Rightmove plc (RMV) operates a property portal in the United Kingdom. The company operates through Agency, New Homes, and Other segments. The Agency segment offers resale and lettings property advertising services on its platforms.
The New Homes segment provides property advertising services to new home developers and housing associations on its platforms. The Other segment offers overseas and commercial property advertising services; and non-property advertising services that include third-party advertising and data services. The company serves estate agents, lettings agents, and new homes developers.
We’re going across the pond in this case study to find out how RMV generated those returns. More importantly, we’ll discuss the reasons for their success, what investors were thinking at the time, and what we can learn from the company’s early days to help us spot tomorrow’s winners.
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Giving Customers A Stake In The Company
It’s February 2006 and RMV is on the heels of going public. It’s at this time the company offers something I’ve never seen until doing this case study. They offered initial IPO stakes to their customers. Real estate agents and developers. RMV’s customers had the chance to invest in the company at IPO.
At first glance this looks like a fleeting story that gets left-for-dead when discussing RMV’s past. But it was a masterclass in product confidence. Think about it. You’re so confident your company will do well that you offer initial shares to the ones that use it the most.
You can read the snippet from the February article on the left.
Network Effects, High Growth, Operating Leverage and a Cheap Price
At the time of IPO, Rightmove was the UK’s largest property listing site on the web. The company commanded 79% market share in total pageviews for a property site. 24/25 top real estate agents listed their homes exclusively on Rightmove. 25/25 of UK’s largest home developers listed on Rightmove. They dominated everything, even the internet. 82% of UK homebuyers that bought their home on the internet used Rightmove.
It’s the classic network effect business model. More home listings means more people visiting the site. More people visiting encourages agents to list their homes on Rightmove. Seeing all the people buying, home developers list their projects on Rightmove. All this reinforces that tremendous network effect. Soon enough, an impenetrable ecosystem is born.
Crazy Revenue Growth
Here’s the revenue growth numbers from 2005 to the end of 2007 (their first year as a public company):
But that wasn’t even the best part about RMV’s model. The company had 100% gross margins and quickly scaled to 50%+ operating margins. How could they do this? A capital-light business model.
RMV’s largest expense was SG&A. As soon as they leveraged those fixed costs, more incremental dollars in revenue dropped to the bottom line.
Cheap Price For Operating Leverage
Operating Margin grew from 27% in 2004 to 53% by 2008. In other words, SG&A was 72% of revenue in 2004 and dwindled to 48% by 2008. That’s powerful and you can see it in the company’s pre-tax profits.
Despite this massive success, the company’s stock price rose a mere 18% from IPO to the end of 2007. RMV ended 2007 with a $609M market cap trading at 21x 2007 pre-tax profits ($28M).
RMV’s Early Days: Inside The Analysts’ Minds
Buying IPOs on the first trading day is always a gamble. Those that invested pre-IPO are quick to take profits. And short-term traders look to catch intraday tops for a swing-low profit. RMV wasn’t spared in its market debut. The stock fell 30% in its first five months of trading. But by mid-July 2007 it sat on a cool 60% gain from its IPO.
What were analysts thinking at the time? Let’s head to a March 2006 article from Mortgage Strategy …
RMV’s stock resembled a toddler’s attention span. Down 11%. Up 12%. Who knew what the next day held.
Hilary Cook, director of investment research at Barclay’s Stock Brokers said of the stock (emphasis mine), “ “The price seems expensive for what is essentially an online estate agency but it is a popular business with a good brand name so no wonder it’s so popular.”
Cook was referring to RMV’s network effect. But she questioned whether the company deserved such a “lofty” post-IPO price. Time and time again: the best stocks always “seem” expensive. At least that’s what Cook thought.
But others weren’t as rosy about the company’s future. One source (from the article above) insinuated that a catalyst was to blame for RMV’s share price advancement. And if you removed the catalyst, the stock would face serious trouble.
