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Zillow (Buy, $42 PO) Stock view: controversy sounding the mortgage business While we still expect Zillow’s core business to have a solid quarter on product improvements, the self-serve platform, and its recent Seller Boost product, the controversy surrounding Zillow’s mortgage business (which potentially has implications for Zillow’s core business and the retail estate industry} has been a key recent driver of the stock. The Consumer Financial Protection Bureau (CFPB} has indicated that it views Zillow’s mortgage referral system as potentially violating parts of the Real Estate Settlement Procedures Act (RESPA}. RESPA (Real Estate Settlement Procedures Act) is an act designed to product potential homeowners by outlawing kickback and referral fees from real estate services, particularly in relation to mortgage brokers who often receive referrals from real estate agents. Since Zillow’s mortgage referrals involve a pre-application and a referral directly to a mortgage agent that than a larger entity like a bank, this could be violating the act. Mortgage brokers often fund some of the real estate agents online advertising expenses and a crackdown on mortgage agents could potentially hurt real estate agents ability to spend dollars on Zillow. For now it is too early to say how this will develop as there are conflicting views for and against this view with the CFPB not releasing an official stance, but we expect this to be a near term overhang on the stock until a clear view of the CFPB’s view and intentions unfold. While a contentious issue, mortgage revenue is still only 8% of total revenue and even a cut back would have a minimal impact to overall revenue growth. As for the impact on real estate agent spend on Zillow, we believe at with only roughly 5% penetration into real estate agents online spend Zillow has plenty of room to grow the core business and the high ROI of the ad unit will ensure agents buy placements on Zillow regardless of mortgage broker involvement and continue to like the stock. Key theme/metric(s) for 1Q: Mortgage requests and revenue per loan With the controversy surrounding the mortgage business, we think investors will be extra focused on the mortgage unit and focus on the mortgage revenue per loan request and consumer load requests. Zillow will be releasing new metrics this quarter to replace ARPA and premier agent count, but has yet to indicate what those metrics will be. Key topics for the call will likely include: 1) mortgage business outlook; 2) premier agent advertising spend; 3) rentals business; and 4) progress on FY17 goals. Biggest 1Q issues/risks: « — If the CFPB decides Zillow violates RESPA, Zillow could face fines and have to retool its mortgage platform. « New metrics for FY17 could give less visibility into the business as a whole. ¢ Slower than expected penetration of self-service platform leading to increased S&M costs. ¢ Potential for a weak 2Q guide if mortgage issues overhang the business as a whole. Top 1Q traffic data points: comScore suggests usage up in 1Q comScore desktop data suggests that unique visitors were down 5% quarter to date (jan. and Feb.) while usage was up 2% QTD. However, on mobile, comScore data suggests usage is up 14% y/y on a bigger unique visitor base to 62mn unique users and usage was up 7%. We note comScore has made several methodology changes which has impacted the consistency of recent months data. Estimates vs. Consensus: We are above the Street Over rev/EBITDA estimates of $239mn/$40mn is above the Street at $236mn/$39mn. We estimate that ARPA will be up 29% y/y to $629 and premier agent subscribers will be flat y/y at 91.9K. Overall, we estimate 28% y/y growth, but note that the mortgage issues could potentially impact revenue. For rentals and other we estimate $32mn in revenue, up 75% y/y. 48 Internet/e-Commerce | 06 April 2017 Bankof America <2 Merrill Lynch HOUSE_OVERSIGHT_014934