September 10, 2015 Zillow Group Inc Making Both Sides Count; Reiterate OW Industry View Attractive Stock Rating Overweight Price Target $36.00 Our AlphaWise study suggests that Zillow is enabling agents to increase their number of dual agency transactions. Given compelling economics this further strengthens the platform's ROI proposition, and gives us increased conviction in our wallet share gain thesis. Zillow is enabling premier agent advertisers to increase the number of transactions within which they represent both the buyer and the seller, known as a dual agency transaction. In a dual agency transaction the agent retains the commission from both "sides" of the transaction and therefore earns a commission of ~6% vs. ~3% earned if representing only one side. The key implication is that dual agency transactions offer lucrative economics, and by driving an increase in these transactions, Zillow is strongly reinforcing the return on investment (ROI) proposition for agents who successfully advertise with the platform. Our Alphawise study finds that for +60% of Zillow premier agents, advertising on Zillow enabled them to increase their number of dual agency transactions and specifically drove a ~30% increase in these transactions. Contrary to common perceptions our work further finds that Zillow is equally effective in generating leads for seller transactions vs. principally generating buyer leads; on a weighted average basis agents indicated an equitable ~50% split in terms of buy versus sell transactions generated from Zillow. MORGAN STANLEY & CO. LLC Dean J Prissman Dean.Prissman@morganstanley.com Jonathan Lanterman, CFA Jon.Lanterman@morganstanley.com Brian Nowak, CFA Brian.Nowak@morganstanley.com Zillow Group Inc ( Z.O, Z US ) +1 212 296-5271 +1 212 761-7688 +1 212 761-3365 Internet / United States of America Stock Rating Overweight Industry View Attractive Price target $36.00 Shr price, close (Sep 9, 2015) $25.07 Mkt cap, curr (mm) $4,415 52-Week Range $28.82-22.99 Fiscal Year Ending 12/14 12/15e 12/16e 12/17e ModelWare EPS ($) (1.09) (0.88) 0.08 0.59 Prior ModelWare EPS - - - - ($) P/E NM NM 331.7 42.4 Consensus EPS ($) 0.29 0.85 - - Div yld (%) 0.0 0.0 0.0 0.0 Unless otherwise noted, all metrics are based on Morgan Stanley ModelWare framework = Consensus data is provided by Thomson Reuters Estimates e = Morgan Stanley Research estimates QUARTERLY MODELWARE EPS ($) 2015e 2015e 2016e 2016e Quarter 2014 Prior Current Prior Current Q1 (0.16) - (0.40)a - (0.01) Q2 (0.26) - (0.22)a - 0.01 Q3 (0.40) - (0.18) - 0.02 Q4 (0.27) - (0.12) - 0.05 e = Morgan Stanley Research estimates, a = Actual Company reported data Given an increase in dual agency transactions our scenario analysis points to a meaningful strengthening in Zillow's ROI proposition - a single dual agency side enables an agent to recoup 50% to +100% of their total annual Zillow ad spend. When factoring in the other "side" of the dual agency transaction, agents stand to generate an ROI of over 50% to +100% on their total annual ad spend from this single transaction. This has the effect of meaningfully bolstering an agent's total ROI when considering income from additional converted Zillow leads, over and above the single dual agency transaction. In turn, this phenomenon appears to be contributing to an increase in agent satisfaction. The +60% of agents whom indicated the Zillow is driving an increase in dual agency transactions for them were 2x more satisfied with their Zillow ROI than the group whom were not seeing the same benefit. Reiterating $36 price target suggesting 44% upside. With our estimates unchanged we reiterate our $36 DCF-based price target which implies 32x FY16E EV/EBITDA vs. Z currently trading at 22x. We note using normalized of 40%, Z trades today at ~13x FY16E EV/EBITDA. Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report. 1
