger as
illegal. While the risk of a lack in Trulia’s stakeholder approval can be
assumed to be low due to the win-win situation both companies get as a
result of this merger, there is a realistic probability that the deal will fail as
antitrust authorities may state objections.
Under Zebra Holdco, Inc. both platforms are supposed to operate as
independent brands because “two brand appeal to a larger audience”, as
Spencer Rascoff, CEO of Zillow states. Fewer than half of Trulia’s
audience visits Zillow and two third of Zillow’s visitors visit Trulia (NBR,
2014). This supports the decision to keep the brands separated. However,
both players already are the biggest companies on the online real estate
market and Zebra Holdco would then cover 24% (inman, 2014) of all US
real estate website visitors as a sum of both independent platforms as
shown in Exhibit 4.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 11
Exhibit 4
In case antitrust authorities evaluate this market share as too large, such a
decision would impact the overall market, as M&A deals would be capped
to a market share at around 20%, which is in between Zillow’s current
share of 16% and the targeted Zebra Holdco share. Moreover, Trulia
would have much more negative effects if the deal does not close because
it is not allowed to acquire other companies or any debt to itself as long as
the Merger Agreement is still valid (NY Times, 2014). In the end, it all
would leave both companies on a stand-alone basis, leaving the market as
an oligopoly to be shared with the remaining largest players.
The stand-alone basis also takes its toll on the operative synergies that the
deal attempts to realize. The disappearance of the massive size of the
combined company would erase any major bargaining power that Zebra
Holdco would have, and also cost reductions achieved by economies of
scale on its value chain. It would also lower at some extent the relevance
Slide 11 © WHU – Otto Beisheim School of Management, www.whu.edu
Antitrust issues would impact the overall market
Source: http://www.inman.com, Team analysis
M&A deals capped to certain market share
December 2013
“Living apart together”
Antitrust issues on Zillow and Trulia Merger limit share of visits at ca. 20% � Oligopoly with 3-5 large players � Organic growth more important than
market consolidation � Economies of scale limited Adverse effect on Zillow’s and Trulia’s market valuation � Less operating synergies � Remaining big players � KPIs: Monetization of revenues due to
brand and service quality and management of cost basis
3.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 12
of further acquisitions that both companies may pursue and will leave
them with organic growth as the best alternative to increase their own
market share.
A further consequence of this scenario would be the necessity from the
companies to rely on the past perceptions the customers and agents already
had about them. This means that their brands and quality of service would
be the first most influential assets they will rely on after the merge attempt
to keep as the largest players in the market. Overall, a deal failure would
have adverse effect on Zillow’s and Trulia’s market valuation.
d) Based on the companies’ present combined market
valuations, what assumptions about their future
would you have to make in order to buy stock in the
combined company?
The combined market valuation of Zebra Holdco adds up to 9,173 m$ and
can is estimated by combining both the market capitalization of Zillow
(6,400 m$) and Trulia (2,773 m$). In order to buy stock in the combined
company, an increase in the share price must be expected. While there is
the argument that Zillow’s market capitalization alone with a price-to-
share ratio of 20 is already significantly higher compared to other internet
companies such as LinkedIn with a price-to-share ratio of 12, TripAdvisor
(12) and Yelp (16) (Barron's, 2014), there is the possibility of Zebra
Holdco’s share price increase under the following assumptions:
© WHU – Otto Beisheim School of Management, www.whu.edu Page 13
Assumption 1:
An increase in market size of the combined company will lead to
an increased EBITDA margin compared to Zillow and Trulia on
a standalone basis.
With the combined visitor share of 24%, Zillow and Trulia are 3.5 times
bigger than the then second largest competitor Realtor.com. Considering
the correlation between market position and the level of profitability of
other internet firms there is a high probability that Zebra Holdco’s share
price will positively influenced by an increased EBITDA margin as shown
in Exhibit 5.
Exhibit 5
Slide 12 © WHU – Otto Beisheim School of Management, www.whu.edu
Market position highly correlated with level of profitability
EBITDA margins up to 70%
Sources: capital IQ, company information, ZU analysis, Bertelsmann SE
4.
1x 3-5x 8-10x
5-30
30-50
50-70
100
Zillow
Immobilien Scout 24
rightmove.uk
REA Group
leboncoin.fr blocket
bytbil.com carsales.com.au
FINN seek
Jobindex
seloger.com
Auto Trader
Auto Scout 24
monster.com
Size versus second player
EB
ITD
A m
argi
n (%
)
Trulia
Zebra
Real estate platforms
© WHU – Otto Beisheim School of Management, www.whu.edu Page 14
The higher profitability is a likely result of higher synergies of scale and
operating synergies of 320 m$ as introduced above. It gives the combined
companies further growth potential, which potentially leads to investors’
phantasies about the optimistic future development of Zebra Holdco.
