Zillow is the premier online real estate portal. It was already the No. 1 player in the space, and it recently acquired its main competitor Trulia, which further strengthenedits grasp on the market.
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Zillow derives its revenue from two major sources: display revenue and marketplace revenue. While both have been performing extremely well, the percentage of total revenue is shifting drastically toward the latter. This is a very good thing for the long-term prospects of the company and the stock.
Revenue and user growth are what's important nowReal estate markets havetraditionally been highly fragmented and local. Consumers had little access to information, largely relying on the expertise of local brokers and realtors to give them access to the marketplace.
Zillow is in the process of massively disrupting this staid system, and its potential is immense. It must focus on ramping user numbers and revenue as quickly as possible. If it's successful, huge chunks of free cash flow will follow, and long-term shareholders will be rewarded.
Average monthly unique users growingZillow's success relies on a competitive advantage known as the network effect. In simple terms, buyers will go to marketplaces where there is the greatest amount of product available. Meanwhile, sellers will list their product where it will be viewed by the biggest number of potential buyers.
Once you have the most buyers and sellers together in one place, more of each will continue to congregate. This creates a virtuous cycle, making it extremely difficult for upstarts to break into the market.
Zillow has grown its average monthly unique users from 17.3 million in Q1 of 2011 to nearly 86 million in Q3 of 2014. This type of user growth provides the company with the juice it needs to grow revenue in two ways, and it is Zillow's most important metric during this period of rapid disruption and expansion.
Total display revenue growing as wellWith all of these eyeballs on its website, Zillow has the opportunity to sell advertisements, and it has done so very effectively. Display revenue has grown from $4.38 million in Q1 of 2011 to $15.95 million by Q3 of 2014. Display revenue was important as Zillow was building out the revenue stream that will drive it to even greater heights in the years to come.
Marketplace revenue now dwarfs display revenueDisplay revenue comprised nearly 39% of total revenue in Q1 of 2011. Even with the growth outlined above, this number had declined to 18% of total revenue by Q3 of 2014. This is because marketplace revenue has grown at an even greater pace. The largest component of marketplace revenue is subscriptions sold to real estate agents. Zillow sells "premier agent" memberships, which provide more leads and a preferred place on the screen next to home searches in that agent's zip code(s). The total number of these premier agents has grown from 10,710 in Q1 of 2011 to 60,877 in Q3 of 2014.
More potential homeowners and renters are drawn to search for their real estate on Zillow because of the availability of information, ease of mobile use, and volume of properties available. Agents feel the need to be on the site because their competitors are, and the nearly six-fold increase in premier agents over the past handful of years proves this point.
This is a recurring revenue model where once an agent is signed up, she will contribute revenue consistently to Zillow unless she decides to quit. There is no need for the company to start from zero every quarter and resell to previous customers. This is a powerful model. As growth slows and less is spent on advertising to acquire new agents, this revenue will drop to the bottom line.
Short-term pressure, long-term opportunityIn the last year, Zillow's stock price has fallen from a high above $155 to under $85, where it currently sits. It is integrating Trulia, has undergone a CFO departure, and remains unprofitable for the near future.
The short-term whims of the market often present long-term investors with good entry points into great companies. Zillow is one of these great companies, and if you think it can disrupt the massive U.S. real estate market, it might be worth taking a closer look.
The article Zillow Group Inc. Is Less Dependent on Ad Revenue, and That's a Good Thing for Shareholders originally appeared on Fool.com.
James Sullivan owns shares of Zillow Group. The Motley Fool recommends Zillow Group. The Motley Fool owns shares of Zillow Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.