Risk Reward Source: Thomson Reuters, Morgan Stanley Research, Note: Historical prices before the stock dividend are pulled from ZG Price Target $36 Price target based on DCF with a 10.4% WACC and 3% perpetual growth rate. Cost of debt is 4% and represents ~7% of capital structure. Cost of equity is based on 1.25 Beta, Risk Free Rate of 2.3% and expected market return of 9.4%. (Our Beta estimate is based off a median value for SMID Consumer Internet stocks. RFR and market return are derived from Bloomberg.) Investment Thesis We believe Zillow is well positioned for the increasing importance of the internet in enabling real estate transactions. Our recent investor survey reveals room for growth: only 30% of transactions are enabled by online leads and Z share is only ~35%. Contrary to investor concerns, our bottom up analysis suggests Zillow agent ad budgets, at $30k per year, are significantly larger than budgets of average agents, implying a low 14% wallet share. Zillow is expanding its TAM by shifting share from low volume agents to high volume agents. We forecast a five-year revenue CAGR of 21% driven by an increase in agent advertisers; and wallet share gains from 15% today to 29% by 2020 and 43% by 2025. EBITDA will grow at a 48% 5-year CAGR due to scale and high incremental margins, enabling +40% margins long-term. Issues arising from the Trulia acquisition are transitory, and we see favorable risk/reward given an already large reset to expectations. Bull $50 45x Bull Case 2016E EV/EBITDA of $205m Base $36 32x Base Case EV/EBITDA of $203m Bear $20 20x Bear Case 2016E EV/EBITDA of $177m Z Sustains five-year CAGRs of 24% and 55% for rev. and Adj. EBITDA. Top 25% agent wallets grow at a 5% CAGR due to large share shift from low volume agents. Base case agent count penetration levels. This drives ARPA above base case levels by 10% and 30% for 2020 and 2025. Given higher levels for incremental margins, Z reaches Adj. EBITDA margins of 41% by 2020 and 48% by 2025. Z Sustains five-year CAGRs of 21% and 48% for rev. and Adj. EBITDA. Driven by 1) Increased advertiser penetration from 40% today to 51% by 2020 and 61% by 2025, 2) Advertiser wallet share gains from ~15% today to 29% by 2020 to 43% by 2025. This drives ARPA and given high incremental margins; Z reaches Adj. EBITDA margins of 36% by 2020 and 44% from 2025. Z Sustains five-year CAGRs of 19% and 37% for rev. and Adj. EBITDA. Driven by 1) Increased advertiser penetration from 40% today to 50% by 2020 and 58% by 2025, 2) Advertiser wallet share gains from ~15% today to 26% by 2020 to 33% by 2025. This drives lower ARPA growth resulting in a lower level of incremental margins; Z reaches Adj. EBITDA margins of 27% by 2020 and 30% from 2025. Key Value Drivers Zillow's place in the ecosystem is dominant, accounting for 51% of industry visits and having reduced its reliance on Listhub. Zillow is changing the way consumers shop for real estate, in turn enabling advertisers to generate healthy ROI and therefore shift ad budgets. A highly scalable model should push margins to +40% given low content costs. Potential Catalysts Improve pro forma disclosures. Forward results showcasing stable trends at Trulia and continued ARPA momentum. Successful integration of the Trulia and Zillow premier agent business (year end). Risks to Achieving Price Target The competitive environment following the Trulia merger is more rational, but News Corp. acquired third-ranked Move and could aggressively invest. The residential real estate industry is sensitive to the economic cycle and interest rates. Zillow is potentially exposed to any slowdown in the housing market. Trulia's challenges prove structural vs. transitory. 2
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Zillow Investment Thesis As discussed in our initiation on Zillow Group (July 2015) our Overweight thesis is predicated on our AlphaWise survey and bottom-up industry analysis, which suggest that the internet and Zillow are reshaping the way consumers shop for real estate, but Zillow's share of advertiser wallets remains low at 15%. We believe this share is poised to rise due to sustained secular shift dynamics coupled with share gains from competitors, in turn enabling Zillow to sustain five-year CAGRs of 21% and 48% for revenue and Adj. EBITDA. Contrary to investor concerns that Zillow's growth will be capped by low advertiser budgets, our analysis suggests Zillow's customer base, successful agents or the top 25% of agents spend ~$30k per year each on advertising, implying Zillow's wallet share is a low 15%. We believe this is set to rise as the internet is enabling more real estate transactions and Zillow is taking share. Based on our proprietary AlphaWise survey, in 2014 successful agents generated ~30% of transactions from online leads, up 800 bps y/y, while Zillow doubled its share of internet enabled transactions to 36%. As a result more ad budgets are shifting online, and are flowing to Zillow; Zillow increased its share of online budgets by 