CoStar is down -9% after posting 3Q24 earnings.

Analyzing CoStar is tricky because not only do they have 6 distinct segments, they are constantly acquiring new companies and are not afraid to aggressively invest in them, which causes distortions to profitability.

Let’s start at the top. Revenues grew 11% y/y. This is their 54th consecutive quarter of double digit growth, or basically every quarter since exiting the financial crisis. Their total revenues of $693mn came in at the low end of their guidance of $692-697mn.

The two largest segments are “CoStar” and Multifamily, which houses their Apartments.com platform among other apartment websites. Each generates over $1bn annually. Their next most meaningful segment is LoopNet, followed by their Information Services segment. As shown below, LTM revenues are currently $2.67bn.

The CoStar Suite.

CoStar revenues were up +10% y/y, but slightly decelerated from last Q (10.4% vs 10.1%).  

It is worth pointing out that as CoStar moves legacy STR customers (hotel data business they acquired) to their CoStar benchmarking product, it moves revenues from the information services segment to CoStar. If you adjust for this, then core CoStar is growing closer to low to mid-single digits.

However, they moved some of their sales force from CoStar to Homes.com for the short-term and are just now returning those sales reps. This is in addition to increasing sales headcount (adding 100 reps to each CoStar, LoopNet, and Apartments.com).

Also explaining the lackluster growth is the macro backdrop. They note that since 2020 it has been the worst commercial market in a generation. Nevertheless, their renewal rate has stayed steady at 93% and they note that NPS scores are at all time highs. Lastly, they imply that as commercial values “reset” with $930bn of loans coming due in ’24, that CoStar will see increased activity and value to the client.

Other Stats:

• On their recently launched lender product, CoStar disclosed they are run rating $50mn in revenue against a TAM of $400mn.
• Launched new institutional client focused product for owners and lenders
• CoStar activity increased 29% y/y
• New high of 164k distinct log-ins in September (240k subscribers vs >230k last Q)

Multifamily.

Multifamily revenues were up +16% y/y and they note they are on track for $1.1bn for the full year or +17% y/y. This is very strong, especially on the back of a strong 2023 when they did +23% y/y growth (2022 was +10% y/y).

They also showed signs of successfully penetrating the smaller unit apartment complexes. If you recall, they have typically been strongest with apartment community owners and 100+ units, whereas Zillow has commanded the smaller unit apartments. On this call they noted “record inventory” in the house, condo, townhouse listing below 20 units.

Part of the more unspoken benefit of the homes.com acquisition is it can help them gain small unit supply. The same way many small apartment owners listed their apartments on Zillow despite it being primarily for single homes, homes.com can bring a similar benefit.   

They now have 75k paying customers on the network and over 10k are in the 5-50 units range.

LoopNet.

LoopNet revenues grew +5% y/y, a deceleration from last quarter’s growth of +6%. Paid listing are up +4%. They note that they had 6x the traffic to their nearest competitor, which is Crex, but we would not be surprised if that figure is embellished.  

They continue to focus on expanding LoopNet internationally after several acquisitions that they brought under the LoopNet brand. They note in the UK they have 2x the traffic of the nearest competitor and 4x in Canada.

Residential (Homes.com)

Despite the residential segment being only 4% of current revenues, what happens to this segment tends to drive the narrative of CoStar.

It shouldn’t be forgotten though that they have only been investing heavily in this platform for about a year, but as Andy notes below, this is a multi-year endeavor.

They continue to invest heavily into Homes.com, noting that the early part of 2024 was a very intensive investment period. YTD they have delivered over 15bn TV ad impressions, run more than 25k commercials, and generated over 80bn digital ad impressions. All of this has boosted unaided awareness from 4% a year ago to 33%. For reference, today Apartments.com is at 67% unaided awareness and they noted that when Apartments.com was at the same point in its journey they were at only 20% unaided awareness.

On NPS for consumers they note that it has climbed from 44 to 75 in less than a year. Homes.com had 85mn monthly unique visitors, a 38% y/y increase.

The thing to keep in mind when it comes to homes is that it is a very infrequent purchase, so every time someone starts a homebuying journey they essentially are coming without any habits. While Zillow has a leg up because of their increased brand awareness and the fact that many people like dream home browsing on Zillow, but when you actually go to buy a home you will want to check more than one site.  

Homes.com advantage comes when an interested buyer tries to reach out to learn more about the home. In Homes.com case, the buyer is connected to the listing agent who is more knowledgeable about the home and can immediately answer any questions. In the case of other sites like Zillow though, they are still connected to a buying agent who knows nothing about the property and will have to inquire on their behalf. You can imagine if the same home is listed on both sites, that a consumer could prefer homes.com since they can talk to someone whose actually been to the home and knows it.   

