What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing in today's video we're going to talk about one recent high profile. Failure in corporate america zillow an online residential real estate marketplace recently announced its third quarter. 2021 financial results, along with moderately strong results on the top line. They announced the winding down of their home flipping business zillow offers zillow offers as a business.

They started in 2018 that engages in buying renovating and selling houses in an automated fashion. On behalf of the company itself in the conference call zillow ceo rich barton said that zillow offers relied too heavily on the difficult problem of predicting home prices. With the recent cooling off of u.s residential real estate prices, much of zillow's inventory of houses ended up depreciating in value by the time they were able to unload them. As a result, they wrote down a nearly half billion dollar loss on zillow offers.

In the most recent quarter alone, this shock law sent the stock tumbling immediately in this video, we'll talk about what business zillow was in what happened with zillow offers and where that leaves the company today, zillow was started in the early 2000s by richard barton and lloyd. Frink, who both worked for microsoft previously barton had the vision of using zillow to digitize the real estate markets. Traditionally, real estate transactions have inherently been face to face, and in person the majority of the time with real estate professionals called agents. It's the job of real estate agents to connect buyers and sellers for real estate transactions.

Usually both the buyer and seller have their own agents to scout the market and represent them in negotiations in general. Whenever there's a situation where each transaction is done with a large amount of in-person dealing and communication, the possibility of digitizing and putting things online is always a consideration in the real estate industry. That's where zillow comes in zillow helps connect home buyers and sellers through their online marketplace. On zillow.com, sellers can list their homes for sale very easily, and buyers can instantly search for homes that fit their geographic area and other factors.

This was a big change from the incumbent system dominated by the mls. The mls, a paid service primarily only used by full-time professional, real estate agents, is a tool that solves the same basic problem of connecting buyers and sellers. The value add from zillow was that anyone can use it to show and view listings whether they want to use a real estate agent or not. This went a long way towards making the residential real estate market more efficient for more than a decade.

Zillow operated this marketplace as its main product. They made money by offering professional services and marketing products to real estate agents on their platform, but the total addressable market for these products in the residential real estate market was clearly capped. There's only so much revenue. You can hope to generate by maintaining a marketplace website.

People only use a few times a year at most. So in 2018 they announced a new radical business idea for a company of their size, large-scale professional house flipping in their 2018 annual press conference. The ceo of zillow touted their new house slipping venture as a huge step for the company rich barton, particularly emphasized that it quote dramatically increases their total addressable market. Unquote, they increase their borrowing capacity by a billion dollars to prepare to buy and renovate large numbers of houses which they did do.

Take a look at this chart of their total and current liabilities over the history of the company, which you can see for yourself on our website wallstreetmillennial.com. You can see that in the third quarter of 2018, they nearly doubled their long-term liabilities in blue to about 700 million dollars. Then, a year later, their long-term liabilities ballooned to one and a half billion dollars all the while their current liabilities, which means mainly short-term debt, increased every quarter to more than 900 million dollars by the end of 2019.. This was all mainly to fund their purchases of houses to flip, but unfortunately, the house flipping proved to be unprofitable.

Flipping houses is traditionally something that individuals can do on a small scale to make profits in the range of tens of thousands or sometimes hundreds of thousands of dollars. It requires extensive knowledge of plumbing electrical interior design and sometimes even construction in order to be successful. On top of that, it needs careful attention to the local market dynamics of the real estate markets in which the flips are being done, and even if everything is done right, a downturn in the market can make flips unprofitable. Here's ceo rich barton on cnbc, reflecting on what happened with zillow's house flipping business.

This was a necessary decision. We just determined that being an eye. Buyer was too risky, too volatile and ultimately addressed too few customers too narrow. So so i mean i i guess some could have suggested to you before you did it that it's going to be volatile and unpredictable and obviously change the sort of uh predictability of your earnings flow.

So to to what extent was this a sort of i told you so moment to some people that said that in the first place we went into the business as a big swing um on the bet that we could actually predict the price of a home? Six months into the future, and do so with a very narrow margin of error and have our hold times be very short. The key is that the success of doing house flipping on a scale as large as zillow requires having very accurate models to predict what the value of a house is and what the value of the house would be after some amount of renovation. The problem is that that's not something that can be easily evaluated by a computer. A machine learning algorithm cannot effectively utilize information about things relevant to a house price as nuanced as, for example, if the floor layout doesn't make sense, a house might appear to an algorithm to be undervalued based on things like total square footage, number of bedrooms and bathrooms.

Comps, etc. But if that's the case, because the house is on a septic system that cost tens of thousands of dollars to get rid of, for example, that might explain why the house isn't actually worth what it might seem on paper. A human buyer would be talking to the seller's agent and learning all these factors on a case-by-case basis, but an algorithm applied to tens of thousands of flips like what zillow was doing, might end up buying all these types of situations. Thinking that's getting a great deal when reality it may not among the investing community.

There were doubters about the idea of zillow offers from the very beginning, the low profit margins and capital intensive nature of the business were always seen as less desirable than zillow's core business. The inherently human and situational reality of house flipping led some to predict that the idea would fail from the beginning: here's steve iceman an investment manager famous for shorting the real estate market in 2008 and being portrayed in the book, the big short back in 2019. I would say: zillow has one of the most flawed business models, i've seen in a very very long time. They had a good business which was their internet real estate platform.

The growth in that has slowed dramatically so that now the growth is zero and in that business they're having real problems um, they like to say that they're experimenting with new pricing, but really what they're doing is they're trying to change the pricing of their entire business. That's a problem. The part of the business i find the most problematic is what they call their. I believe i home business internet buying business where they actually go out and buy homes and flip them.

I actually think the company doesn't understand the risk. The real risks of this business, which are massive and one of the ways you can see that is last night on the conference, call the first words out of the ceo's mouth. When he talked about this business was the how big the tam was, the totally addressable market and, of course, the real estate market in the united states is very, very large. But it's a misapplication of the word tam to apply it to the real estate market because there really is no tam in the way people think about it.

In terms of the internet, there are thousands of mini markets all over the united states, they're all local they're. All extremely different, they all have incredibly different risks. For example, did you know that in dallas there's a problem that many many homes have cracked foundations? These type of different problems exist all over the country. This is a capital intensive business.

I know i know only one thing for certain between now and five years from now assuming the company has some level of success, there will be massive problems that they will uncover. I'm sure there'll be write, downs, i'm sure there'll be impairments, and i'm convinced that the investor base doesn't have a clue about what this business is. Really all about. Zillow now sits on 7 000 houses that they are trying to unload onto the residential markets all across the country and is laying off a quarter of all of its employees as it tries to backpedal on its failed house flipping business.

Although the stock is down massively since the news broke, the reality is that zillow's core business is still strong and actually a very good business. They call it the imt segment. It makes a very high profit margin of close to 30 percent and is incredibly capital light. It's the essence of a tech company.

This part of zillow might not be growing very fast, but it's not like the company is now doomed to fail. If the stock price gets low enough, it may be worth it to investors to consider the stock based on the merits of its non-house flipping businesses, alright, guys that wraps it up for this video. What do you think about richard barton's house, flipping debacle? Should he have known not to do it back in 2018? Let us know in the comments section below, if you enjoyed this content, make sure to hit the like button and subscribe. So you don't miss future videos in the meantime.

Thank you. So much for watching and we'll see you in the next one wall, street millennial, signing out.