Opening up the online property door

PORTFOLIO POINT: Competition in the online real-estate space is tough, but property information company Onthehouse is making up ground after its shares slumped after listing.

Investors in Onthehouse Holdings’ 2011 float must have worried they had bought the worst house in the street when its $1 issued shares tumbled to 33 cents within six months of listing.

The property information company was another example of why it usually pays to buy a float well after listing. That should be at least two years, when there is history as a listed company, more chance to see if the prospectus was reliable, and after restricted securities have come out of escrow and can be sold.

Like houses at an auction, initial public offerings (IPO), especially those vended by private equity firms, are all too often “dressed up” to inflate the valuation. It is not until the new owners move in that problems emerge and the IPO price paid seems ridiculously high in hindsight.

More to the point, why buy unproven listed companies in a volatile sharemarket when so many established ones have traded below their intrinsic value since the 2008 Global Financial Crisis?

My analysis shows almost four in five floats – out of more than 450 – have lost money for investors since August 2007. Yes, there have been stellar exceptions: Carsales.com, TradeMe Group, Corporate Travel Management, and NextDC come to mind. But we’re talking about a handful of investment-grade industrial floats that have had sustained share-price gains over five years, against several hundred dogs.

With those odds, value investors could easily avoid the IPO market. The vast majority have been for speculative mining explorers anyway, and the old problem of stock in the best industrial floats being locked away for clients of sponsoring brokers is alive and well.

Yet this lack of interest in the IPO market creates an opportunity for patient value investors who can wait for the heat to come out of floats and buy after listing, when prices are much lower. The market often banishes an IPO with a slumping share price to the small-cap graveyard, and investors stop looking.

Onthehouse looked like it had one leg firmly planted in that graveyard when its shares were 33 cents and it was the 92nd worst-performing float (out of 103) by the end of 2011. Its first year as a listed company was tough, but there was a lot to like about its strategic progress.

The Brisbane-based company raised $55 million and listed on the ASX in June 2011. Of that, $49.8 million was used to acquire real-estate agent software providers Console and PortPlus.

Onthehouse’s $81.5 million capitalisation at listing was arguably based more on the capital it needed to buy Console and Portplus than on future earnings. Small IPOs often base their valuation around how much money they need, rather than the return they can generate on that capital.

Onthehouse’s forecast price-earnings (PE) ratio was a whopping 41.6 times at listing. Put another way, investors paid $81.5 million for a company with a forecast after-tax net profit of $2 million in FY12, and earnings per share of 2.4 cents. Even by internet stock standards, the valuation was rich.

My guess is Onthehouse needed to buy Console and Portplus quickly, and integrate them with its existing consumer website, to capitalise on the opportunity of building a next-generation property advertising website with free property valuations and data.

Onthehouse was clearly overvalued at its $1 issue price, and undervalued when it slumped to 33 cents in a brutal market. It has since rallied to 68 cents on the back of decent earnings, strong gains in website traffic, acquisitions and more confidence in its business model.

Onthehouse was modelled on US sites Zillow.com, which listed on NASDAQ last year and is capitalised at US$878 million. A similar US site, trulia.com listed on the New York Stock Exchange in September and is capitalised at $US490 million. UK site Zoopla.co.uk has a similar offering.

These sites use free property data to attract visitors, and sell property leads from potential buyers and sellers to real-estate agents. Although their early success has impressed, Zillow, trulia and Zoopla operate in much more fragmented online property advertising markets compared to Australia. 

Onthehouse believes the revenue model in online property advertising will move from paying for classified advertising to performance-based models based on pay-per-lead services. In some ways, Onthehouse resembles carsales.com, which provides data to car dealerships.

The logic is powerful: providing current, free property data, in addition to listings, gives Onthehouse a point of difference over larger rivals REA Group and Fairfax Media’s Domain. In turn, this lures traffic to Onthehouse.com.au and creates buying and selling enquiries.

