AGB 2021.21 - CoStar Group (CSGP)
Expanding TAM within Real Estate
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“We have a strong track record of buying slow-growing companies and accelerating their growth rates. Today, Apartments.com is six times the size it was when we acquired it, LoopNet is over four times, Real Estate Manager is almost six times as big, and COMPS.COM is over eight times as big. Most of these companies were growing in the low-single digits, if at all, when we acquired them, and we then accelerated them to strong, consistent double-digit growth.” – Founder and Chief Executive Officer, Andy Florance, on CoStar’s F20Q3 Earnings Call
CoStar is the leading data provider of commercial real estate information in North America. The company’s core offering, CoStar Suite, is a proprietary database that is provided to customers as a monthly or annual subscription. Customers include brokers, owners, developers, landlords, property managers, financial institutions, government agencies, etc.
The company also operates various online marketplaces where advertisers can list their commercial properties for rent or for sale and where users can access these listings to rent an apartment, rent commercial space, or purchase commercial real estate assets. CoStar does have some exposure to international regions like the U.K., Spain, Canada and Germany, but more than 96% of the company’s revenues is generated in North America.
CoStar was founded in 1987 as a pureplay commercial real estate information provider. Andy Florance founded the company after selling his previous company that provided monthly leasing guides of commercial real estate transactions to brokers. Through a team of over 1,850 researchers, the company continues to add to its proprietary database of for-lease and for-sale listings, building photographs, demographics, maps, floor plans, vacancy rates, average rents, etc. These researchers make over 50k calls per day to keep the database current and sometimes even painstakingly canvas cities and towns for up-to-date for-sale and for-lease data in their cars while working on their laptops.
CoStar Suite has specific modules which include Property, Comps, Tenant, Market Analytics, Lease Comps and Public Record. There are over 6.7M properties tracked with 34M digital images in the database. Over 160k customers subscribe to CoStar Suite and most commercial real estate transactions in North America involve a CoStar user (83% as of 2017). CoStar Suite made up 40% of the company’s FY20 revenues.
The company has been highly acquisitive within the real estate sector over the past decade. Most notably in 2012, CoStar acquired LoopNet, a competing provider of commercial real estate information, though it was well known that CoStar’s database of information was more complete and accurate. LoopNet also had a marketplace business where brokers could list properties that were for rent or for sale. The marketplace had both a free listing and a paid listing feature, which brokers could utilize to prioritize their properties under certain search criteria. The collective information that brokers would enter onto LoopNet would then be packaged and sold to customers if they wanted a light information package that was 5x-10x cheaper than CoStar Suite.
LoopNet along with Ten-X (an online auction platform for commercial real estate, both distressed and performing), LandsofAmerica (online marketplace for rural land), and BizBuySell (online marketplace for small businesses and franchises) made up 16% of the company’s FY20 revenues. LoopNet brings in almost 8M unique monthly users to the site.
After LoopNet was acquired, CoStar learned (through some experimentation) how to operate and generate above average financial returns from an online real estate marketplace. In 2014, the company acquired Apartments.com, one of the leading online listings services for apartment vacancies. Investors were skeptical that CoStar could have similar success in operating an online multifamily marketplace but the company leveraged its learnings from running LoopNet to successfully increase its market share in multifamily after the acquisition closed.
Apartments.com sells advertising packages to owners to list their properties on the site. CoStar has grown the number of properties listed on Apartments.com since the acquisition and now the site has over 60% of properties with over 200 units and 40% of properties with 100-199 units. Apartments.com, along with ApartmentFinder.com, ForRent.com, WestsideRentals.com and ForRentUniversity.com, have over 180M rental updates per month, 45M renter visits, more #1 organic search results on Google than all other competitors combined by a factor of 10x and over 52k paying customers that list on the sites. Collectively, the multifamily segment made up 36% of the company’s FY20 revenues.
The final segment is information services, which is comprised of CoStar’s Real Estate Manager (lease accounting software), Risk Analytics and the STAR Report (data on the hospitality industry). Information services made up 8% of the company’s revenues in FY20.
Historically, CoStar has overdelivered on its medium-term financial targets. The company initially gave out its 2018 target of $1B revenue run-rate and 40% EBITDA margins in 2014. Through many of the successful acquisitions mentioned above and strong organic growth during the period, CoStar finished 2018 with a revenue run-rate of $1.2B with EBITDA margins of 44%. The company’s current target for 2023 is to reach a $3B revenue run-rate with 40%+ EBITDA margins. The growth to $3B revenues implies a CAGR of +19% for 5 years. Over the past 10 years, the company has achieved an average organic revenue growth rate of +15% and growth from M&A of +8%. CoStar expects that organic growth will be the main contributor to reaching the 2023 target.
