Zoopla and Rightmove – are they a cosy duopoly?

Zoopla Property Group listed on the stock market on the 18th June. It’s an opportune time to review that company and its main competitor, Rightmove, because you can read the IPO prospectus of the former on the web. A prospectus always discloses more information than you will normally get although Rightmove is also quite open with information.

These two companies are the gorillas in the on-line property advertising market with Rightmove being larger in size but Zoopla apparently growing more rapidly.  In their financial years ending in 2013, Rightmove had revenue of £139m and Zoopla had revenue of £64m. Pre-tax profits of the former were £97m and the latter were £28m. Rightmove revenue was up 17% in 2013 while Zoopla was up 80% but the latter was probably boosted by acquisitions.

Both these businesses look quite mature in the sense that they both have very comprehensive and similar web site functionality, and have signed up a very large proportion of estate agents in the UK. Smaller competitors have been squeezed out or taken over in recent years. Internet businesses tend to develop into natural monopolies because the largest and most well known businesses have enormous economies of scale – being the first mover also helps a lot. One might expect the market to form a cosy duopoly in due course, although a third upstart is going to try to get into it later this year (see below).

As a result both Rightmove and Zoopla are highly profitable and cash generative. Rightmove has been returning a lot of cash to shareholders via dividends and share buy-backs – for example buybacks of £31m in the first four months of this year alone. With high profits, and little opportunity for expansion  (overseas markets are not particularly open apparently), Rightmove seems to have taken a position of returning cash to shareholders while Zoopla has been more aggressive in trying to capture market share. It is noticeable of late that Zoopla seem to be spending a lot more on advertising in traditional media to gain market awareness in end users of these web sites, but the prospectus also commits them to paying a high proportion of earnings out in dividends (between 35% and 45% of profits – see page 60 of the prospectus).

As already noted though, both companies have signed up a very large proportion of UK estate agents who typically use one or other, and often both services, to promote the properties they represent. Zoopla are charging about £300 per month on average to each “Member” as they call their agency clients to list properties, so you can see the cost per property is not large. In relation to the other overheads of running an estate agency, it must be relatively small. Rightmove typically charge substantially more but claim proportionally more “page views” are generated.

There is still room for expansion of revenue by taking advertising spend from the more traditional print media used by estate agents. Only about 50% of agents promotional spending is on these internet services  and is still growing. Those looking for houses almost certainly use them as the main search medium when actively looking for a new home, so the more traditional media are becoming of secondary importance. The other opportunity for revenue growth is if property transactions rise. They are still nowhere near the peaks achieved in 2006/2007 according to the Land Registry.

Zoopla has more than one web site/brand – Zoopla itself, PrimeLocation and some other more specialist sites. It is not clear what the logic is behind this – perhaps it is for historic reasons.

As regards the valuations of these businesses Zoopla listed at 220p (the share price has not moved much since then at the time of writing). With earnings per share last year of 5.3p that puts them on a historic p/e of 42, which is certainly not cheap.  But Rightmove is not cheap either – a historic p/e of 29 on the current price of 2140p.  Needless to point out to existing Rightmove shareholders perhaps that Rightmove used to be more highly rated but has fallen back in recent months. It reached a peak of 2775 in February so has fallen by 23% since. Whether this is because of the Zoopla listing, or because of more competition appearing, or because a lot of highly rated internet stocks have fallen back is difficult to determine.

These businesses are highly rated of course because they are still growing rapidly, have a high return on capital, good cash generation, no debt and great barriers to entry. They have a great ability to increase charges to agents, and hence profit margins which are already high, much to the chagrin of some agents. When you get a duoply, as the market now appears to be, there is a natural tendency for them not to compete on price.