Catalyst & First-Mover Advantage: Home Information Packs
In 2007 RMV had one major catalyst on the horizon: Home Information Packs (HIPs). Frank Eve, managing director of Frank Eve Consulting, explained HIPs in a Mortgage Strategy article (emphasis mine):
“The development of Home Information Packs is a govern-ment-led initiative that should provide greater transparency for the home buying and selling process. It is proposed that HIPs will be mandatory early in 2007 as a result of the Housing Act 2004. As I have explained in previous articles, HIPs are a compilation of various documents that are normally associated with the sale and purchase of a residential property. The contents of a HIP will be defined in regulations being published this year although it is expected that it will include a report on the condition of a property in the shape of a Home Condition Report, From early 2007, a HIP will be needed on a property before marketing begins.”
RMV moved first and fast. They developed an in-house HIP portal where sellers could store HIP-mandated documents. The company also created a HIP-specific sales agency to help agents deal with HIP documents. But the most important thing RMV did was defer the HIP payments until closing.
Frank reveals why that was such a great move, saying (emphasis mine):
“But the big news is that it has agreed a scheme for the sellers to defer the cost of a HIP so they won’t have to pay for it until they complete the property. This is important and ensures the market has a sustainable option rather than hav-ing to pay for a HIP upfront. It also sends a message to competitors that HIPs will also have to be funded upfront by anyone trying to compete with the Rightmove service.”
RMV moved first and established the “rule of law” in the real estate listing industry. Creating dedicated HIPs technology and offering deferred HIPs payment meant competitors had to do the same. Why would anyone choose a competitor if they didn’t offer deferred HIP payments and a dedicated HIP sales team?
The company jostled on whether to build the HIP software in-house or buy a bolt-on model. Here’s the reason they decided to build in-house (emphasis mine):
“Rightmove understood there was a huge spread of risk involved. Of the many HIP applications reviewed, it felt few had any chance of success. Even the better ones were modifications of existing conveyancing case management systems and raised concerns about the ability to scale up to handle the integration complexities of the HIP market.”
We’re seeing a theme early in the company’s history. The theme is creating the best experience for RMV’s customers. It cost RMV $8.5M to develop the in-house HIP technology and workflows. That’s no chump change. But they did it to service their customer. To make the real estate agent’s job easier.
RMV management knew their business. They knew the power of network effects. Keeping real estate agents happy meant more listings on their site. Which begets more homeowners searching on their site.
As the source above noted, all this investment meant nothing if the UK government does a U-Turn on the HIPs regulations. And a U-Turn is what they got.
When Catalysts Fail, Rely on Core Business
After spending nearly $9M on HIP compliance technology and sales staff, the UK government nulled the initiative. By July 2006 all RMV investment in HIP came to a halt. And with it, a return to focus on their core business.
The news sent share prices plunging 20%+ in a day, and within a week they were down 30% (see chart below).
It’s easy to get scared by the headlines. But the fact remained RMV had a fantastic core business growing revenue 60%+ and expanding operating margins 30%. Going forward, it was the core business that mattered most for long-term success. Not some UK-parliament deal.
RMV management knew this. Miles Shipside, commercial director of RMV commented (emphasis mine):
“We were well placed to be a major player, but are reviewing our position regarding HIPs. Luckily, we have a strong core business. We are disappointed in the change in the government’s policy, but we knew the risks.”
So yes, that source was right in how the market would react to the news of a HIP deal falling through. But what that source missed was RMV didn’t need HIP. The company’s core business still had tremendous network effects.
What The Analysts Got Wrong: Network Effects & “Expensive”
The bear case for RMV was simple. The company was a small-cap internet real estate listing service that had little competitive advantage against its peers. There was a free listing service hitting the market soon, and profits are subject to the gyrations of the housing market.
Mistaking Network Effects As Only “A Good Brand”
Analysts misunderstood a “good brand” for serious network effects. There’s a huge difference. A good brand affords you goodwill with your customers. Yet there’s no incremental value. Hostess Twinkies built a tremendous brand. But the Twinkie itself doesn’t taste better to me the more other people eat it.
Network effects on the other hand add value the more users join the platform. In RMV’s case, the 10,000th user provides more value than the company’s 100th user. The 10,000th customer benefits more than the 100th customer.
