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Morningstar | Dramatic Growth in Apartments.com Drives CoStar's Stellar 2Q Earnings; We Expect to Increase FVE

CoStar Group reported blockbuster second-quarter earnings results, with revenue increasing 16% and net income increasing 44% over the prior-year quarter. As of this writing, the shares are up nearly 9% as investors react positively to the results. CoStar’s impressive performance was underpinned by the breakneck pace of growth in Apartments.com, which has gone from $86 million in revenue when it was acquired in 2014 to a run rate of nearly $500 million in the second quarter of 2019. Despite being outshone by Apartments.com, CoStar Suite continues to post extraordinary growth, with year-over-year revenue growth right in line with the five-year average at 15%.

We are placing CoStar under review as we incorporate the second-quarter results into our valuation model and update a few of our assumptions. We expect to raise our fair value estimate to reflect improved companywide revenue growth assumptions, with a particularly dramatic increase in revenue growth for the multifamily business line, which contains Apartments.com. Management disclosed that it has increased its penetration of the market from 2% in 2014 to around 12% currently. We now expect that CoStar can more than triple its share to around 38% of the addressable market by 2028. CoStar has been particularly successful in pursuing growth among apartment owners with 100 units or more, but it is increasingly looking to penetrate the portion of the market with 5-100 units, which remains largely untapped.

Our more bullish outlook is further informed by improved margin assumptions as we think CoStar will be able to achieve even greater levels of productivity from the sales staff that it continues to add. Additionally, we see the cost of procuring data for CoStar Suite as decreasing over time as more brokers opt to provide their transactions directly to the company through the CoStar Listing Manager tool. Management indicated that 52% of spaces on its platform were added online by users this quarter, a figure we expect to continue to increase. This shift should allow the company to procure increasing amounts of accurate data with less manual effort from its cadre of researchers.

During the second quarter, CoStar acquired student housing marketplace Off Campus Partners for $16 million. Although the acquisition amount is small in absolute terms, we think the company’s push into student housing is strategically sound. The area has seen increased investment and interest from institutional investors, as evidenced by a dramatic compression in capitalization rates over the past several years. Finally, we see potential in the push to streamline the apartment application process on Apartments.com. CoStar is piloting a program that would allow users to apply for an apartment through its website, streamlining what is traditionally a disjointed process. This move has the potential of allowing the company to capture an increasing share of the large portion of the market with less than 100 units that may not have the infrastructure in place to efficiently handle such processes.

We continue to think the commercial real estate industry is poised for dramatic change, with CoStar reaping benefits from many of these changes. Nevertheless, we think giddy investor reaction to such consistently positive financial performance means the stock’s price already reflects expected future growth. We would urge caution when approaching this name, but ultimately see it as a way to play various enduring trends in the industry.