700bps in 2014 and we see a strong upward bias. A lever which further supports the sustainability of budget growth is that Zillow is enabling successful agents to take share from unsuccessful agents. Simply put, low volume agents can't afford to participate with the platform, but since Zillow is gaining share of transactions, these transactions are accruing to Zillow advertisers, successful agents, and much room for share gains remains. As shown in Exhibit 1, the bottom 75% of agents, which are low volume agents and generally not Zillow customers, still control ~40% of transactions but only 16% of the real estate advertising market. Moreover, as shown in Exhibit 2, existing Zillow premier agents in a our AlphaWise survey indicated they have the capacity to increase their total transaction velocity by ~100%, and therefore ample capacity to absorb an even greater share of the overall industry's transaction volume. By driving share to successful agents Zillow is also in effect expanding its TAM by shifting broker economics to advertising. More successful agents have higher commission retention rates, and reinvest a greater portion of their gross commissions in marketing. Our work suggest the top 25% of agents reinvest ~20% of their gross commissions in advertising vs. the median agent, per the National Association of Realtors, investing only 2%. 4
Exhibit 1: % of Real Estate Agents vs. % of Transactions vs. % of Advertising market by Income Bracket Exhibit 2: AlphaWise Real Estate Agent Survey - Q: Based on how you spend your time currently, if you were able to obtain higher quality leads and close these leads more effectively, how many more sides per year do you think you would be able to do? 120% 100% 93% 103% Source: AlphaWise, NAR, Company data, Morgan Stanley Research Capacity for more sides 80% 60% 40% 20% 74% 0% Total 1-9 sides 10 or more sides Reinforcing the ROI proposition for agents via dual agency transactions Today, based on our proprietary AlphaWise study we introduce an additional leg to this thesis. Namely, Zillow is enabling premier agent advertisers to increase the number of transactions in which they represent both the buyer and the seller, known as dual agency transactions. Within dual agency transactions, the agent retains the commission from both "sides" of the transaction and therefore earns a commission of ~6% on the transaction, versus the 3% generally earned if representing only the buyer or only the seller. The key implication is that dual agency transactions offer lucrative economics, and by driving an increase in these transactions, Zillow is strongly reinforcing the return on investment (ROI) proposition for agents who successfully advertise with the platform. Specifically, our analysis concludes: Industry backdrop Source: AlphaWise, Morgan Stanley Research For Zillow's key customer base, agents doing 10 or more sides per year, 67% indicated that Zillow enabled them to increase their number of dual agency transactions, and Specifically that Zillow drove a 28% increase in their number of dual agency transactions; In turn, our analysis on the effect of an increase in dual agency transactions suggests a particularly compelling impact to ROI ie. a single dual agency transaction reasonably brings the potential for an agent to generate an ROI of over 50-100% on their total Zillow annual advertising spend. This has the effect of meaningfully bolstering total ROI when considering income from additional converted Zillow leads over and above the single dual agency transaction. As is widely known within a majority of residential real estate transactions in the US, both the buyer and seller are represented by individual real estate agents. In exchange for their services, a ~6% commission is levied on the transaction, and split evenly between the buyer and seller agents. This is known as a single agency transaction. Dual agency transactions arise when an agent represents both the buyer and the seller in a transaction, and as a result, the agent retains the entire ~6% commission. According to a 2013 study by Journal of Real Estate research ~30% of residential real estate transactions were designated as dual agency. This is largely consistent with our AlphaWise real estate agent study, depicted in Exhibit 3, 3 within which agents doing 10 or more sides 5
