We raise our fair value estimate for wide-moat REA Group REA by 4% to $126 per share following an update on the proposed acquisition of Rightmove, a United Kingdom-based online marketplace for property. Our upgrade consists, in around equal parts, of a 25% probability of the acquisition taking place and the time value of money.

We believe the acquisition would be value accretive to REA Group at current proposed prices. REA Group latest nonbinding indicative proposal is for REA to acquire the business for GBX 770 per share and to pay for the business in roughly equal parts cash and shares. Given we view REA Group shares as materially overvalued, this would be accretive to our valuation, even after adjusting for the 41% premium, compared with the six-month volume-weighted average share price.

We also believe REA Group would be able to create synergies with the UK-based business, which makes around half as much revenue as REA Group, despite having a similar market position in a country with more than twice the population of Australia. We view this synergy primarily as a function of increased revenue growth instead of higher earnngs before interest, taxes, depreciation and amortisation (“EBITDA”) margins, which are already exceptional, at 70% in fiscal 2023. Specifically, REA Group has more experience with usage-based pricing, while Rightmove’s pricing model centers more on the number of users. We view usage-based pricing as inherently better able at capturing value-creation and expect Rightmove would be able to benefit from REA Group’s know-how and capabilities in this area.

We estimate that the acquisition would add around AUD 11 per share to our fair value estimate for REA Group—if it goes ahead as currently proposed. However, we only ascribe a 25% probability of the offer being accepted, which is likely below market expectations, as implied by Rightmove’s share price movements.

REA business strategy and outlook

We expect REA Group’s near-term challenges to center around navigating significant volatility in the Australian housing market. After the onset of the covid-19 pandemic, REA Group received a substantial boost to revenue and profit margins from the booming housing market. We estimate that residential transactions were around a third above trend levels during fiscal 2021 and 2022. With the normalization of interest rates, we expect continuing swings in listings but an eventual return to trend, which started in fiscal 2023.

In the long term, we expect a gradual decline in listings due to friction in the housing market caused by ongoing increases in transaction costs in the form of stamp duty. Total dwelling transactions in the Australian housing market declined for nearly two decades until the onset of the pandemic, despite the number of dwellings increasing around 1.7% per year over the period. We attribute this falling liquidity principally to rising stamp duty, which has increased around five-fold in the past two decades. We do not forecast a significant reduction in stamp duties, despite some State governments undertaking initiatives to replace the upfront stamp duty with an ongoing land tax. We do not believe any Australian state is in a sufficiently financially healthy position to be able to afford this transition, as evidenced by their deteriorating credit ratings and as evidenced by recent state governments' decisions to raise property taxes and remove previously introduced land taxes. We therefore forecast a continuing decline in housing stock liquidity.

We expect REA Group’s growth to be primarily driven by growth in yield, or listing fees, within its residential division, rather than from market share gains. REA Group’s market share versus Domain has remained largely unchanged in recent years and we consider the competitive environment to be stable. Instead, we expect REA Group and Domain to focus on increasing revenue per listing through price increases and through increased depth penetration.

REA bulls say

  • REA Group, together with Domain, effectively operates a duopoly in residential real estate listings in Australia and REA Group is the dominant platform out of the two.
  • REA Group has demonstrated its ability to defend its competitive lead over Domain where it matters most, in audience size, revenue, and margins.
  • REA Group’s deep relationship with corporate parent News Corp provides it with access to some of Australia’s most popular newspapers, websites, and television channels.

REA bears say

  • REA Group’s earnings are affected by the housing market, which is highly cyclical.
  • REA Group has incurred large losses from its international divisions, and many have been disbanded. REA Group’s India division is currently still highly unprofitable.
  • REA Group is attracting increasing regulatory scrutiny.

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Terms used in this article

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.