Why is it a good business?
CoStar’s core business of providing commercial real estate data benefits from intangible assets. Similar to a SaaS offering, Costar Suite is mainly sold as a subscription at one-year terms that renew automatically. This way, the company is encouraging customers to use the product as much as they can to run their businesses and if CoStar Suite ends up providing value, the company can upsell add-on modules or bigger license deals (more users, more geographies). This allows for annual price increases of 4%-6%, which ends up contributing almost 2% to growth for the company. Renewal rates for this business are very high (over 95% of long-term customers renew each year) and the product is very sticky as renewal rates only fell to 85% during the lowest quarter of 2009.
The database that CoStar provides is the most comprehensive in the industry with over 30 years of development and almost $1.5B spent. The number of properties with information on CoStar’s database has grown from under 1M in 2000 to over 6M in 2021. As the company and the database have gotten larger over time, CoStar is becoming more essential in performing analytics and forecasting, such that the company is able to be stricter with customers paying for their services. Discounting has declined over time (although market conditions may also be contributing to this) and the company has successfully been able to prevent users from sharing log-ins within companies.
CoStar’s marketplace businesses like LoopNet and Apartments.com benefit from network effects. While it’s arguable that the competitive advantages for these businesses are not as strong as CoStar’s commercial real estate database, the 2-sided marketplace businesses are leaders in their respective categories. LoopNet attracts the most users (almost 8M MAUs) which in turn attracts brokers to advertise their listings on the site. Similarly, Apartments.com has the most prospective renters and rank highest in Google Search rankings, which makes it easier for the company’s salesforce to convince property owners to advertise on the site.
Ancillary benefits from owning these marketplace businesses is that CoStar gets even more proprietary transaction and listing data that can be looped back into CoStar Suite.
CoStar has also strengthened its competitive positioning by improving assets after the company has acquired them, resulting in new revenue streams. For example, potential renters can now apply directly for a credit, income and background check on Apartments.com so that they don’t need to fill out multiple applications when looking for a new lease. The biggest benefits to these renters are the lower costs to filling out just one application and the time saved from the site filtering which available units these renters qualify for.
CoStar has also been very effective incenting the salesforce to perform actions that are better for the long-term of the company. After fixing and retooling the LoopNet product after the acquisition, the CoStar salesforce was required to sell LoopNet products (20% of the quota before accelerators kicked in) so that the company could grow LoopNet as an advertising marketplace. This was included in the compensation plan until the pricing tiers for LoopNet were close to being rightsized and then the company carved out a portion of its salesforce to be solely dedicated to selling LoopNet.
Another example is when the Apartments.com salesforce was incented in 2016 to have face-to-face meetings with property managers to build stronger relationships for future advertising opportunities. The company had over 100k meetings during the year and this paid dividends in the future as evidenced by the market share gains.
And lastly, the company has evolved into becoming more balanced to the economic cycle after the multifamily and Ten-X acquisitions. Apartment advertising is countercyclical because consumers tend to trade down during times of economic hardship and there in an increase in vacancies. This was the especially the case in 2020 when property owners turned more to online advertising to fill vacancies. And naturally, Ten-X which was founded during the ‘08/’09 financial crisis, tends to get more distressed property auction opportunities when there is a downturn in the commercial real estate industry.
Returns on incremental capital?
Over the past 10 years, CoStar has spent most of its capital on acquisitions (74%) and the remainder on R&D (21%) and capex (5%). Acquisitions are more sporadic than R&D and capex but collectively, CoStar has been able to generate high returns on its capital. R&D is mainly comprised of software development and research costs related to the proprietary database.
CoStar’s acquisition strategy has been to expand into adjacencies within real estate by acquiring a leading company in that space. The company then right sizes the cost structure and evaluates all revenue categories, even shutting down revenue streams if necessary. Then CoStar invests heavily in the business to improve the product, get the customer acquisition strategy correct, and increase awareness of the product. And finally, the company looks to create new revenue streams on top of the data created from the acquisition. For example, Apartments.com led to more multifamily data created on the platform, which allowed CoStar to package and sell that data to property managers that use it to set rents and to developers that need to analyze the profitability of new multifamily construction.
While some may view CoStar’s acquisition strategy as dilutive to the quality level of the company, the path to which CoStar got to where it is today actually makes sense. First, the company built the largest and most comprehensive dataset related to commercial real estate and sold that as a subscription product. We have to remember that without CoStar, a lot of this information would not be available anywhere else. Unlike equities, fixed income and even residential real estate there is no central data repository for commercial real estate.