per year indicated ~32% of their transactions over the past year were dual agency in nature. We emphasize this group as the real estate agent industry is highly bifurcated, with the top 25% of agents representing over 60% of transactions and over 80% of advertising spend; we use 10 or more sides per year as a proxy for the top 25% of agents whom matter most in the industry (please see our initiation for further details). As an aside, the industry bifurcation is evident in our survey results, with dual agency transactions garnering a 10 percentage point higher share for agents doing 10 or more sides versus agents doing less than 10 sides; considering the lucrative economics associated with dual agency transactions, 10 points is substantive difference in our view, and further points to the bifurcation in the share of industry profits when comparing the top 25% of agents vs. all others. Exhibit 3: AlphaWise Real Estate Agent Survey: % of dual agency transactions - Q: Please estimate the percentage of the total number of residential real estate transactions in which you represented both the buyer and the seller, over the past year? 35% 30% 28% 32% % of agents 25% 20% 15% 10% 5% 22% 0% Average Agents: 1-9 sides Agents: 10 or more sides Source: AlphaW ise, Morgan Stanley Research Zillow appears just as effective for agents seeking new sell listings... Considering the principal consumer use case for Zillow centers around search and discovery of homes for sale, a questions remains for many whether Zillow is in fact addressing the "sell" side of the market ie. acting as a lead generation channel for agents seeking consumers that are looking for representation in the sale of their homes. Overall, our AlphaWise agent survey results strongly suggests Zillow is effective for both the sell and the buy side transactions. For example, as shown in Exhibit 4, 4 on a weighted average basis agents indicated an equitable 50% split in terms of buy versus sell transactions generated from Zillow. While, as shown in Exhibit 5 the distribution of responses in terms of the percentage of buy vs. sell transactions generated from Zillow follows a fairly normally distributed pattern. 6
Exhibit 4: AlphaWise Real Estate Agent Survey: Weighted average % of transactions that are buyer versus seller transactions Exhibit 5: AlphaWise Real Estate Agent Survey: % of Zillow transactions that are buyer transactions Source: AlphaWise, Morgan Stanley Research...and is helping agents drive dual agency transactions Source: AlphaWise, Morgan Stanley Research Importantly, our new work leads us to conclude that Zillow is enabling premier agent advertisers to capture more transactions where they represent both the buyer and seller. As noted: In Exhibit 6, 67% of agents doing to 10 or more sides per year, indicated that Zillow enabled them to increase their number of dual agency transactions; While, in Exhibit 7,we note these agents indicated that Zillow drove a 28% increase in their number of dual agency transactions. Exhibit 6: AlphaWise Real Estate Agent Survey - Q: Has Zillow enabled you to increase that number of real estate transactions where you represent both the buyer and the seller? % of respondents whom indicated Yes. Exhibit 7: AlphaWise Real Estate Agent Survey - Q: Please estimate the percentage increase in transactions over the past year, where you represent both the buyer and the seller, because of Zillow. % of agents 80% 70% 60% 50% 40% 30% 62% 53% 67% 20% 10% 0% Average Agents: 1-9 sides Agents: 10 or more sides Source: AlphaWise, Morgan Stanley Research and therefore meaningfully bolstering advertiser ROI Source: AlphaWise, Morgan Stanley Research The key implication is that dual agency transactions offer lucrative economics, and by driving an increase in these transactions, Zillow is strongly reinforcing the return on investment (ROI) proposition for agents whom successfully advertise with the platform. We conclude that a single dual agency transaction reasonably brings the potential for an agent to generate an ROI of over 50-100% on their total annual Zillow advertising spend, meaningfully bolstering total ROI when considering income from additional converted Zillow leads over and above the single dual agency transaction. Putting our survey analysis in context, albeit simplistically, depicted in Exhibit 8 we illustrate that a ~30% increase in dual agency transactions because of Zillow, equates to an incremental 1, 1.4, and 1.8 sides for agents 7
