Zillow has taken a meaningful step toward its ambitious price transparency goal, which is a critical piece of the iBuying adoption puzzle. The company made it official that it will start standing behind the Zestimate as an initial cash offer to sellers in 23 markets. Honoring the Zestimate as an offer has moved from conceptual to testing phase. Not every home will be eligible, of course, as Zillow will initially limit the offers to a subset of homes it feels it can price accurately, likely in the $250,000-$350,000 range. Over time, the algorithms powering the Zestimate will improve, allowing the company to expand eligibility for Zestimate cash offers and win further trust with the consumer.
iBuying is nascent today, accounting for less than 1% of home transactions annually in the US. Over the next decade, we believe that number will reach 10% and, in the process, transform the current friction-filled home buying and selling process by offering a new level of convenience, price transparency, and liquidity.
We believe the live Zestimate cash offer is intended primarily for off-market homes, i.e., homeowners who have not listed their property on the market. While sellers who have already listed their home could pivot and sell to Zillow Offers, they would likely have to navigate a listing agent contract. Also, the live Zestimate will be an initial offer, not final, which is understandable given an in-person tour will be required before a purchase.
- Using the Zestimate as a live offer creates a direct link between Zillow’s large consumer audience and Zillow Offers winning iBuying volume.
- As Zillow uses the live Zestimate offer for brand and trust-building, the size of the spread between the initial offer and the final offer will have a material impact on the extent to which they are able to build trust.
Leveraging their large audience to win iBuying volume
Until now, Zillow’s 200m+ monthly active users have made for a great advertising business, yet it was unclear how Zillow Offers would benefit from the attention the Zillow app commands. Now, a casual user with their home off the market can see a live cash offer on their home, decide to accept it right in the app, and enter the iBuying process. Said and done, Zillow will have acquired a customer for next to nothing. This negligible customer acquisition cost, at scale, should lead to higher margins, which will translate into better offers on homes, leading to more volume and driving the flywheel.
The branding opportunity behind the Zestimate
At first glance, there appears to be risk for Zillow in standing behind the Zestimate to accurately price and profitably exchange homes. In reality, that’s a manageable risk because there will be a human inspection before a final offer. The reason Zillow needs to get the Zestimate right is for brand and trust building. If they’re making initial live Zestimate offers and following a human inspection, material changes are made to the final offers, consumer trust will be eroded. Conversely, if they are essentially honoring the Zestimate with a final cash offer, consumer trust will increase.
The question is whether off-market Zestimates are accurate enough today. While there are nuances in deciphering Zestimate accuracy data, we’ll approach it from a high level. There are roughly 100m off-market homes for which Zestimates are available. Based on Zillow’s reported historical accuracy, we believe around 8% of these can be priced within +/- 1% of the home’s sale price. Putting it together, that gives Zillow Offers a live Zestimate addressable market of 8m homes. For perspective, Zillow purchased 4,162 homes in 2020.
How the live Zestimate changes the iBuying process
Absent a live Zestimate offer, here’s what the typical Zillow Offers process entails today:
A live Zestimate essentially allows homeowners to skip steps 1 and 2. If said homeowner is pleased with the live Zestimate offer, they will save the time, hassle, and money of hiring a realtor and appraiser. While Zillow is clear that the Zestimate is not an official appraisal, as it continues to be refined over time we believe it will move closer to that status. Step number 3, the human inspection element, will remain in place to ensure Zillow is giving sellers a fair final offer. While this human backstop will likely be a part of the iBuying process for the foreseeable future, as the Zestimate is honed and consumer trust in it grows, the need for human inspection will diminish, ultimately moving toward “Zestimate as a final appraisal.” This will result in cost savings for Zillow, that will, in turn, lead to better offers for sellers.
The success of a SPAC, as defined by investing in a good company that offers strong long-term returns on capital, depends entirely on the sponsor.
In our current market, it seems like any sponsor can raise a few hundred million dollars. While some may question the sustainability of that trend, we think capital available to SPACs will stay high over the foreseeable future. SPACs are essentially a risk-free trade with a near-term arbitrage opportunity dependent on market excitement about the sponsor and a longer-term opportunity for dynamic upside depending on the target acquisition. In a choppy market where investors are concerned about a bubble, it’s arguable that such a risk-free trade would only become more desirable.
