Online real estate search companies Trulia Inc (NYSE:TRLA) and Zillow Inc(NASDAQ:Z) are likely to join forces.

On Thursday, media reports said Zillow may acquire its rival Trulia for $2 billion in cash and stock, creating an 800-pound gorilla in the housing search room, and sending paroxysms of apprehension in the residential brokerage business.

 

Trulia Inc (NYSE:TRLA) and Zillow Inc(NASDAQ:Z) Stocks off to the races

Investors, of course loved the deal, never mind that it is still to be confirmed by the two companies.

Z-T-RelativeStockPerformance-2014-07-27_1153

Zillow Inc(NASDAQ:Z) is up 26% post the announcement and Trulia Inc (NYSETRLA) is higher by 39%. Investors savoured the prospects of the merged company having a stranglehold on real estate listings with enough pricing power to demand higher fees from real estate brokers and marketing firms.

Trulia Inc (NYSE:TRLA) and Zillow Inc(NASDAQ:Z) Cornering the market?

The chart below shows how Trulia Inc(NYSE:TRLA) and Zillow Inc(NASDAQ:Z) have come to dominate market shares in the online real estate search business between July 2011 and January this year.

Zillow-Trulia-Combined

Note that Zillow has nearly tripled its market share in this period of 2.5 years, while Trulia managed to grow by about 1.5 times.

From being #3 and #4 in July 2011, Zillow and Trulia rose to #1 and #2 respectively in January this year.

According to latest data from comScore via WSJ, the two companies were easily the most popular real-estate sites in June. Zillow had 53.8 million unique US visitors while Trulia boasted of 31.6 million, putting them, again, at #1 and #2 in the eyeball rankings.

Zillow at the top of its game

Zillow unleashed an advertising tsunami in 2013 to build its brand. Result: A profit of $5.9 million in FY 2012 swung to a loss of $12.5 million. However, revenues galloped higher by 69% to $198 million.

The company is led by highly acquisitive CEO Spencer Rascoff, who bought up two real estate portals and a real estate software company in the last two years, driven by the tailwind of a rapidly improving US residential housing market.

If Rascoff is able to sew up the Trulia acquisition, Zillow would become an absolutely dominant player in the online real estate search market in the US.

Online ‘show-rooming’

‘Show-rooming’ works in reverse in housing. Nearly all house-hunters do their research for houses on the online portal and then contact the brick-and-mortar RE agency or friendly neighbourhood broker to help seal the deal.

The Zillow-Trulia alliance would become the portal with the largest reach and database of housing inventory and the major conduit through which leads will transfer to realtors. This would give it enormous pricing muscle, say industry sources.

Online portals such as Zillow and Trulia have already marginalized the National Association of Realtors, and their combination would take this another step further.

In the long run, it is even conceivable that real estate brokers would be made redundant.

Trulia Inc(NYSE:TRLA) and Zillow Inc(NASDAQ:Z) The internals of the deal

In their research note of July 25, 2014, Raymond James analysts Aaron Kessler and Ben Cohen observe that the deal makes strategic sense given that it would create a clear leader in the market, and avoid an advertising war in online real estate.

“A merger would be highly synergistic whereas we believe revenue levels could be sustained and there should be significant cost leverage as sales forces could be combined and would also be significant cost of revenues, technology, and G&A savings, in our opinion,” they add.

The analysts estimate that post-deal cost synergies could drive Trulia’s EBITDA higher to 40-50% from the current 15%  and lead to an EV/EBITDA multiple of 33x – 38x compared to 61x today, as per the analysis below.

Sensitivity-analysis

 

However, there are skeptics of the deal. ActivistShorts notes that Citron criticized reported potential merger with Zillow, saying that the proposed combined entity would not have the pricing power to “triple ad revenue from real estate agents,” as analyst commentary had suggested. See the full report Citron here.