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Zillow GroupNASDAQ: Z, ZG

Recommendation: Buy

Dane Williams

Buying and selling a home sucks…

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…but it doesn’t have to

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Investment Thesis

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Recommendation:I am recommending a BUY for Zillow Group (Z, ZG), because they have a massive competitive advantage in the emerging online direct home buying industry, which sets them up for substantial long term growth.

Price Target: $48.02

37% upside to current price of

$35.11 (ZG)4.

Revolutionize the home

buying experience

1. Strong core internet business with lots of data

2. Launch of Zillow Offers

model for buying and selling 3. Acquisition of

Mortgage Lenders of America

Rationale:Zillow’s strong core business of providing online information about homes and acquisition of Mortgage Lender’s of America puts them in a position to simplify and control the entire home buying process with their new Zillow Offers business. Ultimately, Zillow is at the forefront of an emerging market which opens up an entirely new source of revenue.

Company Overview

5Sources: Zillow 10K

Company Profile Historical Stock Chart Since IPO

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Volume Adj Close

Total Revenue By Year (millions)Revenue Breakdown (3 Months Ended Dec. 31 2018)

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Rentals

Mortgages

Other (1)

Homes segment

• Zillow Group, Inc. was founded in 2006 in Seattle by Richard Barton and Lloyd Frink, who are former Microsoft executives and co-founders of travel website Expedia

• Specializes in the end to end lifecycle of owning and living in a home: buying, selling, renting, financing, remodeling, etc.

• Zillow.com, along with Zillow’s other subsidiary’s are the leading online real estate platform

• In August 2016, Zillow Group split into Z and ZG, with C shares trading under the old Z ticker and A shares trading under the new ZG ticker

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Industry Overview

6Sources: Bloomberg, Redfin, Statista, Zillow 10K4

Internet Real Estate Overview “iBuying” Overview

• Websites geared towards online real estate marketing –provide information about homes and rentals to prospective buyers

• Partner with realtors in order to assist them with tools that help in marketing homes for sale, finding renters, finding buyers, etc.

• “Kelly blue book of homes”

• AVM – Automated Valuation Model, “Zestimate”

Value of the US Real Estate Sector (Trillions) Real Estate Website Market Share Buy Users

• Tech companies “flip homes” – no realtor necessary• Tech company gives an instant all cash offer to prospective

sellers, usually for 75-100% AVM value of the home• Ex. 1 million dollar home, iBuyer offers 85% value

of home and a 7% repairs fee as opposed to 6% in agent commissions

• Advantage to seller is no worrying about repair costs, seller concessions, or potential mortgage and rental overlaps

• Given an offer as fast as INSTANTLY, no open houses

• iBuyer then sells home at a fixed algorithmic price

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11%Zillow*Trulia*HotPads*Yahoo! Homes**RealtorRedFinHomesOther

*Zillow Group Subsidiary, **Powered By Zillow

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Zillow Group Brands

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Consumer Brands:

Business Brands:

Business Model

8Sources: Zillow 10k

Premier Agents

• 61% of revenue for Q4 2018

• Suite of marketing and business technology tools for real estate agents and brokers

• Offered on a cost per impression basis

• 1 impression = 1 sold advertisement appearing on a page viewed by a user on mobile or website

Rentals

• 10% of revenue• Advertising

services sold to property managers or other rental professionals

• Offered on a cost per lead, cost per click, cost per impression, or cost per lease generated basis

• Also includes revenue from StreetEasy brand on a cost per listing basis

Mortgages

• 6% of revenue• Primarily

advertising sold to mortgage lenders and other mortgage professionals

• Sold on cost per lead basis

• Revenue generated by Mortech –subscription based mortgage software pricing engine + leads

New Revenue (Homes)Old Revenue (IMT)

Other12%

• New construction – advertising to home builders; cost per residential community basis

• Display – graphical mobile and web advertising sold to advertisers promoting their brands on mobile app + website

Mortgages

• Q1 of 2019 will divide revenue into 3 segments – IMT, Mortgages and Homes

• Includes all revenues from MLOA acquisition on October 31st 2018

• MLOA -mortgage originations as well as sale of mortgages on secondary market

Homes

• 11% revenue• Zillow Offers,

formerly Instant Offers

• Buying and selling homes –“flipping” homes

• Began buying homes in April of 2018

• Began selling homes in July of 2018

1. Strong Core Internet Business + Data

9Sources: Statista, Zillow Group 10k, National Association of REALTORS

Dominates Internet Real Estate Market Share Leverage Data Advantage

Mobile Advertising Spending In The U.S. (Billions)