Furthermore, if you want to tour a home with a buying agent, you now must sign a contract first. This is likely to add more friction to the process as buyers could be uncomfortable committing to a buying agent before seeing a home. (Prior to the NAR settlement, the buying agent didn’t need a contract to show a home, so that friction point wasn’t there). With Homes.com, if you are trying to schedule a home tour online you may do so directly with the listing agent without the need for a contract prior. This is not to say that a buyer will not eventually have a buying agent represent them, but just that forcing that “marriage” right up front drives friction.

As a reminder, they monetize Homes.com with advertising subscriptions instead of selling buyer leads. This quarter they disclosed that members listings are viewed 46x more than non-members listings, which may sound more impressive than it really is. All that means is they prioritize listings that pay them. Nevertheless, they also noted that members win 50% more listings than non-members. NPS for member agents climbed 35 points since just May.

On sales agents they have 113 working with another 79 in training. Given the low number of sales reps they had in homes.com, they moved reps from other divisions to prioritize homes.com. This is now being undone as they fill out their homes.com pipeline.

(An unrelated observation is that this may disempower divisional managers who want to run their business autonomously from other business lines and not have the CEO jump in and commandeer resources).

Andy Florance estimates that as they increase their sales force to 600, they could add $142mn in annualized billings each year.

However, as we see below, annualized run-rate subscription revenue actually fell slightly q/q from $68mn to 66mn, showing that despite their best efforts they are having some friction to growing adoption.  

Nevertheless, as he noted in 1Q24, Homes.com started off with a really strong start so some of the reversal could be a byproduct of the fact that they sold the product really well, ahead of actually making the product really good.  Which isn’t exactly a positive, but it is still early innings.

The macro could also be a factor: September homes sales dropped to their lowest level since 2010. Although the impact to Homes.com is a little unclear: higher prices might push buyers away, making the need to advertise a home increase, or the less inventory could mean it is easier to stand out, reducing the need to market the home.

Other Updates

Before we move down the P&L from revenue, there are a few other comments:

First, they announced the acquisition of Visual Lease. They are rumored to have paid $272mn. From their press release:

“The strategic acquisition is expected to enhance CoStar Group’s Real Estate Manager business line and provide additional lease management and accounting services to current Visual Lease customers. CoStar Real Estate Manager, used by large enterprise-level customers, providing vital lease administration reporting and compliance services, ensuring seamless workflows between real estate and accounting teams.

By combining CoStar Group’s resources with Visual Lease’s diverse customer base, best-in-class customer retention, deep lease portfolio management expertise and a user-centric design, we’re well positioned to offer a more comprehensive service offering and continuing growth, growing both nationally and internationally in this segment.”

Second, Andy Florance gave a short update on the economy.

• Offices prices are down -18% y/y and -43% below their market peak (and that does not account for inflation which would increase these figures).
  • All time high vacancy rates in office, but optimistic that is starting to turn.
• Multifamily prices are down -11% y/y and -25% off of their peak.
  • Multifamily absorption was 174k, double last years levels and near record levels seen in 2021
  • New Construction continues to outpace absorption, and vacancy remains elevated at 7.9%
    • 720k new units under construction
• Industrial and retail are down only -5% from peak.
• Commercial real estate economy is starting to show signs of a recovery, from what they believe is likely a cycle bottom.
• Average residential mortgages are down 170bps y/y, but many homeowners having locked in very low rates, which has kept inventory very tight and prices high.

Third, on guidance:

• Annual revenue guide $2.72- 2.73bn, +11% growth at midpoint
  • Slightly down from last Q guidance of $2.735- 2.745
  • Noted reflects a lower residential guide
• 4Q revenues of $693-703mn, +9% y/y growth at midpoint
• Annual EBITDA guide $205-215mn, +5% at midpoint
  • Range increase $10mn from last Q
  • 4Q EBITDA $76-86mn, +5% at midpoint
• Non-GAAP EPS of $0.67-0.69 for full year 2024, based on 408mn shares
  • Doesn’t include acquisition dilution

Profitability.

They note “The early part of 2024 was our most intensive investment period into Homes.com. The profit margin of our commercial information and marketplace businesses remained strong, increasing to 43% in the quarter.”

While we do not know how that 43% figure is calculated, no doubt their underlying economics are much better than the GAAP figures we see below. Their EBITA margin for 3Q24 was just 5%. This compares to 24% for 2022. One of the key differences is S&M which was 48% of revenue (down 510bps q/q), compared to 31% for 2022.

