Can anything stop the Rightmove juggernaut?

A business like this is a rare beast and one that many investors would love to have owned a slice of at some time over the past 18 years. However, it’s a basic law of business economics that high profits attract the attention of competitors who want to grab a slice of the pie. So far, Rightmove has been able to fend off the competition and thrive, but can it continue to do so?

I am going to take a closer look at Rightmove’s business model to see if the good times can last.

The business

Rightmove is the dominant property portal in the UK with a market share of 74 per cent. Its rightmove.co.uk website is one of the most visited sites in the UK, attracting 139m visits per month. It has more than 20,000 advertisers displaying 1.2m UK residential properties on the site.

It makes money by selling advertising and related property data services to estate agents, lettings agents and new home developers. It also advertises overseas properties. The business is dominated by sales to estate agents, which currently account for 76 per cent of total revenue.

Sensational financial performance

Rightmove has been able to consistently grow its revenues while achieving very high rates of profitability. Since 2007, revenues, operating profits and free cash flow have grown rapidly with very little additional investment in the business. Surplus cash flow has been used to buy back shares, with the shares outstanding being reduced by nearly a third.

Source: Company reports. Note the number of shares has not been adjusted for the 10-for-1 share split in 2018

This growth has been achieved while delivering probably the best financial performance of any company listed on the London Stock Exchange in terms of operating margins, return on capital employed (ROCE) and free-cash-flow (FCF) margins.

Source: Phil's calculations

These numbers paint a very compelling picture of how good a business Rightmove is. However, the task of the diligent investor is to try to understand the business behind the numbers and see how Rightmove has been able to produce such numbers. What is even more important is to then work out whether they can stay that way.

Rightmove’s economic moat – the power of network effects

A consistently high share of a market, combined with high profit margins and a high ROCE, is a sign of a business that has a very strong economic moat – something that stops competitors taking business away from it and reducing its profitability.

How has Rightmove built this moat? One of the reasons is that it got into the property portal market before any of its current competitors – something known as first-mover advantage. Over the years, it has built up the number of agent and builder customers and turned that into a brand that property hunters flock to free of charge.

In doing so it has created a powerful network linking property sellers with property buyers that has become more valuable as more people have used it. It has become the go-to website for anyone looking for a home to buy or rent and so has entrenched the agents and home builders who advertise on it within the network.

So much so that leaving the network may have significant negative implications for their competitive position and business health. Rightmove has created a brand and service that has become synonymous with estate agency itself. To leave and go elsewhere is a risk that few estate agents have been prepared to take.

As we shall see shortly, this has given Rightmove immense pricing power with an ability to increase its prices to customers without destroying its business. This has enabled it to grow in a way – with high margins and cash flows – that has allowed it to create huge value for its shareholders.

Rightmove has also benefited significantly from having a low level of fixed costs (mainly technology, wages and business premises) relative to the scale of the business (revenue). It has then been able to leverage those fixed costs by growing its revenues, which has fed through into its impressive margins and returns performance.

We can see this by looking at the company’s incremental profitability and cash generation from its revenue growth. It has been able to deliver very high incremental operating and free cash flow margins – the additional profit and free cash flow that comes from extra revenues.

Sources: Company reports, Phil's calculations

Could Rightmove become the victim of its own success?

Rightmove’s pricing power is best demonstrated by the progression in its average revenue per advertiser (ARPA) per month. This is the average amount of money it receives per estate agency branch and new homes development site. During the first half of 2018, agencies were paying an average £940 per month with home developers paying £1,286. 

The company has been able to achieve this by selling higher-value packages with more services (such as market analysis, valuation tools, lead generation analysis, marketing and branding products), but also with significant year-on-year price increases. At its half-year results in July 2018, Rightmove said that 51 per cent of its agent customers were spending more than £1,000 a month, with 16 per cent spending more than £1,500. Its retention rate of agents was high at 94 per cent.

Back in February 2017, a slide in its 2016 full-year results presentation hinted at an aspiration to ultimately achieve much higher ARPA. The company pointed to the £2,500 per month average that estate agents were spending with local newspapers in 2007. If Rightmove could achieve this in the next decade without losing lots of customers then its shares would undoubtedly be a screaming buy right now.

Some might say that the £2,500 figure is somewhat unrepresentative given the change brought about by digital advertising since 2007 and the pressure on rates. A more pressing point is whether Rightmove can keep on increasing its prices.

If you trawl the internet and read estate agency forums and trade publications you will find that Rightmove and its pricing is a hot topic. There are some agents that think it is very good value for money, but there are also many grumbles about how they perceive Rightmove to be ripping them off and abusing its market position.

Despite a plethora of estate agents on the high street, there can be no disputing that the industry is facing a lot of pressures right now. The market for existing homes is stagnating and profit margins are under considerable pressure.

Agents are receiving fewer selling instructions and have downwards pressure on commissions. Lettings businesses are a more reliable source of cash flow, but with tenant fees due to be banned in 2019 the profitability of this business is likely to decline. The last thing many agents say they need right now is a big price increase from Rightmove.

Some smaller agents have said that the monthly fee they pay to Rightmove is more than the rent they pay on their offices. In some areas where the housing market is weak, the monthly fee is being spread over fewer properties sold and reducing profits.

There is also disgruntlement over the opaqueness of Rightmove’s charging structure. In addition, there has also been some unhappiness over Rightmove’s use of geographical pricing for advertising.  