When the fervor around any and all pre- and post-transaction SPACs eventually calms and premiums offered to those issues become more rational, we expect the market to embrace the necessity of quality sponsors to capture the dynamic upside potential of a SPAC investment. Capital will remain available to SPACs in the future, but it will accrue to the best sponsors just as capital always accrues to the best investors.
So, what makes a good sponsor?
We think good SPAC sponsors have four qualities, particularly as it relates to bringing venture-style tech companies into the public market:
- An understanding of investing in companies early in their lifecycles.
- An ability to help public investors understand the potential of the company and its technology.
- An ability to raise the profile of a small cap company, grounded in near-term realism and long-term possibility.
- An ability to attract good companies. It is the first three that enable this last one.
Good sponsors understand early lifecycle companies
Since SPACs offer the unique advantage of talking about forward projections where traditional IPOs can only talk about past performance, SPACs are well suited to bringing venture-stage companies into the public markets, and we’ve previously described SPACs as public venture capital. As such, we expect the majority of SPACs to be used for companies earlier in their lifecycle than traditional IPOs. Good sponsors need to possess the skillset to assess early-stage companies where intangibles are often more instructive than tangibles.
While all investors public and private look at team as a factor for investment, team is particularly important in venture investing. Public investors often define good management teams by past execution and delivery on financial performance, something not readily available for earlier-stage companies. Good sponsors must know how to assess emerging managers as part of deploying SPAC capital, particularly the ability of management to convey vision, develop technology, hire a strong team, and deal with greater volatility in the business than might happen in a more mature company.
Beyond management, good sponsors also need to be able to assess the company’s technology on two major planes: feasibility and market desirability. This can be a challenging equation. If auto experts were to offer a feasibility assessment of Tesla in its early days, they would likely have been fairly negative on Tesla’s ability to bring down battery costs, improve range, and build cars at scale. Of course, they would have been terribly wrong. Good sponsors need to avoid backing companies with obviously weak or flawed technology, but the best investments often come from places where experts believe something impossible. Extraordinary results always come from the consensus impossible becoming possible.
On market desirability, good sponsors need to have a strong view of how the target acquisition’s technology can help create a future to which we’re already moving or to blaze a trail to a future that no one even sees yet. The latter case is always the rarest find in investing, whether public or private.
Good sponsors help public investors understand the long-term opportunity
Investing in the public markets is a different game than investing in the private markets. Public marks can create wild swings in asset valuations that private markets don’t suffer from (at least visibly), and liquidity gives public investors the ability to exit positions at any time where private investors are locked into the assets they buy. These dynamics create shorter-term performance demands on public investors relative to private investors, which often results in shorter-term investment theses. Good sponsors must understand these unique demands from public investors and help the acquisition company anchor their long-term vision with investors to create a stable base.
Despite the short-term performance demands of the public markets, there is a strong desire for long-term growth opportunities. Everyone wants to find the next Tesla or Facebook to own for a decade. Good sponsors should be able to credibly explain why public market investors should believe in the long-term growth potential of their investments and frame how to measure progress along the way in an effort to navigate short-term market demands.
Good sponsors bring exposure to their companies
Over the long-term, great public companies that consistently execute and ultimately deliver strong earnings always earn investor attention and fair market valuations. In the short term, public investors are trying to figure out which companies are going to be great and allocate capital appropriately.
Since most new SPACs will be smaller cap companies with limited investor attention, good sponsors should help to bring short-term attention to the companies they acquire. Short-term attention can be beneficial because for a small cap company it may result in a valuation higher given greater demand for shares. Higher valuations create optionality for the company in terms of raising additional capital on attractive terms or using stock as a currency to make strategic acquisitions.