• Zillow brands control 65% of internet real estate traffic

• In 2019 U.S. real estate agents and brokers will spend 8.3 billion in residential advertising, and real estate developers will spend 715 million

• Greatest amount of web traffic = greatest amount of data on customers and their preferences

• Room to grow into international markets

• “Zestimates” on over 100 million homes in the US can be used for effective iBuying

• Ability to use data to personalize the home buying and selling experience

• Provides unmatched data on homes to customers, helping people make informed decisions

• Zillow’s data is relevant to buyers, sellers, renters, homeowners, agents, and other professionals

• Data as a foundation for new products

$31.7$46.7

$60.7$75.0

$90.3$105.3

$118.9$131.4

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Unique Users and Visits by Quarter (millions)

2. Zillow Offers

• Increasing consumer choice – convenience• Analogous to Netflix entering original

content• Capital intensive, but demonstrates

significant potential for Zillow to provide better service to customers and generate more revenue

• Increase total addressable market

10Sources: Crunchbase, Statista

Emerging Market Logical Next Step For Monetizing Data

• iBuying is a new practice in the real estate industry

• In 2018 the aggregate transaction value of homes in the U.S. was $1.8 trillion

• Real estate commission revenue was $87 billion

• Creating an entirely new category of real estate -> disrupt industry

• Zillow has access to capital and data which will allow them to scale better than competition

Redfin

• Significantly less data• Only 5% of real estate

traffic• Late to iBuying

market, fewer locations

Opendoor

• Private• Only an iBuying

company à lacks core internet + data

• $325M in series E funding June 2018

• $1.7B valuation

Knock

• Private, even smaller and younger than Opendoor

• Weak name recognition

• $400M in series B funding January 2019

Competitors Cannot Compete With Zillow’s Massive Real Estate Database

2. Zillow Offers

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Zillow HQ, SeattleRedfin HQ, Seattle

Opendoor HQ, San Francisco

Knock HQ, New York City

3. Mortgage Lenders of America

12Sources: Statista, 2018 Q4 Earnings Call

End to End Real Estate Platform• Involvement in all aspects of home ownership while

streamlining the process• Positioning Zillow as the go to company for all

things related to real estate• Expands on Zillow’s role in mortgages

• Previously offered technology to mortgages lenders with Mortech

• When an agent brings a buyer to a Zillow owned home, the transaction can close more quickly and with greater certainty

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Home Purchase Refinancing Improvements

Purchase Volume of Mortgages in the United States from 2015 to 2017, by type (in millions)

Edge Over Other Real Estate Tech Companies• Redfin, Opendoor, and Knock do not own a

mortgage lender• Prevents competitors from offering as

seamless of an experience as Zillow• Adds another part of the home buying transaction

process which Zillow can simplify• Zillow is focused on not just the selling piece to

iBuying, but the purchasing aspect as well• MLOA purchased for integration w/ Offers program

• Like payments integrated in Uber

4. Revolutionize Home Buying Experience

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Amazon: Invent and Simplify -Leaders expect and require innovation and invention from their teams and always

find ways to simplify […] As we do new things, we accept that we may be misunderstood for long periods of time

Dominate Market Share

Proprietary Data

Invent and Simplify

Traditional SaleZillow Offers SaleHome Sale Process

Preparations:Showings:

Time:

Offer:

Cost:

Just request offer online

Zillow home evaluation

Choose your closing date

Cash and done

Potential service fee for repairs

Repairs, cleaning, staging, etc.

Open houses, schedule around showings

List for weeks or months + 30 days to close

Risk of sale falling through

Buyer and seller agent commission, rent or

double mortgage, seller concessions

Key Risks

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û Mortgage lending can have many associated risks; little data on MLOA past performance as it is a new acquisition

û Potential real estate market slow down

û Increase in millennial home buying: 34% to 36% of home buyers from 2017 to 2018 –> negative impact on premier agents rentals

û Transition to instant offers – lack of experience buying and selling homes

Key Risks Mitigants

ü Adding a mortgage lender to the Zillow Group portfolio is a necessary step in providing seamless home related services

ü The ibuying model is designed to work in any real estate market – does not require homes to be increasing in value in order to turn a profit

ü While premier agents rentals may take a hit, PA homes will benefit, and Zillow Offers is targeting millennials who are most willing to adopt “uberized” home buying

ü ibuying is a new concept to all of Zillow’s competitors as well and Zillow has IMT business to fall back on in case of issues with Zillow Offers

Sources: National Association of Realtors

Final Recommendation

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Base Case

Price Target: $48.02Upside: 27%

Recommendation:I am recommending a BUY for Zillow Group (Z, ZG), because they have a massive competitive

advantage in the emerging online direct home buying industry, which sets them up for substantial

long term growth.