Then CoStar entered the online marketplace business for commercial real estate with LoopNet. Leveraging that expertise, the company then entered into the online marketplace business for multifamily residential property. And with that expertise, CoStar has recently entered the residential real estate software and advertising business.
LoopNet was acquired in 2012 for $883M or 7x revenues. The company had identified synergies of $20M at the time of the deal but captured much more over the years. At the time, LoopNet had 5.8M registered users on the site and 3.6M monthly active users. Because LoopNet also had an information offering (some even called it CoStar lite), there was a lot of regulatory scrutiny when the deal was announced. It took over a year to close. Under the terms with the FTC, LoopNet had to divest its minority stake in Xceligent, which was an information service similar to CoStar. There was also a 5 year FTC consent order which ended in August of 2017.
Even with the restrictions on how CoStar could compete using LoopNet during those early years, the company created value under two phases. The first phase was to convert the existing LoopNet customers on the information side to CoStar Suite. CoStar sales professionals called on over 100k brokers that were on the platform (it was estimated that only 20k were paying customers of LoopNet) to explain the advantages to subscribing the CoStar, which wasn’t that easy of a sell due to the 5x-10x higher price point for CoStar Suite. The conversion rate was around 40%. This first phase lasted 18 months and resulted in over $100M in incremental revenues.
The second phase was to improve the advertising side of the business. First CoStar removed all the free listings on LoopNet. This removed any possibility of a transaction being facilitated on the platform without CoStar directly benefitting from it. Potential advertisers were then divided into 24 groups and targeted with different price tiers according to their profiles and user activity. This optimized pricing for LoopNet. Phase 2 is expected to result in over $100M in incremental revenues as well. Collectively LoopNet has increased revenues over 4x since it was acquired.
Apartments.com was acquired in 2014 for $585M or 17x EBITDA. CoStar was able to bring that multiple down to ~11x after cost cuts but the revenue increases after the acquisition tell the main story. At the time of acquisition, there were 18.5k paying advertisers of the 450k properties on the site. After rightsizing the cost structure, the company heavily invested in TV and digital marketing, increasing its share of all multifamily related internet traffic. CoStar invested over $100M in 2015 and that number jumped to $150M in 2019 and $250M in 2020. More than 45M potential renters visit Apartments.com and CoStar’s other multifamily sites each month. There is clear separation from the competition when it comes to engagement, unique visits and page views.
CoStar has acquired other multifamily sites such as ApartmentFinder.com, WestSideRentals.com and ForRent.com. With the growth in the Apartments.com operation, these other sites experienced slowing growth and financial hardship before they were acquired by CoStar. And with the backend investments already in place, the company was able to cut costs massively post acquisition. For example, ApartmentFinder.com was acquired for $173M or 7.6x EBITDA but the multiple was reduced to just 2.4x after removing cost redundancies.
HomeSnap was acquired in 2020 for $250M or 6x revenue and Homes.com was acquired in 2021 for $156M or 10x revenue. HomeSnap is the #3 or #4 marketplace in residential real estate purchases after Zillow and Redfin. Both sites service real estate agents, and while there is a lot more competition in this specific area of real estate, the company has the expertise from improving marketplaces in commercial real estate and multifamily residential real estate. CoStar has admitted that these acquisitions will take longer than previous acquisitions for them to achieve scale and to effectively compete against the larger competitors.
Ten-X was acquired in 2020 for $188M or 3x revenues. Ten-X is the leading digital auction site for commercial real estate transactions. The platform transacted on $24B in asset sales, commanding over 90% of all digital commercial real estate transactions. Because the business is countercyclical, revenue had been declining since 2015 but the company believes that it can grow the non-distressed portion of the business.
We estimate that CoStar has generated returns on incremental capital between 17%-25% over the past 4 years. Because the acquisitions tend to be lumpy (though the company is very active) and CoStar invests heavily into the acquisitions for future growth, the returns tend to fluctuate somewhat. During years of heavy reinvestment, the returns look more muted because the purchase multiples tend to imply lower returns than the company average. However, as CoStar rightsizes the acquisitions and invests for growth, the return profile looks much better in future years.
CoStar’s addressable market continues to expand as the company enters new markets. At the time of its IPO, the company was often questioned about its limited TAM and this was fair given that CoStar was just an information provider of commercial real estate data at the time. The company has reinvested its excess cash to expand its TAM over the years in multifamily, commercial real estate marketplaces, residential real estate marketplaces and software, and commercial real estate digital auctions.
