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Dec 8, 2016

S3 BLACKLIGHT: Zillow’s Increasing Shorts May Be Indicating a Housing Slowdown

Real estate e-commerce provider Zillow Group Inc. C share’s (Z US) stock price is up 58% on the year and its A shares (ZG US) are up 44% on the year as the strong real estate market increased clicks on their many websites. According to its CEO Spencer Rascoff, Zillow and its subsidiaries control between two thirds and three fourths of the online real estate market.

Zillow’s stock price climbed recently on their announcement of a $400 million capped call convertible bond which will be used to pay off the existing debt on their Trulia acquisition, and to increase its already dominant sector market shares through investment in internal growth and modernization, and for potential outside acquisitions. Zillow recently reported positive 3rd quarter earnings showing a profit of $0.04/share versus analyst expectations of a loss of $0.02/share. While recent revenue growth was strong, both net income and cash flows were underwhelming.

Zillow has two main revenue streams, advertising from realtors and brokers as well as advertising from housing peripheral providers in sectors such as furniture, electronics, cable, and construction. If, like some analysts propose, the U.S. housing market is peaking due to recent overbuilding, and mortgage rates continue to rise in anticipation of an increase in the Federal Funds rate, Zillow’s two major revenue streams may be impaired. Short sellers have been increasing their positions in both the A and C shares since the end of October.

There is still ample stock available to borrow in both these securities, but borrow rates are starting to increase as short interest levels are nearing historical highs of $1,041 million in Z US and $511 million in ZG US. Borrow rates are in the 1.00% to 1.25% fee range and are poised to run higher as short demand continues. Stock borrow rates when Zillow hit its historical short interest highs in September-October of 2015 were around the 13% fee level for Z US and the 25% fee level for ZG US.

Investors buying or selling Zillow are making an indirect wager on the U.S. housing market and ultimately on a broad based U.S. economic recovery. Zillow’s website clicks are dependent on the turnover of domestic housing, and those clicks turn into advertising dollars. If President-elect Trump’s policies jumpstart a 1%-2% increase in GDP, the resulting prosperity will bolster the domestic housing market and send Zillow’s revenues soaring. If short interest stays at these levels or continue to climb, short sellers are looking for a short term weakness in the housing market. A decrease in Zillow’s short interest would be a signal that the housing market is poised for another recovery and short sellers are getting out of the way of a resurging U.S. economy.

For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC     Ihor.Dusaniwsky@S3Partners.net
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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