But this has prompted a new entrant into this market backed by a number of high-end estate agents. This will be called Agents Mutual and was planning  to launch in September this year, but is now scheduled for January 2015 according to their web site.  They clearly intend to focus on competing on price, i.e. providing a cheaper service to agents. But whether they will be able to drive sufficient internet users to their new web site to look for property when Rightmove and Zoopla are already well established in people’s minds seems questionable. As far as the end users are concerned, the site that has the most properties listed (and hence from the most agents) is always going to be the most attractive. They might have a very tough task ahead of them. In the meantime though they might evoke competitive responses from Rightmove and Zoopla that may reduce their profit margins in the short term.

How this will play out remains to be seen. But it is odd that even two players can be successful in this market. Zoopla’s recent growth to get near to Rightmove’s market position is surely down to Rightmove not reacting to competition but continuing to return cash to shareholders rather than using it to protect their market position. But a third market participant of significance seems to be unlikely if the existing incumbents react appropriately.

In the meantime Rightmove looks cheaper on the fundamentals than Zoopla unless you wish to hedge your bets on these sector players. But with Zoopla being apparently more aggressive than Rightmove and a new market entrant coming, there is clearly some uncertainty that is undermining the share price of Rightmove. Only the normal enthusiasm for IPOs which are often talked up by the promoters probably enabled Zoopla to list at the price that was obtained.

Also bear in mind that although most of the existing shares in Zoopla were placed (with no new money raised), over 28% are still held by DMG Media Investments Ltd (part of Daily Mail and General Trust) and Atlas Ventures still have a 6% stake. They may in due course wish to dispose of those holdings. A 28% stake does of course give substantial influence over the affairs of the company (and would be sufficient to block an unwanted takeover for example).

For existing Rightmove shareholders, there does not seem great merit in moving to Zoopla unless you lack confidence in the management of the former. Whether new investors should buy the shares in either company at this time probably depends on your attitude to highly rated “growth” stocks in general and at this time in the stock market cycle; and your view of the likely outcome of market battles in this sector.

Roger Lawson 28/6/2014 (note: the author has a holding in Rightmove).

Pay at RBS – over 99% in favour

The Royal Bank of Scotland (RBS) held its Annual General Meeting yesterday (the 25th June). Most of the media did not even bother to report it.

There were some shareholders present who spoke against the remuneration at the company, but when it came to a vote  the proxy counts were 99.81% in favour of the Remuneration Report and 99.66% in favour of the Remuneration Policy. PIRC had also opposed the Remuneration Policy before the meeting. A summary of what they said is that the maximum potential payout under the long-term incentive plan is excessive as it can amount up to 300% of salary. They were also disappointed that the bank had found a way to circumvent the spirit of the European CRD IV regulations. A new fixed share allowance is replacing the annual bonus, which they did not consider appropriate as the share allowance acts as a guaranteed bonus. They pointed out that from 2014, Executive Directors will be eligible to receive up to 400% of salary through the share allowance and the long-term incentives.

Even with the Government holding 85% of the company, and obviously voting for these proposals, it is disappointing that there was so little other opposition. It just shows how ineffective the new UK regulations on remuneration are in practice.

One other issue raised at the meeting was about the activities of the GRG business unit at RBS which was accused of killing off small firms to the financial advantage of RBS. Indeed one shareholder named Gavin Palmer apparently said RBS had been covering up for “corporate psychopaths”. Gavin is of course well known to some ShareSoc members for his vigorous approach to companies.  

Kentz, Victoria, AstraZeneca, and SSE

A number of companies on which ShareSoc has commented recently were in the news today (23/6/2014) or over the preceding weekend. Let’s cover each in turn:

Kentz

Kentz received a cash offer for the company of 935p from SNC-Lavalin this morning. That’s a premium of 33% to the recent share price. With such a premium and the stated support for the offer from the directors, it looks likely to succeed.  This will avoid the directors of Kentz having to deal with the issue of what to do with the problem that shareholders voted down both the Remuneration Policy and Remuneration Report resolutions.

Victoria

ShareSoc was involved in this carpet company when the directors fought acrimoniously over the future of the business. After a poor financial track record, investors (many related to the founders) wanted a new board which they eventually got. Geoff Wilding was appointed as Executive Chairman with a remuneration package based on a CFD – a Contract for Difference (no doubt for tax reasons). Shareholders approved this rather unconventional arrangement. Mr Wilding seems to have subsequently made good progress in reviving and rationalising the business.