Higher valuations may also create a higher bar for performance, but if the company and sponsor do a good job anchoring a stable investor base on the long term as described in point two, the company should be offered some flexibility on quarterly demands so long as progress is made toward the long-term vision. A company that doesn’t perform over the medium to long term is going to suffer multiple compression and abandonment no matter what, so we believe maximizing optionality in the nearer term as a way to potentially accelerate the company’s progress is worth any short-term pressure. This is a venture mindset applied to the public markets — use all levers to create dominant positions in nascent markets.
It’s important to note that exposure doesn’t mean pushing a stock price beyond reason. Exposure should come with a rational view of near-term price activity given long-term potential. If near-term speculation gets out of hand, we believe good sponsors should try to temper markets as well. A sponsor that develops a reputation for pumping up companies well beyond reason will quickly be recognized as a bad sponsor.
Good sponsors attract good companies
Companies considering a SPAC will come to realize that the marketing component of being a public company is where sponsors can add the most value. If a sponsor can understand early-stage company dynamics, help position a long-term vision with public investors, and bring attention to the company, that sponsor should attract good companies, creating a virtuous cycle of good sponsors marrying good companies.
We can invert the duty of a good sponsor to create a fifth rule: Good sponsors should help public investors avoid bad companies. Investing in venture-stage companies is not the domain of most public market investors. It requires unique analytical skills, a strong vision for the future, and a stomach for potential volatility before valuations can be tied to tangible output. Reputation matters in all things, and as good sponsors build a reputation for helping position good companies in the public markets, those sponsors will operate as the gatekeepers of public venture capital.
Annual shareholder events tend to be uneventful, with the exception of the Q&A session. This year, Apple fielded 17 questions, six of which we deemed noteworthy. The bottom line is the company remains in a favorable position to continue to capitalize on the accelerating digital transformation. Despite the recent market pullback, our long-term $200 view on shares of AAPL remains unchanged.
Here are the key questions and our takeaways:
“What are the ways in which Apple is diversifying its supply chain?”
Apple’s response: The company had little to say with the exception of reiterating its commitment to contribute $350B to the US economy.
Our takeaway: Absent was any language about diversifying the supply chain away from China. While other countries will play a bigger role down the road, the shift away from China will move at glacial speed.
Regarding M&A, “Are there any acquisitions in the future?”
Apple’s response: Cook noted that they made about 80 acquisitions through the 2015 and 2016 period, and from 2017-present they’ve made 17 acquisitions.
Our takeaway: Of course they’re not going to answer this question. Regarding historical M&A, not all acquisitions are created equal, so there are limited insights from the step down in M&A pace. Our takeaway is Apple likely feels confident with internal innovation. We don’t see any mega acquisitions as likely over the next few years.
“Are you worried about regulation forcing a change to the App Store business model?”
Apple’s response: Cook acknowledged that regulatory scrutiny is reasonable and that “Apple doesn’t have a dominant position in any market we compete in.”
Our takeaway: Apple has done the best out of Big Tech in navigating the regulatory threat by making proactive changes to the App Store. While not out of the woods, they’re on track to emerge largely unscathed.
“Why don’t you increase your dividend more?”
Apple’s response: The company said they “plan annual dividend increases.”
Our takeaway: While there was no commentary about share buybacks, we expect the company to maintain its historical cadence of increasing dividends and buybacks when they report their March quarter. Investors don’t fully appreciate the positive significance of Apple returning to net cash neutral. The company ended December 2020 with $84B in net cash.
“What will the impact of new stimulus measures be on the business?”
Apple’s response: Cook took the high road and focused on the stimulus’ purpose of helping people and would not speculate on the impact to Apple.
Our takeaway: We expect Apple will receive a small benefit in 2021 from consumer stimulus spending. We believe this is already reflected in the Street’s 21% y/y growth estimate for FY21.
“What do you see as the most challenging obstacle ahead for 2021?”
Apple’s response: Cook said, “I don’t see obstacles so much as opportunities,” and highlighted the degree to which the Apple teams rose to the occasion last year as an indication that the company is prepared to handle whatever comes its way.
Our takeaway: From a product or competitive standpoint, we don’t see Apple being impacted by major obstacles in 2021. From an investment perspective, a continued rotation out of Big Tech would weigh on shares. Even if that happens, we expect investors to return to Apple given its foundational position in the future of tech.