They note that they will continue to invest heavily, but do not expect to increase the cadence. Overtime advertising expense is going to be replaced by sales force expenses.

Business Commentary.  

Big picture, core CoStar revenue growth has been struggling. After adjusting out STR and backing out the impact of new product growth, it is likely only low to mid single digits. This isn’t a criticism though, given how bad the commercial end markets have been. And in fact, it speaks to the diversification of the product, value it provides, and ability of management to continue to add new modules to the product that they were able to grow at all and retain 93% of their customers.

Homes.com looks like it slowed down despite an incredible amount of resources spent on it, which leaves investors questioning whether the fall will accelerate when S&M is pulled back from market-saturating 80bn impressions. Annualized bookings dropping slightly q/q from $66 to $68mn, despite the increased focus of the sales force, which adds further investor concerns that this business won’t be a breakout success like apartments.com.

However, these are myopic thoughts. The success or failure of homes.com isn’t going to be dictated in a few quarters and by and large, things are trending positive for homes.com as they are still progressing ahead of where apartments.com was at the same point in their business turnaround cycle.

We will say that it is a little odd the shuffling of sales force personnel around different divisions for such a short period.  Andy notes they are less productive because they don’t know the product and it comes at the cost of sales of other products, which leaves a question as to why do it in the first place. He’s done this in the past with LoopNet and Apartments.com (although with LoopNet it was a cross-selling force that he shifted incentives around, before they created dedicated sales forces). It is possible he does this to help spin up the network effects of the marketplace, getting more agents to utilize the product so it is a better experience for consumers, or perhaps it is also to increase business momentum. Either way, Andy Florance has earned investor trust by successfully running several distinct real estate data businesses over the past almost 4 decades.

Nevertheless, near term numbers look bleak: 9 month FCF is down 30% to ~$182 vs, ~$263mn in the same period last year, margins have compressed to 5%, EBIT has been cut in half y/y, and their net income is entirely generated by the interest income on their cash.

Having said that, this is nothing that new for CoStar. As an owner-operated business they often invest aggressively and have always felt that there is a large opportunity ahead that has perpetually depressed margins.

In terms of mature margins, they have noted they can achieve 40%+ long-term, but our range we will use in our updated DCF is 35% to 45%. (See our original report for more commentary around mature margins).

International is a large opportunity that should get more investor attention, but it is still very small today. Total international revenues are just $34mn this Q or about 5% of revenues. However, that figure is +57%, or +11% excluding their acquisition of UK-based residential portal OnTheMarket.

There is currently no real estate data player internationally that does what CoStar does domestically. International is a slow, but long runway growth opportunity. (More info in the TAM section of our report).

They note that they have grown revenues double digits each quarter for the last 54 quarters. Their markets are still underpenetrated that another 54 quarters, or more, of double digit growth is not out the question. With this in mind, we have updated our reverse DCF below.

Valuation.

With $5bn of cash and about a $1bn of debt, their current EV is around $25bn. With $2.72bn in revenues for this year, they trade around 28x mature margin earnings (40% margin assumption).

We re-ran our Reverse DCF with some slight assumption updates and narrowed the range. We narrowed the number of assumptions shown primarily so this is easier to update going forward, but please refer to original reverse DCF for a fuller range of potential outcomes.   

Below we slightly increased our revenue growth assumptions in the out years. The 8% scenario is unchanged, but for the other two revenue scenarios (10% and 12%) we bumped up Y6-Y10 revenue growth 100bps and Y11-Y20 revenue growth 200bps. To clarify, this has nothing to do with any changes this quarter, but rather after reflecting on the runway of the business, we felt our high growth scenarios should continue to reflect double digit or near double digit growth for a longer period of time.

In all scenarios we still assume GDP-like growth after Y20, which is very likely too conservative. However, its impact is relatively small. In our highest revenue growth scenario, increasing Y20 to Y30 revenue growth from 3% to 6% increases annualized returns about 50bps. So, if an investor particularly believes they will have a multi-decade runway of high growth, they may add ~50bps to the returns below. Members Plus can of course adjust all assumptions in the Excels.

Our margin assumptions are shown below.

If you recall, we ran our DCF excluding the residential operations, which we did again below.

Based off of the same assumptions in the reverse DCF we ran in our report for residential, layering a successful residential operation adds anywhere from 1% to 1.5% to the annualize return.

Other Comments.

Here are a couple of other interesting quotes from the earnings call:

The point is that a second tier player will show higher growth rates in a higher vacancy market, but that is a signal that they are a 2^nd tier player because the increase in growth rate is a byproduct of their worse performance prior (essentially they are more cyclical).

And to conclude this update, we will let Andy Florance have the last word below.