Zoopla Property Group listed on the stock market on the 18th June. It’s an opportune time to review that company and its main competitor, Rightmove, because you can read the IPO prospectus of the former on the web. A prospectus always discloses more information than you will normally get although Rightmove is also quite open with information.
These two companies are the gorillas in the on-line property advertising market with Rightmove being larger in size but Zoopla apparently growing more rapidly. In their financial years ending in 2013, Rightmove had revenue of £139m and Zoopla had revenue of £64m. Pre-tax profits of the former were £97m and the latter were £28m. Rightmove revenue was up 17% in 2013 while Zoopla was up 80% but the latter was probably boosted by acquisitions.
Both these businesses look quite mature in the sense that they both have very comprehensive and similar web site functionality, and have signed up a very large proportion of estate agents in the UK. Smaller competitors have been squeezed out or taken over in recent years. Internet businesses tend to develop into natural monopolies because the largest and most well known businesses have enormous economies of scale – being the first mover also helps a lot. One might expect the market to form a cosy duopoly in due course, although a third upstart is going to try to get into it later this year (see below).
As a result both Rightmove and Zoopla are highly profitable and cash generative. Rightmove has been returning a lot of cash to shareholders via dividends and share buy-backs – for example buybacks of £31m in the first four months of this year alone. With high profits, and little opportunity for expansion (overseas markets are not particularly open apparently), Rightmove seems to have taken a position of returning cash to shareholders while Zoopla has been more aggressive in trying to capture market share. It is noticeable of late that Zoopla seem to be spending a lot more on advertising in traditional media to gain market awareness in end users of these web sites, but the prospectus also commits them to paying a high proportion of earnings out in dividends (between 35% and 45% of profits – see page 60 of the prospectus).
As already noted though, both companies have signed up a very large proportion of UK estate agents who typically use one or other, and often both services, to promote the properties they represent. Zoopla are charging about £300 per month on average to each “Member” as they call their agency clients to list properties, so you can see the cost per property is not large. In relation to the other overheads of running an estate agency, it must be relatively small. Rightmove typically charge substantially more but claim proportionally more “page views” are generated.
There is still room for expansion of revenue by taking advertising spend from the more traditional print media used by estate agents. Only about 50% of agents promotional spending is on these internet services and is still growing. Those looking for houses almost certainly use them as the main search medium when actively looking for a new home, so the more traditional media are becoming of secondary importance. The other opportunity for revenue growth is if property transactions rise. They are still nowhere near the peaks achieved in 2006/2007 according to the Land Registry.
Zoopla has more than one web site/brand – Zoopla itself, PrimeLocation and some other more specialist sites. It is not clear what the logic is behind this – perhaps it is for historic reasons.
As regards the valuations of these businesses Zoopla listed at 220p (the share price has not moved much since then at the time of writing). With earnings per share last year of 5.3p that puts them on a historic p/e of 42, which is certainly not cheap. But Rightmove is not cheap either – a historic p/e of 29 on the current price of 2140p. Needless to point out to existing Rightmove shareholders perhaps that Rightmove used to be more highly rated but has fallen back in recent months. It reached a peak of 2775 in February so has fallen by 23% since. Whether this is because of the Zoopla listing, or because of more competition appearing, or because a lot of highly rated internet stocks have fallen back is difficult to determine.
These businesses are highly rated of course because they are still growing rapidly, have a high return on capital, good cash generation, no debt and great barriers to entry. They have a great ability to increase charges to agents, and hence profit margins which are already high, much to the chagrin of some agents. When you get a duoply, as the market now appears to be, there is a natural tendency for them not to compete on price.
But this has prompted a new entrant into this market backed by a number of high-end estate agents. This will be called Agents Mutual and was planning to launch in September this year, but is now scheduled for January 2015 according to their web site. They clearly intend to focus on competing on price, i.e. providing a cheaper service to agents. But whether they will be able to drive sufficient internet users to their new web site to look for property when Rightmove and Zoopla are already well established in people’s minds seems questionable. As far as the end users are concerned, the site that has the most properties listed (and hence from the most agents) is always going to be the most attractive. They might have a very tough task ahead of them. In the meantime though they might evoke competitive responses from Rightmove and Zoopla that may reduce their profit margins in the short term.
How this will play out remains to be seen. But it is odd that even two players can be successful in this market. Zoopla’s recent growth to get near to Rightmove’s market position is surely down to Rightmove not reacting to competition but continuing to return cash to shareholders rather than using it to protect their market position. But a third market participant of significance seems to be unlikely if the existing incumbents react appropriately.
In the meantime Rightmove looks cheaper on the fundamentals than Zoopla unless you wish to hedge your bets on these sector players. But with Zoopla being apparently more aggressive than Rightmove and a new market entrant coming, there is clearly some uncertainty that is undermining the share price of Rightmove. Only the normal enthusiasm for IPOs which are often talked up by the promoters probably enabled Zoopla to list at the price that was obtained.
Also bear in mind that although most of the existing shares in Zoopla were placed (with no new money raised), over 28% are still held by DMG Media Investments Ltd (part of Daily Mail and General Trust) and Atlas Ventures still have a 6% stake. They may in due course wish to dispose of those holdings. A 28% stake does of course give substantial influence over the affairs of the company (and would be sufficient to block an unwanted takeover for example).
For existing Rightmove shareholders, there does not seem great merit in moving to Zoopla unless you lack confidence in the management of the former. Whether new investors should buy the shares in either company at this time probably depends on your attitude to highly rated “growth” stocks in general and at this time in the stock market cycle; and your view of the likely outcome of market battles in this sector.
Roger Lawson 28/6/2014 (note: the author has a holding in Rightmove).