Now the company has announced a Special Dividend of £2.95 per share when the share price was only £3.21 the previous Friday. As the CFD was performance based and depended on total return, the Special Dividend payment will apparently crystalise  the CFD but instead of taking the remuneration as cash Mr Wilding is taking it in new shares. This will increase his holding to 50% of the enlarged share capital.  

So in reality existing shareholders are being offered the market price of the company, and to be left still holding 50% of it. Needless to say the share price rose substantially this morning. But how this deal is to be financed is not totally clear – it may become plainer when the full documentation is provided. But investors must surely be happy with events of late. However not all will be pleased with holding shares where there is a dominant investor with 50% or more of the company.

AstraZeneca

The Financial Times reported on the previous Saturday that AstraZeneca are considering selling the rights to some of its future revenues. It suggested this would “help stifle any renewed takeover attempt” by Pfizer. In other words, this looks like a “poison pill” under another guise. By bringing in billions of dollars in cash, and returning the cash to shareholders, the rump of the business would become much less attractive to a buyer (and of course effectively hamper any future management of the business). Is it not astonishing that the directors of the company would even consider such a proposition? How can this be in the interest of investors or other stakeholders in the company in the longer term? It surely confirms what is already apparent from the past actions of the directors of AstraZeneca – namely that they were intent on thwarting the offer from Pfizer without letting shareholders  decide for themselves on the merit of the offer. A highly dubious approach by the directors of the company. Surely the CEO and the board as a whole need to focus on delivering the future drugs pipeline that they have promised, rather than doing clever financial deals that will hogtie the company going forward.

SSE

Lastly we commented on the accounts, and the enormous “adjustments” that were used to get respectable headline profit figures in last years figures from SSE. Reading the Annual Report in full also raises some other issues.

There are 10 directors, including  8 non-executive directors (including the Chairman). We learned from the banking sector debacle that having directors with no experience of the sector in which a company operates to be a big mistake. But the non-exec directors of SSE have the following backgrounds:

Lord Smith: An accountant with a background in financial services (and a director currently of 2 banks).

Jeremy Beeton: A civil engineer with a career in Bectel. At least a background of some relevance.

Katie Bickerstaffe: Previously a director of Dixons, Kwik Save and Somerfield.

Sue Bruce: A career local government officer – currently a Chief Executive of Edinburgh Council.

Richard Gillingwater: Corporate finance background and a director numerous other companies in a variety of sectors (other than where SSE operates).

Peter Lynas: An accountant with a background in defence companies – currently Finance Director of BAE Systems.

Lady Rice: A career banker, currently Managing Director of Lloyds Banking Group Scotland and a director of the Court of the Bank of England.

Thomas Thune: An extensive international career in the oil and marine industries (with A.P. Moller-Maersk).

In summary, it’s difficult to identify that any of these non-executive directors have much experience of the utilities and power generation sector and most have none. So we have a board with only two executives who know much about the industry and 8 non-executives who don’t. You can imagine who might dominate the decision making in that case. In addition, they have non-execs who have full time jobs elsewhere, and even the executive directors have other jobs (for example, the Finance Director is a non-exec at Stagecoach Group).

The Remuneration Policy and Remuneration Report for SSE also shows rapidly rising pay for the CEO and incentives that can add up to 250% of base salary.

But if you wish to attend the AGM to make some comments on these matters, you will need to go to Perth on the 17th July because that’s where the meeting is being held.

Roger Lawson

ASOS fire halts operations

A major fire at ASOS’s Barnsley distribution centre late on Friday night (20/6/2014) has caused it to suspend operations. At the time of writing (the Sunday morning following)  their retail web site was still not available to shoppers with a message saying the company had “pressed pause on the ASOS web site”.  It also suggested they expected to be back in operation in the next day or so. It is believed that the fire might have been the result of arson. It is believed the Barnsley site handles most orders taken by ASOS (not just UK ones), and well as acting as a major distribution centre for the goods.