When CoStar acquired Apartments.com, the TAM was estimated to be $2B, given the types of properties that were advertising on the platform at the time. The company has been able to move down market to successfully get owners of smaller units to advertise on the platform as Apartments.com has grown its market share against the competition. Apartments.com currently captures 60% of the properties with over 200 units and 40% between 100-199 units.
Further down market to properties under 100 units, CoStar’s market share gets more thin, but herein lies the opportunity. Through some branding efforts, the company can promote its other multifamily marketplace sites to capture the smaller property market. It’s estimated that CoStar’s addressable market in multifamily is $8B-$10B.
LoopNet’s addressable market is smaller but very meaningful at $2B-$2.5B. CoStar Suite is still underpenetrated in non-broker users such as owners, investors and lenders. Only 10% of commercial property owners are clients of CoStar Suite. Just for reference, CoStar Suite generated $665M in revenue in FY20, implying a TAM of almost $7B.
And Homes.com + HomeSnap compete in a very large market with Zillow and Redfin being the largest players in that space. Residential real estate brokers pay $10B for software and marketing per year.
With a reinvestment rate between 60%-120% and a return on incremental capital between 17%-25%, we estimate that CoStar has increased its intrinsic value between 15%-20% over the past 4 years. As mentioned before, because the reinvestment rate is high and it tends to fluctuate depending on the size of the large acquisitions in any given year, the returns look lumpier than they are. The company continuously looks to make acquisitions in adjacencies within real estate. We expect that the reinvestment rate will remain elevated as the company is looking to deploy its excess capital that it raised during the second quarter of FY20.
What else is important?
With the lockdown measures and most companies adopting work from home policies, the impact was different across segments within real estate. Office and parts of retail were negatively impacted while multifamily and single family residential saw a boost in demand. And because CoStar’s products are natively digital, the company benefited from Covid much more than even the company had expected.
Preparing for a drawn-out downturn, the company raised capital in the public markets through an equity offering of 2.6M shares at $655/share (pre-split) for $1.7B in proceeds. CoStar also raised $1B in debt. Some of this cash was used to make acquisitions like Ten-X and HomeSnap but the company did raise more than it needed.
Operationally, the company quickly pivoted to virtual service demos in the sales process and increased paid digital, retargeting and social media marketing to gain market share, especially in the multifamily segment. As mentioned before, demand for apartments are countercyclical in nature and the company used that opportunity to further solidify its lead in multifamily. For CoStar Suite, the company paused price increases for the time being.
Antitrust concerns for future acquisitions
One of the main reasons TAM has always been an issue with CoStar is that it’s difficult for the company to make acquisitions to grow its core CoStar Suite product. And because the product gets better each year and the company is able to implement annual price increases, it’s difficult to estimate just how much customers are able and willing to pay for the data product.
The company’s acquisition of LoopNet was drawn out due to antitrust concerns and eventually closed with many conditions: (1) divesting its minority interest in Xceligent and providing a one-time contact data download of customers who placed listings on LoopNet, (2) data downloads of any customers of CoStar Suite in any city that Xceligent enters over the following year, and (3) requiring CoStar to offer customers a one-time opportunity to break their contracts early without penalty.
Even in the multifamily space, CoStar has faced regulatory concerns over M&A. In 2020, when RentPath was undergoing bankruptcy proceedings, CoStar reached an agreement to acquire the company for $588M. After many months, the FTC filed an administrative complaint and a suit in federal court to block the acquisition for competitive reasons. The concern was that CoStar would then have too much market share at 70% of the 200+ unit property owners and 50% of the 100-199 unit property owners advertising on CoStar’s sites.
While the company has operations internationally in the U.K., Spain, Canada and Germany, this is still a very small portion of the company’s revenues at ~3%. CoStar did get more international exposure with the STR acquisition (data provider for the hospitality industry) in 2019 but it still remains very small. To make meaningful strides in gaining market share internationally, the company will likely have to make more acquisitions in the future, but at least these may be viewed more favorably by regulators.
The roadmap will most likely be first expanding CoStar Suite to include international datasets, which will require heavy investment of opex. The company has started this process in 2021 in a handful of cities in Europe, but this will take many years to build a competitive dataset from the ground up. Any acquisitions that can speed up that process will be very helpful to gaining meaningful traction quickly. CoStar expects that international is 2x-3x the market size of the U.S.
After making headway with CoStar Suite internationally, the company can then rollout a similar playbook that was used in the U.S., acquiring companies in product adjacencies like marketplaces, auctions, multifamily, etc.
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Fantastic overview thank you
Thank you very much, I didn't know the company but I'll take a look after your interesting article!