BAM Key Details:

  • After conducting a forensic review on Zillow, Spruce Point Capital has published a report detailing its strong sell investor opinion on Zillow Group, Inc. 
  • The report breaks down five key reasons for the 40-60% long-term downside risk Spruce Point sees for Zillow stock values. 

On Tuesday, March 5, 2024, Spruce Point Capital announced a strong sell investor opinion on Zillow Group, Inc. The research opinion is based on the investment management firm’s full review of Zillow, taking its history and current challenges into account. 

Spruce Point founder and Chief Investment Officer Ben Axler did not mince words when he discussed the firm’s report in a CNBC news segment

The report and his overview focused on five key reasons for the firm’s belief in a long-term downside risk to Zillow stock values of 40% to 60%, with share prices falling to $23–$35.

Byron Lazine reviewed the report and the CNBC interview on today’s Hot Sheet and disputed a few points. We’ll include some of his comments here, but watch the full podcast below to hear the complete breakdown and his response to Spruce Point’s research opinion. 

Read on for the highlights. 

Overview of the Spruce Point report

Spruce Point Capital Management, LLC (“Spruce Point” for this article) is a New York-based investment management firm focusing on forensic research and short-selling. 

This week, they issued a report titled, “Zillow’s Sinking Foundation,” which explains in detail why they believe Zillow stock values face a long-term downside risk of 40% to 60%. 

The table of contents below lists out the main points: 

Spruce-Point-report-TOC-image

Included in the report is a Q&A interview with an unnamed former Zillow senior executive. Here, we’ll focus on the reasons for Spruce Point’s strong sell opinion as well as where Byron Lazine disagrees with Spruce Point founder Ben Axler. 

#1— “Zillow Is a Mature Business with a History of Failures”

Among the key points listed in a press release, Spruce Point included its assessment of Zillow as “a mature business under increasing pressures with recent failed growth initiatives that illustrate management is incapable of innovating and delivering on goals as Zillow quietly retracts 2025 revenue targets.”

Speaking of those failed growth initiatives, Spruce Point founder and Chief Investment Officer Ben Axler mentioned, in a CNBC news segment, Zillow’s failed iBuyer experiment. From there, he discussed Zillow’s “super housing app,” and how he sees that newest development playing out: 

Ultimately, we think that’s going to fail, and you don’t need to take our word for it…So, we think this is a company that has generally disappointed and will continue to disappoint in the future.

Ben Axler

Founder and Chief Investment Officer for Spruce Point Capital

Byron offered some clarification on the super housing app and Zillow’s progress toward making their platform the one-stop shop for all things housing-related: 

The super housing app is what Zillow’s been talking about for quite some time, and they’re making the claim here, Spruce Point Capital, that it’s going to fail. Now, Zillow has been talking about the super housing app coming, coming, coming, and then, in the last six months, Zillow has said, “The super housing app is here. It’s called Zillow.” So, some people were confused. They were waiting for a new app. And what Zlilow’s saying is, “No, we’re building Zillow as the super housing app. We’re building everything into it.”

Byron Lazine

#2—Zillow’s business model is in the crosshairs of commission litigation

Another point Axler brought up in the CNBC interview was the legal pressure real estate brokerages are under with commission lawsuits and the DOJ proposal to decouple commissions. 

He argued that the outcome of these lawsuits poses significant risk to Zillow’s revenue, since their business model relies heavily on buy-side real estate commissions.  

Their biggest customer basically is buy-side real estate brokers. And the real estate brokerage industry is under some legal pressure. So, the National Association of Realtors just lost a lawsuit that could decouple commissions between buying brokers and selling brokers. Ultimately what that means is we think brokerage commissions are going to come down, the amount of capital to real estate brokers to pay for advertising on Zillow is going to be reduced. And that’s ultimately going to pressure their revenue and earnings outlook.

Ben Axler

Founder and Chief Investment Officer for Spruce Point Capital

Byron acknowledged that some of the data Spruce Capital could draw upon to make their conclusions is freely available online. But he questioned whether the firm had made a significant investment in ground-floor insights from agents with first-hand, daily experience with what Zillow brings to their business. 

This was to drive home the point that, as Byron put it, in order to get the deep insights they would have needed for a reliable investment opinion, Spruce Point would have had to offer more than what many agents are offered by investment firms in exchange for their time. 

The agent that values a $100 Amazon gift card to trade [their] time, is probably not the agent that has the insights you’re looking for….that may not be the ground-floor data that you want.