doing 10, 15, and 20 sides respectively. As discussed in our initiation, Zillow's primary customer base are successful or professional agents whom do 10 or more sides a year, hence we focus on this group versus the longer-tail of casual/part-time agents; for example an agent doing 5 sides per year earns a modest $16,000 in net commissions before business expenses and tax; and on this basis simply cannot afford to meaningfully advertise with Zillow absent investment funded from sources other than their income. Exhibit 8: Potential increase in the number of dual agency transactions per year from Zillow Source: AlphaW ise, Morgan Stanley Research Building on this analysis, in Exhibit 9, 9 we depict a set of scenarios which illustrate the ROI/payback for agents whom generate incremental dual agency transactions because of Zillow. The specific variables we control for are 1) The level of ARPA spend 2) The number of incremental dual agency sides, corresponding with our analysis above in Exhibit 8, 8 and 3) The total number of sides or transactions an agent completes in a year. Based on these variables, we highlight a set of outcomes we believe to be reasonably conservative and overall find a particularly compelling ROI/payback: For example, if a Zillow premier agent who does 10 or more total sides per year and spends $4,500 per year in advertising with Zillow (inline with annualized reported ARPA), garners 1 additional dual agency transaction because of the platform, the incremental sides equates to $5,265 in incremental net commissions to the agent. This implies that the agent would recoup 117% of their total annual advertising investment before factoring in income from the other side of the dual agency transaction. When factoring in the other side of the dual agency transaction, the agent's total ROI on their annual Zillow ad spend would equate to ~134% from the single transaction. Since this analysis doesn't consider any additional transactions generated because of Zillow, when factoring in the value of income generated from additional Zillow leads which convert, the agent's overall blended ROI would be far higher. Looking at another example which considers the potential long-tail of low ARPA agents: If the same 10 side per year agent were to advertise at ARPA levels that are 50% and 100% higher than the blended company average, they would recoup 78% and 59% of their total annual advertising investment just from the incremental side, and when factoring income generated from the other side of the transaction, this one transaction alone would generate a ROI on the agent's total annual Zillow ad spend of 56% or 17%. Once again considering this analysis doesn't factor in the value of income generated from additional converted Zillow leads, the agent's overall blended ROI would be far higher. Looking at a final example for a higher volume agent whom does 20 total sides per year, our survey results suggest an uplift of 2 additional dual agency transactions because of Zillow. Assuming the agent is spending 100% more per year with Zillow than the blended company average (ie. $9000), the additional 2 dual agency sides would enable them to recoup 117% of their total annual advertising cost. When factoring in the other sides of the dual agency transactions, the agent's total ROI on their annual Zillow ad spend would equate to ~134% from the two transactions. In line with the other examples discussed above the agents overall ROI on their ad spend would be far higher, when factoring additional converted Zillow leads. Putting this in perspective, the key conclusion is that dual agency transactions are highly lucrative, and by driving an increase in these transactions, Zillow is driving meaningful ROI for agents. Based on our analysis, a single dual agency transaction reasonably brings the potential to generate an ROI of over 50-100% on an agents total annual ad spend, 8