Rightmove calculates a virtual office to work out its charging for online adverts. It takes the three-month average number of properties advertised and compares that with the 12-month national average of stock per branch. So if an online agent has 100 properties and the national average is 31, Rightmove will charge it on the basis of three virtual offices. It divides 100 by 31 and rounds down to the nearest whole number.

Controversy has arisen due to Rightmove’s definition of a geographic area, which has impacted on agencies advertising properties some distance from their branch. If an agent has more than 50 per cent of its properties advertised outside a 100,000 property radius then Rightmove will calculate the equivalent additional branches and increase its monthly fee accordingly.

For example, if an agency has 100 properties advertised and 60 are outside the defined geographic area. Then Rightmove takes the 60 and divides by 31 and then adds one to the result to work out the number of virtual branches and monthly fee. In this case the answer would be two.

This seems fair enough to me and creates a fairer playing field between bricks-and-mortar and online estate agents. That said, according to a recent article on Property Industry Eye website, it appears that Rightmove may have reduced its definition of a property radius from 200,000 properties back in 2015. If so, then this may well have allowed it to increase its virtual branches and revenue growth rate.

I can see how rural agents might be upset about this. I can also see the argument that it protects existing agents in an area from unfair competition from outside the area.

As far as I can see, rising monthly fees are good for Rightmove as long as its customers have enough cash flow to pay them and they perceive them to be good value for money. It cannot be taken for granted that they can keep on doing this at the same rate going forward.

How effective is the competition to Rightmove?

Given Rightmove’s current 94 per cent retention rate among agents it looks as though the answer is “not very”.

Zoopla looks as though it is an effective competitor and also offers a range of additional tools and analysis to help its customers. It also charges a lot less than Rightmove. In 2017, its average revenue per property partner was £359 – less than half Rightmove’s ARPA.

At its half-year results in May – its last as a publicly quoted company – it said that it had 15,264 agencies as customers in the UK and was advertising 982,000 properties. This makes it not far off the size of Rightmove (17,585 agencies and 1.2m properties).

Given the huge discrepancy in price, it begs the question as to why more agents don’t use Zoopla instead of Rightmove? This may happen in the future, but it is not happening now.

Back in 2015, a group of estate agents set up a mutual portal with the aim of challenging the dominance of Rightmove and substantially lowering their advertising costs. The company is now known as On the Market (OTM) and is listed on the Alternative Investment Market (Aim).

Up until now, OTM has not inflicted any damage on Rightmove. It may never be in a position to do so. Before becoming a public company it was designed to work for its members rather than shareholders. Its current strategy of offering free one-year trials to agents and removing its previous one-other-portal condition has seen it grow its advertising base rapidly to more than 11,000 branches, but the business lost money in the first half of 2018.

The hope is that customers on free trials will start paying and that the portal will become self-financing. While its monthly fees are very cheap (around £250) for paying customers, it may have difficulty convincing customers that it does anything different to, or offers as good a service as, Rightmove or Zoopla. This is evidenced by Zoopla winning back customers who had previously left it for OTM.

This week has seen the launch of Rummage4Property, a portal backed by agents and major housebuilders that intends to charge a flat fee of £100 per month. The business is run by former City property analyst Anthony Codling and shows the belief that a bite can be taken out of Rightmove’s profits.

And OTM and Zoopla have agreed to list their lettings properties on Facebook Marketplace. This seems like a strange decision – as it may see their customers question their service – and it remains to be seen if this will really bring the kind of coverage and leads that will unnerve Rightmove.

Rightmove in a recession

Perhaps it is only a recession and an associated housing market slump that can stop Rightmove’s ARPA and revenue growth?

Rightmove performance in the last recession

Source: Company reports

During the last recession in 2008-09, Rightmove was able to pretty much hold its ARPA and operating profits flat albeit at much lower levels than it is achieving currently. To me, it is the next housing market downturn rather than the current competitive landscape that is the biggest threat to Rightmove’s profitability and progress. It may not be able to hold its prices given that its monthly fees are now a much bigger proportion of an estate agent’s monthly costs than they were in the last recession.

Possible signs of weakness at Rightmove

Rightmove has performed so well that it is difficult to point to any possible chinks in its armour.

Source: Company reports

Two possible signs of weakness are the stagnation in the number of advertisers in 2018 and the reduction in the number of customer leads from its adverts since 2015. The latter may be a sign of a reduction in Rightmove’s effectiveness, but could equally be due to a weakening property market. Rightmove continues to argue that the quality of its leads remains very high and that they are vastly more effective in generating sales for its customers than its competitors’.

Source: SharePad

Judging by current consensus estimates for Rightmove’s turnover growth, City analysts continue to assume that ARPA will increase and more customers will trade up to higher-value products. It seems that a sharp slowdown in the property market is not currently anticipated.

Not much progress is expected in operating margins. earnings per share (EPS) growth is expected to be faster than revenue growth due to the continuing repurchase of shares. That said, profit forecasts have barely changed during the year, indicating that there is not much upwards momentum with the business at the moment.

Rightmove shares have struggled to make progress in 2018 due to its high valuation and concerns regarding its growth prospects and competitive position. However, it remains an outstanding business that is currently selling for just over 23 times on a rolling one-year forecast price/earnings (PE) basis.

If you believe that the company can continue to dominate the property portal market and keep on increasing prices without losing customers, then there’s a case for arguing that the shares are not desperately expensive. This is obviously the view of Fundsmith’s Smithson Investment Trust, which listed Rightmove as one of its top t10 holdings this week.

Those who think that its customers may have been squeezed enough in a weakening UK housing market will stay well clear of the shares.