Appendix

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Valuation – Comparable Companies Analysis

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Valuation StatisticsMarket Enterprise EV / Revenue EV / EBITDA Price / Diluted EPS

Company Ticker Capitalization Value 2018A LTM 2018A LTM 2018A LTMRedfin Corporation RDFN $1,724 $1,409 2.6x 2.8x NM NM NM NMeXp World Holdings, Inc. EXPI $661 $643 2.5x 1.5x NM NM NM NMRE/MAX, LLC RMAX $677 $443 1.6x 2.1x 3.2x 4.6x 42.7x 84.6xTripAdvisor, Inc. TRIP $7,067 $6,480 4.3x 4.0x 39.1x 27.6x NM NMNetflix, Inc. NFLX $156,796 $163,361 10.4x 10.4x 134.0x 97.4x 214.1x 254.8xZillow Group, Inc. ZG $7,647 $6,940 5.1x 5.2x 66.3x 275.8x NM NM

25th Percentile $669 $543 2.1x 1.8x 3.2x 4.6x - -Mean 33,385 34,467 4.3x 4.2x 58.8x 43.2x 128.4x 169.7xMedian 1,724 1,409 2.6x 2.8x 39.1x 27.6x 128.4x 169.7x75th Percentile 81,931 84,921 7.4x 7.2x 134.0x 97.4x - -

Operating StatisticsRevenue Revenue Growth EBITDA EBITDA Margin

Company Ticker 2018A LTM '17-'18A LTM 2018A LTM 2018A LTMRedfin Corporation RDFN $487 $487 32% 82% ($35) ($35) -7% -7%eXp World Holdings, Inc. EXPI $500 $500 - 834% ($21) ($21) -4% -4%RE/MAX, LLC RMAX $213 $213 10% 21% $97 $97 46% 46%TripAdvisor, Inc. TRIP $1,615 $1,615 4% 9% $237 $237 15% 15%Netflix, Inc. NFLX $15,794 $15,794 35% 79% $1,688 $1,688 11% 11%Zillow Group, Inc. ZG $1,334 $1,334 24% 58% $25 $25 2% 2%

25th Percentile $350 $350 5.3% 15.1% ($28) ($28) (5.8%) (5.8%)Mean 3,722 3,722 20.1% 205.0% 393 393 11.9% 11.9%Median 500 500 20.7% 78.9% 97 97 10.7% 10.7%75th Percentile 8,705 8,705 34.2% 458.1% $963 $963 30.2% 30.2%

Valuation – WACC

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Capital StructureDebt-to-Total Capitalization 10.57%Equity-to-Total Capitalization 89.43%

Cost of DebtCost of Debt 2.47%Tax Rate 20.60%

After-tax Cost of Debt 1.96%

Cost of EquityRisk-free Rate(1) 2.52%Market Risk Premium(2) 5.00%Levered Beta 1.28

Cost of Equity 8.92%

WACC 8.19%

Debt Outstanding Amount Interest rate % of Total Weighted2.0% Convertible Senior Notes Due 2021 $395 2.000% 46.5% 0.9%Convertible Senior Notes Due 2023 295 1.500% 34.7% 0.5%Convertible Senior Notes Due in 2020 10 2.750% 1.1% 0.0%Revolving Credit Agreement With Credit Suisse AG 117 5.860% 13.8% 0.8%Warehouse Lines of Credit - Facility 33 4.730% 3.9% 0.2%Total Debt $849 2.5%

Current Share Price $35.11Current Shares Outstanding 204.6Equity Value $7,183.51Total Debt $849Total Equity $7,183.51

Valuation – DCF (Base)

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FYE December 31, FYE December 31,($ in millions) 2015A 2016A 2017A 2018A 2019E 2020E 2021E 2022E 2023E 2024E 2025ETotal Revenue $644.7 $846.6 $1,076.8 $1,333.5 $1,876.5 $2,376.1 $2,845.5 $3,237.5 $3,605.0 $3,893.2 $4,123.8