Byron Lazine

As a Zillow Flex Partner, Byron’s insight into Zillow’s programs and its continual drive to innovate makes him question Spruce Point’s conclusion that legal pressures and actions from the DOJ could ultimately lead to significant losses in stock value for Zillow. 

Spruce Point sees a struggle ahead for Zillow as it adapts its business model to changes in the U.S. real estate industry. It sees Zillow stock values plummeting long-term to $23 to $35 a share.

As of today, Zillow’s stock is up over $55 a share. 

#3—Homes.com is a rising (and often underestimated) threat to Zillow’s dominance

Axler also mentioned Homes.com and CoStar as a significant, though often overlooked, threat to Zillow’s position in the industry. He touched on CoStar’s massive new ad campaign which started with four Super Bowl ads for Homes.com

Axler implied that this competition has already affected Zillow’s bottom line: 

Ultimately, page views on the site are going down, revenue for Premier Agents [is] going down…. 

We think, ultimately, there’s been more competition. And one of the biggest stories, now, is CoStar, which is a company three times the size of Zillow…You may have watched the Super Bowl. They’re unleashing a billion-dollar advertising campaign with multiple ads, so Zillow’s core business is under pressure. The regulatory regime for their customers is under pressure. Ultimately, the stock trading at six times revenues we think should compress down to a low growth 2-3 times multiple to reflect low single-digit revenue growth.

Ben Axler

Founder and Chief Investment Officer for Spruce Point Capital

Byron noted, however, that it makes sense that page views would go down in today’s market. Mortgage applications are decreasing, and the number of properties selling remains low. So, it makes sense that page views on Zillow would go down as well.

Asked whether he considered M&A optionality a risk to Spruce Point’s short, Axler responded in the negative. Byron agreed, pointing out that there’s really only one obvious entity that could acquire Zillow, and that’s CoStar. 

I agree with Ben. This isn’t the time that somebody would come in and try to acquire Zillow. I don’t think that’s on the table in any fashion. You have a CEO who’s a founder. And founders are typically going to fight tooth-and-nail on an acquisition.

Byron Lazine

#4—Zillow’s aggressive accounting practices enable premature revenue claims

Axler brought up Zillow’s Flex model as a pivot for the company that could ultimately compromise its ability to bring in enough revenue to justify current stock values. 

So, traditionally, they’ve sold a lot of advertising leads. But now, what they’re doing is giving these leads away to brokers and getting paid if they convert on a closed sale. So, that’s a different proposition. And we think…there just aren’t enough trained brokers for them to convert. They’re not disclosing what percentage of these are converting. And most importantly, they’re booking revenue when they distribute these leads even though they may never convert these leads into revenue. So, we think there’s earnings quality issues there.

Ben Axler

Founder and Chief Investment Officer for Spruce Point Capital

Byron took issue with Axler’s assumption that there aren’t enough trained agents to get the kind of lead conversion Zillow depends on to make its Flex model work. 

He knows what he’s talking about on their model—the Flex model—which is now where Zillow takes 40% on a closed commission….. Here’s where I definitely think he’s got something wrong: …he says (he doesn’t) believe there are enough trained agents in America’ to take on the leads that Zillow’s providing. 

Zillow accounts for about 3% of total transactions, closed transactions, across the U.S. And they want to get that to 6%… Ben Axler doesn’t believe there are enough well-trained agents in America to account for 3% or 6% of total closed transactions? That’s ludicrous….

Byron Lazine

#5—Spruce Point has concerns with Zillow’s governance and shareholder alignment

Axler didn’t discuss this point in the CNBC segment, but the Spruce Point report brings up its concerns with Zillow’s shareholder alignment—or, allegedly, the lack thereof:

“Through ownership of the Company’s 10-1 voting Class B shares, Zillow’s co-founders Rich Barton and Lloyd Fink have total voting control. In the aftermath of the Zillow Offers disaster in 2021, approximately $8 billion of shareholder value was destroyed yet executives came away largely unscathed. In fact, executives even received compensation increases.” 

Spruce Point also detailed its concerns regarding Zillow’s governance and executive compensation structure: 

“We also find it concerning that executive compensation is not tied to financial performance and Zillow does not have any formal clawback policy that would enable the Company to recoup compensation given to executives in the event of a financial restatement. Spruce Point believes the voting control paired with exceptionally long-tenured directors has effectively turned the Company’s Board into a “good old boys club,” especially because four of Zillow’s seven independent directors have been on the Board since 2005.” 

Read the full report for more. And don’t miss Byron’s point-by-point response on the Hot Sheet