meaningfully bolstering total ROI when considering income generated from additional converted Zillow leads over and above the dual agency transaction. Exhibit 9: Zillow dual agency transaction ROI/payback analysis Baseline Inputs Average home price $234,000 x Incremental commission 3% = Gross broker commissions $7,020 Average Zillow Agent monthly spend (2Q15) $375 x months per year 12 = Average Zillow agent annual spend $4,500 Blended ARPA at 50% above average $6,750 Blended ARPA at 100% above average $9,000 Incremental dual agency sides 1 2 Agent scenario: sides per year 10 15 20 15 20 ARPA (Reported) - $375 per month Gross broker commissions $7,020 $7,020 $7,020 $14,040 $14,040 x Assumed agent/broker split % 75% 75% 75% 75% 75% = Incremental income $5,265 $5,265 $5,265 $10,530 $10,530 / Average Zillow spend per year $4,500 $4,500 $4,500 $4,500 $4,500 = % of Investment recouped 117% 117% 117% 234% 234% Income from other "side" $5,265 $5,265 $5,265 $10,530 $10,530 + Incremental dual agency income $5,265 $5,265 $5,265 $10,530 $10,530 = Total income from transaction $10,530 $10,530 $10,530 $21,060 $21,060 - Average Zillow spend per year $4,500 $4,500 $4,500 $4,500 $4,500 = Investment return $6,030 $6,030 $6,030 $16,560 $16,560 / Average Zillow spend per year $4,500 $4,500 $4,500 $4,500 $4,500 = Return on annual Zillow spend 134% 134% 134% 368% 368% ARPA + 50% - $563 per month Gross broker commissions $7,020 $7,020 $7,020 $14,040 $14,040 x Assumed agent/broker split % 75% 75% 75% 75% 75% = Incremental income $5,265 $5,265 $5,265 $10,530 $10,530 / Average Zillow spend per year $6,750 $6,750 $6,750 $6,750 $6,750 = % of Investment recouped 78% 78% 78% 156% 156% Income from other "side" $5,265 $5,265 $5,265 $10,530 $10,530 + Incremental dual agency income $5,265 $5,265 $5,265 $10,530 $10,530 = Total income from transaction $10,530 $10,530 $10,530 $21,060 $21,060 - Average Zillow spend per year $6,750 $6,750 $6,750 $6,750 $6,750 = Investment return $3,780 $3,780 $3,780 $14,310 $14,310 / Average Zillow spend per year $6,750 $6,750 $6,750 $6,750 $6,750 = Return on annual Zillow spend 56% 56% 56% 212% 212% ARPA + 100% - $750 per month Gross broker commissions $7,020 $7,020 $7,020 $14,040 $14,040 x Assumed agent/broker split % 75% 75% 75% 75% 75% = Incremental income $5,265 $5,265 $5,265 $10,530 $10,530 / Average Zillow per year $9,000 $9,000 $9,000 $9,000 $9,000 = % of Investment recouped 59% 59% 59% 117% 117% Income from other "side" $5,265 $5,265 $5,265 $10,530 $10,530 + Incremental dual agency income $5,265 $5,265 $5,265 $10,530 $10,530 = Total income from transaction $10,530 $10,530 $10,530 $21,060 $21,060 - Average Zillow spend per year $9,000 $9,000 $9,000 $9,000 $9,000 = Investment return $1,530 $1,530 $1,530 $12,060 $12,060 / Average Zillow spend per year $9,000 $9,000 $9,000 $9,000 $9,000 = Return on annual Zillow spend 17% 17% 17% 134% 134% Source: AlphaW ise, Company data, Morgan Stanley Research Our analysis is consistent with the agent satisfaction levels regarding Zillow ROI suggested by our AlphaWise survey. Specifically, as shown in Exhibit 10, when segmenting the results of our survey by the 62% of agents who indicated that Zillow is driving an increase in their number of dual agency transactions versus the 38% who indicated Zillow is not, we observe a distinct difference in satisfaction levels: 9
Among agents that said Zillow enabled them to increase their number of dual agency transactions, 80% indicated they were extremely satisfied or satisfied with their ROI from Zillow. This is ~2x the proportion of extremely satisfied and satisfied respondents from the group who indicated that Zillow did not drive an increase in their number of dual agency transactions ie. 42% indicated they were extremely satisfied or satisfied. Similarly, where agents indicated they were dissatisfied with their ROI from Zillow: For the group who indicated Zillow is driving an increase in dual agency transactions, a modest 7% indicated they were extremely dissatisfied or dissatisfied versus ~34% for the group who indicated that Zillow did not drive an increase in their number of dual agency transactions. Exhibit 10: AlphaWise Real Estate Agent Survey: Level of satisfaction with ROI (% of respondents) 60% 50% 40% 30% 20% 10% 0% 7% of respondents were not satisfied with Zillow ROI 1% 6% 80% of respondents were satisfied with Zillow ROI 13% 33% 47% Extremely Dissatisfied Neutral Satisfied Extremely dissatisfied satisfied Zillow drives an increase in dual agency transactions - 62% of agent respondents 34% of respondents were not satisfied with Zillow ROI 15% 19% 24% 24% 42% of respondents were satisfied with Zillow ROI 18% Extremely Dissatisfied Neutral Satisfied Extremely dissatisfied satisfied Zillow does not drive an increase in dual agency transactions - 38% of agent respondents Source: AlphaW ise, Morgan Stanley Research Is a sustained increase in dual agency transactions tenable given the potentially conflicted interests of agents? A hallmark of the US residential real estate market is the