This is not the first time ASOS has been hit by a fire. Back in 2005 they were out of action for several weeks due to the Buncefield oil storage disaster – Buncefield was adjacent to their distribution warehouse. However the company quickly recovered operationally at the time and were covered by insurance but it did hit their financial figures. The shares were suspended at the time.

This is what finance director Jon Kamaluddin said afterwards “We have always known that operating from one site would be an Achilles’ heel for us, but where do you draw the line? Do you set yourself up in two warehouses and incur the cost of running across two operations, or do you accept that this is a risk in your business model and take out insurance to cover that risk? That is the decision we made”.

No doubt we will see whether they learned from that previous event and how good their disaster recovery plan is. But being out of action for more than  24 hours for an on-line retailer is surely not a good sign.

The share price of ASOS has been falling rapidly since March, particularly after the recent profit warning. It has been one of the most traded AIM shares, and one of the largest companies on AIM. This latest hiccup will no doubt not improve the share price when the market opens on Monday, assuming the shares are not suspended.

Roger Lawson

Berkeley Group and Housebuilders

Berkeley Group issued their preliminary results this morning (18/6/2014). For those holding housebuilders shares (like this writer), they are worth commenting on perhaps as investors in such companies seem to be getting twitchy. With Mr Carney hinting that interest rates may rise sooner than expected, house price inflation powering ahead while general inflation remains low, and politicians criticising the Government “Help to Buy” scheme, one can understand why the share prices of many builders have fallen back from their peak.

For example Berkeley peaked at 2777p in February but is 2260p at the time of writing, i.e. down almost 19%, with the results announcement not having any immediate impact. Indeed the financial figures were much as expected.

Berkeley may be of particular concern because they are focussed on expensive developments in London (average selling price last year of £423,000) and people view the London market as particularly over-blown, with lots of foreign buyers allegedly buying “off-plan” and then not occupying the property. This is seen potentially as a target for political action in future because of the shortage of housing for occupation by Londoners. The increase in average selling prices has certainly enabled Berkeley to generate higher profits (up 40% last year) with diluted earnings per share up 34%.

House builders share prices have a strong seasonal effect, and are also cyclical as the housing market is driven by boom/bust in the general economy, and Government interference on interest rates. As Chairman Tony Pidgley says in the results announcement: “The Board is confident that Berkeley has the right plan to deliver long-term sustainable success, but remains alert to the inherently cyclical nature of the property market and the uncertainty surrounding future tax policy and political decision-making. Monetary policy and the financial stability of banks, which is currently a concern of regulators, are both factors influencing the housing market in the long-term. Provided any future increases in interest rates or regulation of mortgages are matched with future wages growth as the economy expands, the prospects for the housing market remain positive.”

Looking ahead, it does seem that investors are getting nervous after a very strong run in the share prices of builders in recent years. The prospective p/e for Berkeley is now less than 10. But the company says it  is on target to return £1.7bn to shareholders by 2021, while providing “a sustainable business thereafter”. The current market cap of the company is only £3bn. Is the share price too low based on the fundamentals, or is the market simply thinking ahead?

Investors Chronicle reported on Bellway in its edition last week. They came to the conclusion that it “is just too cheap” after noting its high return on capital, virtually no debt and strong margin improvement. Indeed this is typical of many housebuilders. They used to be highly geared operators with high fixed costs and low margins. With borrowings to finance large land banks, they were always vulnerable to sales declines. Whenever there was low interest rates and a boom in house buying, they geared up production and then fell flat on their face when business dropped off.  But the picture now seems somewhat different. They seemed to have learned to be more conservative about raising production while enjoying the benefit of selling prices rising faster than costs. So perhaps this time it is different. Trying to predict with certainty what might happen is not easy, but with companies likely Berkeley and Persimmon actually returning cash to shareholders in a substantial way, this should surely minimise the risks.