Assumption 2:
Three major drivers mainly influence share prices: Revenue,
numbers of visitors, number of agents registered
Exhibit 6 shows that both Zillow’s and Trulia’s share price development
was highly correlated to financial and operational figures from the
respective past quarters:
• Revenue
• Number of visitors
• Number of agents registered
Exhibit 6
It can be assumed that due to a stronger market position of both companies
all three parameters will increase leading to an increased stock price. This
development is supported, as both platform brands are to operate Slide 13 © WHU – Otto Beisheim School of Management, www.whu.edu
Online and mobile trend will help Zebra to realize synergies
98%
0
40
80
01.10.12 01.10.13 01.10.14 Q3/12 Q3/13 Q3/14
0
60
120
180
01.10.12% 01.10.13% 01.10.14%Q3/12 Q3/13 Q3/14
Zillow Trulia
98%
97%
Revenue (m$) 78%
90%
73%
Visitors (m)
Agents (000)
Share prices mainly influenced by three major drivers (correlations in %)
Sources: Zillow, Trulia, Bloomberg, Morgan Stanley, UBS
4.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 15
separately which reduces the risk of agent/visitor overlap elimination.
Furthermore, both platforms can introduce volume discounts for agents,
which motivate to place real estate listings on both platforms. This again
raises revenues. As further visitors are attracted by more comprehensive
real estate databases, this figure will most probably increase as well and
also drive revenues from third party advertisements on the Zillow’s and
Trulia’s websites.
Assumption 3:
There is a significant growth potential in the online real estate
market, from which Zebra Holco’s share price will very likely
benefit.
90% of US Americans begin their home searches online. In addition to
this, Zillow and Trulia currently cover only 4% of all US American real
estate agencies’ marketing spend, which is estimated at 12 bn$ per year
(CNN, Zillow buys Trulia for $3.5 billion, 2014).
The real estate market can be described as stable and the clear trend
towards online and mobile real estate search gives rise to further growth
opportunities for the combined company. In this context, Zebra Holdco’s
growth is strongly supported by the synergy advantages, e.g. when it
comes to the joint development of new smartphone apps and the marketing
of both platforms. This cost optimized approach in a growing market will
most likely result in a favorable stock price development.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 16
e) What trades, if any, would you recommend around
this transaction and why?
The merger transaction of Zillow and Trulia can be seen as the starting
point in the US American online real estate market consolidation. In order
to further exist on a competitive level, other real estate platforms are
forced to grow. As such a growth is organically not possible at the high
speed required, it can be assumed that other players will merge as well in
order to gain size from acquisitions.
Trading recommendation 1: Buy shares of Move, Inc.
The real estate website Realtor.com will become the second largest
platform visitor-wise in case the Zillow/Trulia merger succeeds. A clear
buying recommendation for the shares of Move, Inc., the operator of
Realtor.com can be formulated, as two scenarios seem likely:
(1) Zebra Holdco or another participant in the online real estate
market, such as Yahoo! Homes, acquires Move. In this case
Move’s share prices potentially increase due to a premium paid on
the share price by the acquiring company. Exhibit 7 shows
premiums, which have been paid on 638 technology M&A
transactions with a deal volume of >100 m$ and change of control
considered since 2004.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 17
Exhibit 7
(2) Move acquires another market participant. In this case, Move’s
share prices are likely to increase because of the company’s growth
potential with regards to increased revenues, visitors and agents
registered analogue to the correlations discussed above.
Trading recommendation 2: Buy shares of Wayfair LLC.
There are companies that might benefit from the online trend for real estate
searches. Exhibit 8 shows potential real estate buyers/renters needs along
the process chain. While Zillow and Trulia already cover the home search
process and act as a broker for mortgages, both can furthermore direct
customers to insurance companies and remover agencies or craftsmen
platforms, which are related to the process steps “close the deal” and
“move to new home”. These companies have the opportunity to advertise
Slide 14 © WHU – Otto Beisheim School of Management, www.whu.edu
Trading recommendation around the Zillow and Trulia Merger
Source: Zebra Holdco SEC form S-4, Team analysis
Significant premiums at technology M&As Benefit from online trend
Deal volume >$100m and change of control transactions considered
638 transactions since 2004
Home search
� Core business � Starting point for customer
Close the deal
� Act as mortgage broker � Offer insurance for new
home
Move to new home
� Remover agency service � Offer craftsmen platform
Home search
� Home improvement � Interior design � Online furniture shop
Trading recommendation: Move, Inc. Trading recommendation: Wayfair LLC.
