Zillow Inc’s (Z) Offer For Trulia Inc (TRLA) Is A Hail Mary

Wall streetDavid Trainer: Zillow Inc (NASDAQ:Z) agreed on Monday to acquire fellow real estate listing site Trulia Inc (NYSE:TRLA) for $3.5 billion in an all stock deal. TRLA shareholders will receive 0.444 shares of Z for each share they hold, which should increase Z’s outstanding shares by about 41%.

The market has reacted enthusiastically to this deal. Z is up roughly 20% since the news of the potential acquisition first broke. TRLA is up 55%, and has a further 10% to go to meet the stated acquisition price.

Most analysts have hailed the deal as one that will give the combined company massive pricing power and make it the dominant player in online real estate listing. However, analysts have overstated the positives and significantly understated the risks from this acquisition.

Burning Cash

Both Z and TRLA have had consistently negative free cash flow, which they finance by further diluting their shareholders. Between 2011 and 2013, Z increased its total shares outstanding by ~38%. TRLA increased its shares by 34%. Both companies are aggressively diluting shareholders to fund their operating losses.

Z’s acquisition of TRLA is an acceleration of this trend. This acquisition will dilute the stock by a further 40%, and the combined company should, at least at first, burn even more cash. Both companies are already operating at a loss, and acquisition costs in the first year will use up additional cash. Z appears far from done with losing money and diluting investors.

Why Investors Are Excited

A combined Z and TRLA would have a dominant market share in the online real estate market, up to 71% according to some sources. Already some are predicting that Zillow could become “the Facebook of homes”, a place where every home’s information has to be if it wants to sell.

Investors are also predicting an earlier path to profitability if the companies combine. Management has projected $100 million in cost savings once the acquisition is complete, and increased pricing power is also expected.

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