The Real Deal National

The “Big Short” investor that bet against subprime has a new target: Zillow

Steve Eisman, who famously shorted the subprime market, has his sights set on the listings giant
By Rich Bockmann | July 24, 2019 08:00AM

Left to right: Former Zillow CEO Spencer Rascoff, Zillow CEO Rich Barton, and Steve Eisman (Credit: Getty Images and JD Lasica via Flickr)

Left to right: Former Zillow CEO Spencer Rascoff, Zillow CEO Rich Barton, and Steve Eisman (Credit: Getty Images and JD Lasica via Flickr)

In “The Big Short” – the 2015 film about the financial crisis – actor Steve Carell plays a character based on noted short seller Steve Eisman, who made hundreds of millions of dollars betting against collateralized debt obligations laden with subprime residential mortgages.

In real life, Eisman is now a portfolio manager at the investment management firm Neuberger Berman, where today he’s shorting companies like Barclays and TD Bank.

But one of his largest short positions is in the Zillow Group, which Eisman believes has run out of new ideas to grow its stagnating home-listing business.

“Basically what was happening was Zillow got to a very large size for its platform. Growth was slowing dramatically,” he told The Real Deal. “I thought there was a lot more competition for the platform and so I thought the growth in the platform was really just going to continue to slow.”

Betting on slow growth

Zillow, which declined to comment through a spokesperson, hit Wall Street with much fanfare in 2011, when its stock price more than doubled on the first day of trading from its initial public offering price of $20 per share. At the time, the national housing market was still in the nascent days of a stubbornly slow recovery from the Great Recession, and there was plenty of runway ahead of the Seattle-based listings platform.

Zillow went on to acquire StreetEasy for $50 million in 2013 and Trulia for $3.5 billion the following year, and investor confidence in the growing company pushed its stock higher. But as time went on, revenue growth began to slow: In 2015, Zillow recorded revenues of just shy of $645 million, a 98 percent jump over the previous year. Last year, however, the company saw revenues grow just 24 percent from the previous year to about $1.3 billion.

And the slowing growth hasn’t gone unnoticed on Wall Street. Zillow’s stock price spent the back half of 2018 in a nosedive after peaking at slightly more than $65 per share in mid-July.

That’s where short sellers like Eisman see opportunities. In its simplest form, a short is a bet that a company’s stock price will be worth less in the future. The short investor borrows stock when it’s high and then sells it when the stock drops – the difference between the two prices is all profit.

But so far this year, Zillow’s stock price has recovered some of the losses it saw in 2018 as investors get behind what the company believes is its next big growth opportunity: the Zillow Offers home-flipping platform. The company replaced CEO Spencer Rascoff in February, tapping Rich Barton to spearhead a full repositioning from a model largely dependent on advertising revenue paid by real estate agents to margins on house-flipping and mortgage originations.

In June, Atlanta-based SunTrust bank initiated coverage on Zillow with a “buy” rating, estimating a potential 40 percent revenue growth over the next seven years from the iBuyer program.

The company is scheduled to report second quarter earnings on Aug. 7. The high end of its guidance puts year-over-year revenue growth at nearly 83 percent.

Ben Schachter, an analyst at the Macquarie Group investment bank, said Zilow is “clearly a company in transition” from one that relies on its traditional listings platform to push revenues to one betting that the iBuying model is its future.

“If you’re bullish on the stock, you’re really bullish on the iBuyer model,” he said. “I think a big execution challenge is, can they make that model work while trying to turn around the core business that had slowed? In our view, the opportunity is there but the execution is not going to be easy.”

What Tesla might tell us about Zillow’s future

Zillow is one of the most shorted stocks out there right now.

Investors had shorted $1.27 billion worth of Zillow stock as of late June, according to Nasdaq. That put Zillow in the top 30 short positions by dollar volume.

But as a percentage, the Zillow short position is up there with what Elon Musk calls “the most shorted stock in the history of the stock market.”

Short positions in Zillow accounted for 21.7 percent of the company’s “float” – or the total shares of the firm’s stock that are available to trade. That puts Zillow in the same neighborhood as Musk’s Tesla, which has about 35 percent of its float shorted.

The reason so many are bearish on the company is because earnings from its main line of business have ground to a near-halt. Premier Agent, Zillow’s flagship program that charges agents a fee for advertising, accounted for 67 percent of its revenues last year – a level of concentration that makes the company extremely vulnerable to even small decreases in advertiser spending.

Premier Agent posted less than 2 percent year-over-year growth in the first quarter of 2019. And even by its best estimate, Zillow’s own guidance puts Premier Agent growth at less than one percent for the second quarter.

So the company is betting it can drive revenues through Zillow Offers, which it launched in April 2018. Zillow isn’t necessarily looking to make money on the values of homes that it purchases rising, but on the 6 to 13 percent fee it collects from sellers, as well as ancillary lines of business like mortgage origination and title insurance.

The cost of scaling homebuying

Zillow sold 414 homes in the first quarter of 2019, but when costs like purchasing and marketing the homes were factored in, Zillow Offers lost $45.2 million. And bearish investors like Eisman say it’s a ticking time bomb that will explode if the housing market cools and Zillow is left with a large inventory of unsold homes on its books.

That would, of course, be a windfall for his short.

“In a recession, you’re going to get your head handed to you,” he said. “I think that was an admission by the company that their basic business was faltering or slowing and they needed to seek alternatives to jump-start the growth.”

In the meantime, Barton told investors on the company’s most recent earnings call in May that Zillow is leaning into the early success of Zillow Offers.

“Despite the bear spying at the empty garbage cans in our backyard, one must only look in the front yard to see something astounding happening,” he said. “I know we still have much to prove to you before the fog is fully clear on Zillow Offers.”