Mistaking RMV as Expensive
Barclays analyst Hilary Cook said RMV “seemed expensive” during the company’s first year of trading. The company traded at 21x its 2007 pre-tax profits. Granted, that’s not “cheap”. But is it expensive when you consider the company’s torrid growth phase?
Between 2004 – 2007 RMV grew operating income 227% from $8.6M to $28.12M. Let’s consider growth by taking the EV/EBIT and dividing it by the annual EBIT growth rate: 21.6x / 75 = 0.28x.
That means by the end of 2007, RMV traded roughly 0.28x its Price / EBIT Growth. Expensive? I don’t think so.
So far we’ve discussed RMV’s history from IPO to 2007. Now let’s examine the most turbulent time in the company’s history: 2008 – 2009. The Great Financial Recession.
Focus On The Business: Navigating The Housing Crisis
A housing crisis isn’t the best thing for an online real estate listing company. Nobody wanted to buy a home during the GFC. In fact, not many people could buy a house. Millions of people were without jobs. Home developers stopped building houses.
How would RMV — a company that lives on people buying homes, agents selling homes and developers building homes — survive?
Let’s take a look at their 2007 – 2010 financials (see below):
RMV experienced one 6% decline during the GFC. That’s incredible for a housing company whose revenues should’ve tied to the general housing market.
Let’s look further down the income statement to Operating Income. Notice RMV operating margins. They grew during the GFC. It’s this operating leverage that kept RMV alive and thriving during one of the scariest housing downturns in history.
They did this in three ways:
- 100% Gross Margins (zero cost of goods sold)
- SG&A is the largest operating expense
- No debt and very low D&A expense
Nowhere is this competitive advantage more visible than RMV’s Operating Margin trends (see below):
Look only at the company’s business performance and unit economics and you see a great business. You don’t see a stock price. But if you did, you’d expect maybe a slight dip in the stock before a rapid thrust higher. Here’s what actually happened to RMV’s stock price during those years:
Between 2007 and 2009 RMV’s market cap declined 75% peak-to-trough. Yet when you look at the above income statement you don’t see a company losing 75% of its market cap. While RMV stock declined 75%, the company grew revenue $13M, operating income $10M and expanded operating margins 800bps.
That’s every long-term investor’s dream: a declining share price with increasing improvements in business economics.
We’ve developed the Macro Ops Composite Score (MOCS) to remove share price bias from the fundamental business analysis. Let’s run Rightmove through the MOCS system to see how they would’ve scored during their early trading years.
The Rightmove PLC MOCS Report
RMV scored a whopping 90.6 on the pre-Garbage Bin MOCS. That puts it in the 90% percentile of companies and square in the “Why don’t we own this stock?” range.
A few categories drove most of RMV’s score:
- Moat: 20/20 points
- Financials: 16.50/20 points
- Potential: 17/18 points
These categories represent the highest weighted scores in the MOCS report. It reiterates the importance of what makes a Super Stock:
- Strong, durable balance sheet
- (Widening) Competitive Advantages
- Massive industry/secular potential
We reduced RMV’s score by 3 points after running it through the Garbage Bin Test. The company lost points on industry disruption (more companies moving online) and outside forces (housing market).
That leaves us with an 87.6 MOCS, falling under the “Why haven’t we invested?” ranking. It’s also one of the highest-rated companies we’ve studied.
You can check out RMV’s MOCS score here.
Review: Network Effects, Operating Leverage, and A Great Business Model
Like most Super Stocks, the bull case rested on a few key variables. First, the company needed to expand its user base and real estate agent base. The more agents and users on the platform, the more valuable that platform becomes to both homebuyers and agents.
Having the most users and agents incentivized home developers to list their properties on Rightmove. This meant more eyeballs on the homes and more homes sold.
In turn, RMV operated an asset-light, low-cost business model. The company’s highest expense was SG&A, which stayed flat as revenue increased. This allowed the company to navigate the GFC with ease while growing operating margins 800bps.
Here’s a stock screener that would’ve picked up RMV during 2004-2005:
- Revenue Growth YoY: 25% or Greater
- Operating Margin: 20% or Greater
- Current Ratio: 1.5x or Greater
- Market Capitalization: $1B or Less