Revenue Growth -- 31.3% 27.2% 23.8% 40.7% 26.6% 19.8% 13.8% 11.4% 8.0% 5.9%

ExpensesCOGS 60.1 69.3 85.2 153.6 372.6 581.0 766.9 896.8 1,011.7 1,104.5 1,186.5

Gross Profit $584.6 $777.3 $991.6 $1,179.9 $1,503.9 $1,795.1 $2,078.5 $2,340.7 $2,593.3 $2,788.7 $2,937.3 Gross Margin 90.7% 91.8% 92.1% 88.5% 80.1% 75.5% 73.0% 72.3% 71.9% 71.6% 71.2%

SG&A (excl. SBC) 387.9 607.5 545.4 665.7 1,032.1 1,188.0 1,365.8 1,521.6 1,658.3 1,751.9 1,814.5

R&D 184.5 255.6 320.0 410.8 523.2 578.2 625.8 679.0 722.8 773.4 785.0

Operating Expenses 572.4 863.1 865.4 1,076.5 1,555.3 1,766.2 1,991.6 2,200.6 2,381.1 2,525.3 2,599.4

Operating Income (EBIT) $12.2 ($85.8) $126.2 $103.4 ($51.4) $28.9 $86.9 $140.1 $212.2 $263.4 $337.8 EBIT Margin 1.9% (10.1%) 11.7% 7.8% (2.7%) 1.2% 3.1% 4.3% 5.9% 6.8% 8.2%Income Tax Expense (24%) (4.6) 0.1 (89.6) (31.1) (12.3) 6.9 20.9 33.6 50.9 63.2 81.1

EBIAT $16.8 ($85.9) $215.8 $134.5 ($39.1) $22.0 $66.1 $106.5 $161.3 $200.2 $256.8

Cash FlowPlus: D&A 75.4 100.6 110.2 99.4 139.9 173.5 199.2 216.9 234.3 245.3 251.6

Discretionary Cash Flow $92.2 $14.7 $325.9 $233.9 $100.8 $195.4 $265.3 $323.4 $395.6 $445.4 $508.3 Less: Increase in NWC 0.0 (4.7) 17.4 (239.4) (113.2) (93.5) (103.3) (83.0) (74.5) (57.8) (38.4)

Less: CapEx (52.7) (62.1) (66.7) (66.1) (93.0) (117.8) (141.0) (160.5) (178.7) (193.0) (204.4)

Free Cash Flow $39.5 ($52.1) $276.6 ($71.6) ($105.5) ($15.9) $20.9 $80.0 $142.4 $194.6 $265.5 Free Cash Flow Growth -- (232.1%) (630.5%) (125.9%) 47.3% (85.0%) (231.9%) 282.1% 78.2% 36.6% 36.4%

Unlevered Free Cash FlowWACC 8.19%Discount Period 0.5 1.5 2.5 3.5 4.5 5.5 6.5

Discount Factor 0.96 0.89 0.82 0.76 0.70 0.65 0.60

Present Value of Free Cash Flow ($101.4) ($14.1) $17.2 $60.7 $100.0 $126.2 $159.2

Valuation – DCF (Base)

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Enterprise ValueCumulative Present Value of FCF $347.8 Terminal ValueTerminal Year Sales $4,123.8 Exit Multiple 4.2x

Terminal Value $17,178.2 Discount Factor 59.95%

Present Value of Terminal Value $10,299.1 % of Enterprise Value 96.7%

Enterprise Value $10,646.9

DCF Implied Equity Value and Share PriceEnterprise Value $10,646.9

Less: Total Debt $848.6 Plus: Cash & Cash Equivalents $1,554.9

Implied Equity Value $11,353.2

Implied Share Price $55.49

Shares Outstanding 205

Comps Implied Equity Value and Share PriceEnterprise Value $5,555.1

Less: Total Debt $848.6 Plus: Cash & Cash Equivalents $1,554.9

Implied Equity Value $6,261.4

Implied Share Price $30.60

Shares Outstanding 205

Method Weight PriceComparable Companies 30% $30.6 DCF 70% $55.5

Fair Value Estimate $48.02

DCF Sensitivity AnalysisWACC

55.49 6.2% 7.2% 8.2% 9.2% 10.2%2.2x $34.92 $33.06 $31.32 $29.70 $28.18 3.2x $48.57 $45.90 $43.41 $41.08 $38.91

EV/Sales 4.2x $62.21 $58.73 $55.49 $52.46 $49.64 5.2x $75.85 $71.57 $67.57 $63.85 $60.37 6.2x $89.49 $84.40 $79.66 $75.23 $71.09