5.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 18
on online real estate platforms and benefit from an increased marketing
coverage, as their target group, the home buyers/renters, can increasingly
be addressed on the real estate websites. This at the end might positively
influence revenues and growth of the third parties and lead to a share price
increase.
Exhibit 8
Wayfair LLC. covers a wide range of services in the process step “make it
your home”. The website Wayfair.com offers home improvement advices
and suggests interior designs. Furniture can be purchased online on this
website. Besides advertising on Zillow and Trulia, Wayfair LLC. could
enter into a cooperation with Zebra Holdco and e.g. offer a 5% welcome
discount to customers who contacted the real estate agent via Zillow or
Trulia. By doing so, Wayfair LLC. would also benefit from increased
growth potential and consequently rising share prices as discussed above.
Slide 14 © WHU – Otto Beisheim School of Management, www.whu.edu
Trading recommendation around the Zillow and Trulia Merger
Source: Zebra Holdco SEC form S-4, Team analysis
Significant premiums at technology M&As Benefit from online trend
Deal volume >$100m and change of control transactions considered
638 transactions since 2004
Home search
� Core business � Starting point for customer
Close the deal
� Act as mortgage broker � Offer insurance for new
home
Move to new home
� Remover agency service � Offer craftsmen platform
Make it your home
� Home improvement � Interior design � Online furniture shop
Trading recommendation: Move, Inc. Trading recommendation: Wayfair LLC.
5.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 19
3. Wrap-up
Recapitulatory, the merger of Zillow and Trulia will change the online real
estate market quite a lot. The strong combined company will use its
bargaining power and exploit economies of scales. Further consolidation is
likely will affect other companies significantly.
1. Which company is getting the better deal and why?
Zillow gets a slightly better deal based on market capitalization and share
of synergies.
2. Does the structure of the deal make sense for each company?
The structure makes sense because it facilitates further organic and
inorganic growth for both.
3. What will the futures likely be for each company on a standalone
basis if the transaction fails to close?
Antitrust issues may cause a failure and will lead to a living apart together
scenario with lower valuations.
4. What assumptions about their future would you have to make in
order to buy stock in the combined company?
Online and mobile trends remain strong and monetize; operating synergies
will be exploited as planed.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 20
5. What trades, if any, would you recommend around this transaction
and why?
Participate in further M&A deals and benefit from online trend in real
estate and related markets.
© WHU – Otto Beisheim School of Management, www.whu.edu Page 21
List of References
Barron's. (August 09, 2014). Zillow Shares Could Fall By Half. Retrieved October 28, 2014, from http://online.barrons.com/articles/SB50001424053111904329504580071503076700616
CNN. (January 29, 2009). Money & Main St. Retrieved October 26, 2014, from How a 'perfect storm' led to the economic crisis: http://www.cnn.com/2009/US/01/29/economic.crisis.explainer/index.html?_s=PM:US
CNN. (July 28, 2014). Zillow buys Trulia for $3.5 billion. Retrieved October 27, 2014, from http://money.cnn.com/2014/07/28/real_estate/zillow-buys-trulia-for-3-5-billion/
CNN. (July 28, 2014). Zillow CEO: Why Trulia is worth it. Retrieved October 28, 2014, from http://money.cnn.com/video/news/2014/07/28/zillow-ceo-trulia-deal.cnnmoney/
inman. (February 04, 2014). Visits to real estate websites surge 25 percent from December to January. Retrieved October 21, 2014, from http://www.inman.com/2014/02/04/visits-to-real-estate-websites-surge-25-percent-from-december-to-january/
NBR. (July 28, 2014). Why Trulia deal won’t fix Zillow’s stock for long. Retrieved October 29, 2014, from http://nbr.com/2014/07/28/why-trulia-deal-wont-fix-zillows-stock-for-long/
NY Times. (July 31, 2014). Deal Book. Retrieved October 26, 2014, from http://dealbook.nytimes.com/2014/07/31/in-deal-for-real-estate-listing-trulia-zillow-comes-out-on-top/?_r=0
Refkin, J. The zero marginal cost society.
Zillow, I. (July 28, 2014). Form 8-K. Retrieved October 21, 2014, from http://investors.zillow.com/secfiling.cfm?filingID=1193125-14-284607&CIK=1334814