Citadel Moves Into Zillow

 | Nov 30, 2012 | 2:00 PM EST
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According to a recently disclosed filing with the Securities and Exchange Commission (SEC), as of Nov. 19, Citadel Investment Group owned 1.6 million shares of Zillow (Z), a real estate website, which is best known for its "Zestimate" of property values based on a proprietary formula. This gives Citadel, which is managed by billionaire Ken Griffin and his team, more than 6% of the total shares outstanding. The fund's 13F filing shows that it owned about 440,000 shares of Zillow at the end of September, indicating that Citadel bought more Z shares in the last two months.

Zillow went public in July 2011, trading between $30 and $35 per share in the days after its IPO. Its stock price rose 82% in the first nine months of 2012, but plummeted in early November after the company reported that its internal estimates of revenue for the fourth quarter were below analyst expectations. Zillow currently trades at 150x trailing earnings, so any indication that its growth trajectory is slower than previously expected tends to have a powerful effect on the stock price. Griffin and his team seem to have taken the pullback as a signal to start buying.

Of course, Zillow has also been in the news recently upon buying HotPads. In pure financial terms, this isn't that big a move, as the $16 million acquisition price represents a small portion of Zillow's nearly $230 million in cash (and the company's $870 million market capitalization). However, it's somewhat significant because HotPads provides information on rental real estate; Zillow has historically been focused on homes for sale, and has begun expanding its offerings into rentals. Given the timing of Citadel's filing, most its shares seem to have been purchased before this move was made public. So it likely didn't play a role in the fund's decision, but any investors currently thinking of getting in should be aware of this recent development. Zillow has made a number of other acquisitions in 2012, including a mortgage software company and another rentals-focused site, RentJuice.

In late September, Citron Research -- a company which frequently publishes in-depth cases for shorting public companies it believes to be overvalued -- argued that Zillow's price would eventually fall to "single digits." Certainly the stock price has fallen considerably since that time -- from above $40 to $26 -- but given how bearish Citron's conclusions were, its arguments are still worth reviewing. In its report, the company pointed to strong insider selling, a business model dependent on phone marketing to realtors (with no public discussion of churn rate), and survey data suggesting that realtors don't consider Zillow as useful as in the past (among other factors). While we don't mind some degree of insider selling ( it makes sense for insiders to diversify their wealth away from the company where they earn their income), heavy selling is something to note.

In the third quarter of the year, Zillow reported that its revenues had increased 67% over the third quarter of 2011. This brought sales up 79% in the first nine months of 2012 compared to the same period a year ago. So, while revenue is growing rapidly, the growth rate is slowing down. Zillow approximately doubled its spending on sales and marketing. However, most other costs were held down and the company reported $2.3 million in earnings (or $0.7 per share). Annualized, that yields a price-to-earnings ratio (P/E) of 94. Cash flow from operations was up 60% in the first nine months of 2012 from its levels a year earlier. Analyst estimates for 2013 imply a forward P/E of 48, which is still high but would at least represent an understandable multiple for a fast-growing company. The stock is widely shorted: The most recent data show 7.6 million shares held short.

We wouldn't recommend Zillow to investors, at least until the company continues its earnings growth for a few more quarters and begins to look better in terms of its valuation multiples. Citadel's participation is interesting but the fund's position is dwarfed by that of short sellers. Zillow's business model and acquisition spree are well worth questioning at current prices.

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