The “eyeballs” from that traffic are used to sell advertising. Suncorp, for example, signed up in March for a 12-month sponsorship. The big prize is selling leads from potential property buyers and sellers who seek valuations and other data to real-estate agents for a fee.

Onthehouse also provides real-estate agent software and sells real-estate data, but the main game is online property advertising, which was worth $283 million in 2010 and is growing rapidly, according to research group Frost & Sullivan. The market for real-estate agent software and data was worth a combined $150 million.

Onthehouse could be one of the rare companies that provide multiple solutions across the value chain. Providing rich data empowers consumers to make more informed property decisions, and thus lifts their level of engagement on the website, which is great for advertisers and sponsors. As more enquiries are made, more leads go to property agents, who get a better return on their marketing dollars.

It’s all about scale and data: achieving a sufficient mass of site visitors should enable Onthehouse to monetise its real-estate database in quick time. In September, it paid $3.5 million to acquire another 50%, and move to full ownership, of property data company Residex.

Residex’s 20-year history gives Onthehouse a huge database to work with and, more importantly, secures an important strategic asset. Residex is a key player in the property data market, along with RP Data, Price Finder and the Fairfax-owned Australian Property Monitors.

Onthehouse’s strategy is working: revenue rose 22% to $20.3 million in FY12, and net profit of $2.1 million was slightly ahead of prospectus forecasts. Operating cash flow soared from a negative $613,000 in FY11 to $6.4 million in FY12, and net debt is just $1.3 million. Onthehouse should be able to acquire smaller businesses and invest for faster organic growth without taking on huge debt or diluting shareholders with excessive share issuance.

Website traffic is growing strongly: there were more than 1.2 million unique browsers in August 2012 on onethehouse.com.au, and 2.5 million property reports generated. Brokers have described Onthehouse as reaching a “sweet spot”, where it now has enough traffic to sell enquiry leads to agents and ramp up earnings.

The company has only scratched the surface with its traffic and property data. Distributing it through mobile devices has great potential, as does selling it beyond the property industry to banking, conveyancing and other markets that rely on property transactions.

The main doubt is whether Australia can ever accommodate three large property websites. History shows the leading advertising website in an industry enjoys a sustained gap over its nearest rival; think Seek, REA Group, Carsales.com and Webjet. More site users attract more advertisers and content, which in turn attracts more users – and makes it near impossible for rivals to close the gap created by this competitive advantage.

REA Group easily dominates Australia’s online property advertising market and the number-two site, Domain, could be reinvigorated as Fairfax Media aggressively chases its digital future. It is hard to see Onthehouse ever becoming the dominant property advertising site, given this competition. (REA Group is majority owned by News Ltd, owner of Eureka Report).

Another problem is the subdued state of Australia’s property market and a struggling real-estate industry. A weakening property market could dampen traffic growth at onthehouse.com.au, and reduce demand for real-estate agent software and property data sales.

However, REA Group’s success this year shows how property advertising sites can continue to grow by taking market share off printed publications, and how dominant online advertising sites have significant power to lift prices and boost revenues, if volumes slow.

Another challenge for Onthehouse is brand awareness. At some point, it will have to spend millions on marketing to raise its profile. It has done exceptionally well to attract website traffic through search-engine optimisation techniques, but a bigger advertising campaign will eventually be needed.

I give Onthehouse an A3 quality score and it would not surprise me to see Onthehouse edge towards its $1 issue price within 12-18 months if the property market recovers, its website traffic hurtles higher, and as brokers and small-cap fund managers pay more attention.

If it continues to disrupt its industry, Onthehouse might become a takeover target for one of the big online property advertisers. It could give Domain more punch to take on REA Group, and REA Group more data to enrich its website content and entrench its leadership position.

Either way, Onthehouse has a valuable strategic position and open share register. It looks like a company that is worth much more in the hands of a big player than as a standalone operation.

Roger Montgomery is an analyst at Montgomery Investment Management and author of Value.able, available exclusively at rogermontgomery.com.