Roger Lawson

Magna Carta and Bank Nationalisations

There was an interesting letter in the Financial Times on Saturday (14/6/2014) from Prof. Tim Congdon.  As a former Northern  Rock shareholder he pointed out that the latest results from Northern Rock Asset Management (the “bad” part of the bank that was left after the good part was sold off to Virgin) showed underlying profits of £1.16bn. So it has achieved profits of almost £3bn in the last 39 months and is likely to generate a few more billion before the mortgage book is wound up.  

Everyone is surely aware that the company was nationalised in February 2008, with no compensation paid by the Government of the time. As originally expected, it looks like the Government is going to make very substantial profits from the nationalisation. The Government did not permit a normal commercial valuation of the business but passed an Act of Parliament that guaranteed that no compensation would be payable. Prof Congdon points out that the company had shareholders funds of £1.7bn at the time and the stock market valuation had been a lot higher in the past. In addition the traditional role of the Bank of England to provide cash to balance sheet solvent but illiquid banks was subverted by the decisions of Governor Mervyn King, and the failure to step in promptly caused a run on the bank that fatally undermined the whole financial sector. In due course this led to a major decline in the whole UK economy.

Now Prime Minister David Cameron is today talking about how we are failing to promote British values. He seems particularly keen on Magna Carta as an example of how the English established democracy and respect for the law.  One of the key clauses in that document (turned into modern English) reads as follows: “No free man shall be seized or imprisoned, or stripped of his rights or possessions, or outlawed or exiled; nor will we proceed with force against him, except by the lawful judgment of his equals or by the law of the land. To no one will we sell, to no one deny or delay right or justice”.

Clearly these principles were overturned in the cases of Northern Rock and Bradford & Bingley. Decisions were made by the executive branch of the Government and pushed through Parliament that overrode the principle of no confiscation of property without compensation. An appeal to the Courts and ultimately to the European Court of Human Rights proved ineffective because the Courts simply said that the Government had the right to do these things without reference to legal principles (much as in the old days the King would have claimed the same rights to do anything he chose as a “divine right”).

It is for these reasons that former shareholders in Northern Rock and Bradford & Bingley still feel aggrieved. Incidentally there is a meeting for Bradford & Bingley shareholders in Bradford on the 27th September – see www.sharesoc.org/BB-Meeting-Announcement-Sept2014.pdf for more details. One of the speakers will be George Galloway so it should be a lively event.

We surely need a new Magna Carta, i.e. a clear “Bill of Rights”, to re-establish the principle that the Government is bound by the rule of law and a set of principles, not a body with a free hand like former kings.

Roger Lawson

ASOS – when everyone wants out

This morning (5/6/2014) ASOS issued a trading statement before the market opened. It wasn’t all bad in that total retail sales at constant currencies rose by 33% in the last quarter – and there are not many businesses that are growing at that rate. However,  EBIT margin guidance was reduced from circa 6.5% to 4.5% for the current financial year due to increased promotional activity and the relatively higher proportion of European sales. US and ROW sales growth was perhaps seen as disappointing being particularly hit by the strength of sterling.

The share price promptly collapsed. The last few trades the previous day were done at about 4530p. This morning the first trades were reported at 2770p and it subsequently fell further  giving a fall of over 40%. In other words, with large numbers of small trades going through it looked like a typical panic where investors wanted out at any price.

The last time I commented on this company was in September 2013 when the share price was 5110, so it had already fallen back substantially from that level before today. I questioned the fundamental valuation and said “It certainly looks as though buyers have been driving the stock price up not on any fundamental valuation but on speculating on what others might pay for the shares, i.e. it’s the typical ‘tulip’ bubble when stock is in short supply“.

If there is nothing supporting the underlying valuation then share prices can collapse in this way before investors can exit. Now one can argue about how the fundamental value of early stage companies can be calculated – albeit that this was one with a history of profits. But investors who have simply been speculating in these shares should not complain if they have been caught out. You can never get out fast enough from such stocks when they trip up.

Roger Lawson