fiduciary responsibilities of buyer and seller agents. Namely, for sellers' agents, all else held equal, obtaining the highest price, and for buyers' agents similarly obtaining the lowest price. As such, a tangential question that emerges from our analysis is whether a step-up in the percentage of dual agency transactions is tenable. We argue yes: As ultimately the decision (for the most part) is at the discretion of home buyers, and tools such a Zillow provide a level of information transparency to inform the home buying process not previously available. In fact, much of this information was previously walled within the confines of Multiple Listing Services (MLS), only made available to agents. On this basis, before the advent of Zillow and similar platforms, buyer agents enjoyed a far greater information advantage and therefore offered buyers a more valuable service. Hence we contend that increased adoption of tools such as Zillow has and will continue to drive an increase in the number home buyers that are comfortable with dual agency transactions. Looked at from a bigger picture perspective, as depicted in Exhibit 11, we note buyer agents are uncommon intermediaries within numerous international residential real estate markets, such as the UK, Australia, France and Spain. While we acknowledge their absence likely introduces some pitfalls, at the same time we think it clearly speaks to the idea that home buyers can capably shop for residential real estate without agent representation. 10
Exhibit 11: Selling and buying agent practices within various international markets Source: Global Property Guide, International Real Estate Review, W SJ, Morgan Stanley Research What Gives Us Confidence In June 2015, we conducted an online survey with 211 real estate brokers and agents across 5 of the most populous metro areas in the country: New York, Los Angeles, Chicago, Miami and Dallas. Respondents have been working with residential real estate for 8 years, on average. About 1/4 of respondents are independent (i.e. not affiliated with any franchisor). Conclusions based on total sample have a maximum margin of error of +/- 2.5% at 90% confidence level. 11
Exhibit 12: Zillow Revenue Drivers Source: Company data, Morgan Stanley Research 12
Exhibit 13: Zillow Quarterly Income Statement Source: Company data, Morgan Stanley Research 13
Exhibit 14: Zillow Annual Income Statement Source: Company data, Morgan Stanley Research 14
Exhibit 15: Zillow Balance Sheet and Cash Flow Statement Source: Company data, Morgan Stanley Research 15
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Morgan Stanley and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Research, including market making, providing liquidity, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis. Morgan Stanley may have a position in the debt of the Company or instruments discussed in this report. Certain disclosures listed above are also for compliance with applicable regulations in non-us jurisdictions. STOCK RATINGS Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Global Stock Ratings Distribution (as of August 31, 2015) For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively. 16
COVERAGE UNIVERSE INVESTMENT BANKING CLIENTS (IBC) STOCK RATING CATEGORY COUNT % OF TOTAL COUNT % OF TOTAL IBC % OF RATING CATEGORY Overweight/Buy 1206 36% 356 44% 30% Equal-weight/Hold 1446 43% 352 44% 24% Not-Rated/Hold 94 3% 11 1% 12% Underweight/Sell 601 18% 83 10% 14% TOTAL 3,347 802 Data include common stock and ADRs currently assigned ratings. Investment Banking Clients are companies from whom Morgan Stanley received investment banking compensation in the last 12 months. Analyst Stock Ratings Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Not-Rated (NR). Currently the analyst does not have adequate conviction about the stock's total return relative to the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months. Analyst Industry Views Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below. In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below. Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below. Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index or MSCI sub-regional index or MSCI AC Asia Pacific ex Japan Index. Stock Price, Price Target and Rating History (See Rating Definitions) Important Disclosures for Morgan Stanley Smith Barney LLC Customers 17
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