We raise our fair value estimate for narrow-moat Domain DHG to $4.43 per share from $4.20 following the announcement of an improved nonbinding indicative proposal from wide-moat CoStar Group to acquire the business (see our note “Domain: CoStar Offers to Buy Australia’s Struggling Number 2 Property Portal). We assume a 100% probability of the business being acquired for the proposed offer. Our stand-alone valuation for the company remains $2.65 per share.

Our assessment that there is a 100% probability that the offer is accepted is based on the unanimous decision by the Domain board to engage with CoStar to facilitate due diligence. It is also based on the known willingness to sell the business by 60% shareholder Nine Entertainment and our view of the unlikelihood of a higher bid by another party.

We believe Domain is uniquely valuable to CoStar, as it can run the business at a significantly lower cost once it moves the business onto its own platform, thus boosting margins. This has been a successful strategy by CoStar in a series of prior acquisitions. These include LoopNet for commercial property, Apartments.com for rentals, and Homes.com for residential purchases.

Our fair value estimate for wide-moat peer REA Group remains AUD 126 per share. We don’t agree with the market selloff of REA shares since the initial offer for Domain was made by CoStar. While we think CoStar’s ownership of Domain could increase competition, we believe this is offset by REA Group being able to raise prices further without facing regulatory scrutiny than would otherwise be the case.

Domain unlikely to find higher bidder

We expect Domain’s near-term challenges to center on navigating significant volatility in the Australian housing market. After the onset of the covid-19 pandemic, Domain 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 and we expect that Domain, as the second-largest real estate listings platform, benefited disproportionately from this event.

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 growing around 1.7% per year over the period. We attribute this falling liquidity 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. We therefore forecast a continuing decline in housing stock liquidity.

We expect Domain’s growth to be primarily driven by growth in yield, or listing fees, within its residential division, rather than from market share gains. Domain’s market share versus REA Group has remained largely unchanged in recent years, with a slight deterioration in fiscal 2024, and we consider the competitive environment to be stable. Instead, we expect Domain and REA Group to focus on increasing revenue per listing through price increases and through increased depth penetration.

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