On Tuesday, Zillow Group had a terrible, horrible, no good, very bad day.
After lowering its 2018 revenue projection, the Seattle-based listings giant watched its stock plunge around 15 percent. Nearly a dozen Wall Street analysts cut their price targets, and investors sold 18.7 million shares, compared to 3.7 million one day earlier.
CEO Spencer Rascoff went on Bloomberg TV and CNBC to defend his strategy to transform Zillow from a listings marketplace into an “end-to-end provider of housing-related services.”
Ironically, the company’s second-quarter revenue rose 22 percent to $325.3 million, and Zillow narrowed its losses to $3 million, compared to $21.8 million during the second quarter of 2017.
But Zillow’s rental business had a tough quarter, and its foray into home-buying and mortgage origination (announced Monday) has spooked some investors. After Zillow lowered its full-year revenue target to between $1.32 billion and $1.35 billion (compared to $1.43 billion and $1.58 billion), Wall Street balked. Analysts from Bank of America Merrill Lynch downgraded the stock, which opened at $50.04 per share on Wednesday — around 14 percent lower than Monday’s closing price of $58.15.
“Anytime the stock price declines like this, it’s painful in the short term,” Rascoff said Tuesday on Bloomberg, as he sought to minimize the damage. “It’s disappointing, but we think the long-term story is intact.”
Still, for a number of analysts — and shareholders — the second-quarter results were a wake-up call.
The stock experienced heavy trading on Tuesday, when 18.7 million shares were bought and sold, compared to 3.7 million shares a day earlier.
According to Shyam Patil of Susquehanna Financial Group, Zillow’s quarterly update “provided further evidence that the core [business] is struggling.”
In recent months, Zillow has diversified, in part, because revenue growth from Premier Agent, its lucrative agent advertising program, has been declining. In April, Zillow announced it would start buying and selling homes through Instant Offers (now called Zillow Offers); last month, it introduced tools for renters to find and pay for apartments online; and on Monday, Zillow said it would acquire a mortgage lender in the Midwest and would begin originating loans.
But in his Aug. 7 research note, Patil called the nascent Zillow Offers business a “low-margin and capital-intensive home flipping business.” And Bradley Berning, an analyst at Craig-Hallum Capital Group in Minneapolis, advised investors to “hold” the stock for that reason, citing the risks and “significant capital requirements” associated with the changing business model.
“We have been, and remain cautious on the impact of this new business to the earnings volatility, capital intensity and valuation,” Berning wrote. “Adding a mortgage business to help ‘subsidize’ the Homes business bidding to drive volume only adds another volatile, market-sensitive revenue stream.”
Merrill’s Nat Schindler — whose downgrade featured prominently in the stock’s downfall — expressed concerns that Zillow had shifted its business model from being a marketplace for agents and buyers to home selling and mortgage lending. “The quarter revealed challenges for multiple business segments that limit our optimism on FY19 upside,” he wrote in a note to investors. “Zillow is taking longer than expected to ramp up the Homes business.”
During Zillow’s earnings call, Rascoff said he thinks that the mortgage business could ultimately yield north of $800 million in revenue a year.
In fact, John Campbell, an analyst at Stephens, said Zillow’s second-quarter results essentially amounted to “growing pains” associated with Zillow Offers, after the company said it’s taking four to six weeks to close deals, instead of a couple of days, as originally projected.
“Some hiccups in the business triggered a large downshift guidance which is likely to spook some investors,” he wrote in a note to investors, in which he urged clients to buy Zillow stock. “We believe that this could be the first of several vertical integration efforts that come over the next several years.”
RBC Capital Markets Mark Mahaney conceded that Zillow Offers “carries VERY high execution risk,” but he also said: “The new growth opportunity that is Zillow’s direct participation in Instant Offers opens up the father of all TAMs” — the $1.7 trillion U.S. home-buying market.
Indeed, Mahaney said he thinks Zillow’s “expansion story is still well intact,” even if certain segments are moving slower than expected. He noted that Zillow’s stock dipped in 2015 after it acquired Trulia; the company that emerged as a stronger one. “We could see a repeat here.”