Are Zillow investors better off without iBuying?

In 2018, first real estate market Zillow ( Z -0.70% ) (ZG -0.70% ) embarked on a new strategy dubbed Zillow Offers, where he started buying his own homes. Fast forward about three years and a few billion dollars in home purchases later, and the company is now shutting down the initiative entirely.

Since the announcement of this liquidation in the fall of 2021, Zillow stock has fallen more than 57%. But with the Zillow offerings about to come out, investors might actually be better off. Let’s see why.

Quit iBuying

Before we get into Zillow’s future prospects, it’s worth understanding why Zillow exited the home buying business in the first place.

Streamlining the end of Zillow offers during the Q3 2021 conference call, CEO Rich Barton said, “Put simply, our observed error rate has been much more volatile than we ever would have. conceived.” In other words, the value of homes acquired by Zillow strayed too far from the company’s estimates. This hurt Zillow’s profitability and increased its balance sheet risk, as home values ​​could swing wildly.

But price uncertainty wasn’t the only reason iBuying hurt Zillow. Zillow’s core business (everything except Zillow offers) generates revenue through its online marketplace, where it helps people discover and move into new homes. As the premier destination for real estate search, Zillow needs to maintain a strong brand in the eyes of consumers.

Zillow Offers, however, was beginning to put that brand at risk. 90% of Zillow’s offers on homes were rejected by sellers, suggesting that Zillow was damaging its reputation with many homeowners. This has raised concerns that homeowners may be less likely to adopt Zillow’s other products in the future.

While it’s now pretty obvious that Zillow’s entry into the iBuying space was a mistake, the resulting pivot wasn’t all bad. For starters, management said in late 2021 that the winding down of Zillow offerings was going better than expected. Zillow has already sold or entered into contracts to sell 85% of the homes in its inventory. And the company even now expects to generate positive cash flow following the liquidation. Now Zillow has racked up more than $2 billion in losses that it can carry forward to help offset some of its future taxes.

What’s next for Zillow?

Despite the frantic run by the company and its shareholders over the past year, Zillow’s marketplace was still home to 198 million unique users in the fourth quarter, and the company’s name continues to be synonymous with the real estate market. Not only does Zillow have more than three times the daily app users of its closest competitor, but according to Google Trends data, more people search for the term “Zillow” than “Real Estate”.

From this large user base, the company can generate revenue in several ways. The biggest way Zillow makes money is through its “Internet, Media and Technology (IMT)” segment. Within IMT, Zillow leverages its vast marketplace to connect potential buyers or tenants with real estate agents; in return, Zillow is compensated by the agents.

Over the years, Zillow has added additional products, such as closing services and home loans. Still, IMT represents just under 90% of Zillow’s business once you exclude its shuttered iBuying unit.

It looks like this IMT segment is a solid business on its own. IMT generated approximately $1.9 billion in revenue and $545 million in pre-tax profit in 2021, up 30% and 107%, respectively, from the prior year.

As Zillow continues to shut down its home offers business, the profitability of Zillow’s remaining operations should become more evident.

Is Zillow a buy?

Since announcing the closure of its iBuying segment, Zillow’s market capitalization has fallen more than 50% and now stands at $11.8 billion. While it’s hard to rate Zillow on eventual earnings, given the losses in the Zillow offerings segment, the total market capitalization is roughly equal to just over 20 times the pre-tax earnings of its IMT segment.

All of this means that investors today essentially get the same growing, industry-leading market as before, but now with less balance sheet risk and greater profitability. As a bonus, Zillow stock is now trading at a significantly cheaper valuation. For investors who have considered Zillow in the past, now seems like an opportune time to buy stock.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.