OnTheMarket — First day OnTheMarket

The property portal market is unusual, as paying customers, ie the estate agents, also supply the inventory (the property listings) in order to attract the portals' consumer audiences. OnTheMarket was set up by estate agents themselves, acting as a mutual interest group, as an alternative route to market in reaction to a UK property market portal landscape which they felt was detrimental to their interests. Agents’ Mutual created the OnTheMarket portal, offering member agents access to potential house purchasers at a significantly lower cost than the alternatives. Agents’ Mutual demutualised during 2017 as part of the preparation for the listing on AIM.

OnTheMarket (OTM) is the third player in a market dominated by two other portal providers, Rightmove, which is the market leader and which has a business model predicated on maximising volume and using market dominance to increase pricing; and ZPG, owner of Zoopla and PrimeLocation, which has extended its online franchise into ancillary offers to homeowners, such as price comparison and switching services. By using these portals, estate agents lose ownership of their data, which they might otherwise use to drive other revenue streams for themselves. Until this fund-raise, OTM has not had the marketing firepower to grow its share aggressively. By using a combination of equity to sign up agency groups on long-term contracts and advantageous pricing packages for others, it should be able to build its market awareness and its revenue base. A successful venture will also ensure that estate agents guarantee a sensibly priced route to market over the longer term.

Management is well versed in the segment, with the CEO, commercial director, brand director and the CTO all having been involved in the building of the PrimeLocation brand and overseeing its sale into DMGT (now part of ZPG). This team also set up OnTheMarket. The CFO’s experience is from a broader range of commercial and financial businesses.

Recent financial performance has been hampered by the absorption of management time and the holding in escrow of funding resource during complex litigation over the nature and competitive implications of the ‘one other portal’ rule. This limited agents under contract to OTM to choose from either Rightmove or Zoopla, but not both, in addition to their OTM listings. While the Competition Appeal Tribunal found in the group’s favour, the complainant has been granted the right of appeal to the Court of Appeal, although it is as yet unclear on what legal grounds the appeal has been lodged. The ‘one other portal’ rule has been withdrawn in any event for new contracts, for reasons unconnected with the litigation.

The £30m gross being raised is to invest in sales and IT resource, expand the product offering and to fund an aggressive marketing programme to build awareness and recruit agency groups. The figure is lower than the £50m being discussed when flotation was first postulated, but should nevertheless provide a strong stimulus to propelling the market share which the group needs in order to benefit from the network effect. The financial modelling that Edison has carried out rests on three key metrics: agency branch recruitment, average listing fee per branch and marketing spend. On listing of the shares, the largest shareholder will be Schroder Investment Management, with 6.0%, followed by Jason Walker (founder of Victoria Plumb) with 3.1% and Albert E Sharp LLP with 3.0%.

The outward-facing offer appears to the property buyer as fairly similar to those of the two market leaders, unsurprising given that the OTM website’s build and design has been carried out by the same individuals who created the PrimeLocation website, with the benefit of the experience and of the technological improvements available since. However, the business case differs in that it rests on the system being designed to provide agents (the suppliers of the inventory, without which there is no content) with a fairly priced service, whilst still developing a profitable growth business and a platform for ongoing revenue development. The key distinction between OTM’s outward offer is the ‘new & exclusive’ inventory, displayed at the top of the listings. Although this is not a contractual obligation for agents, it is in their interest to grant exclusivity to OTM before the properties are released to other portals (at higher charges). It also gives a clear incentive for seriously interested potential buyers to visit the website and to set up alerts aligned to their requirements (as opposed to much of the website traffic, which is simply taking an interest).

The estate agency market is highly fragmented and there is a clear opportunity to build a strong franchise to compete with the market incumbents, with relatively little regard of the short-term variations of the UK residential property market.

OnTheMarket represents the web presence of a group of UK estate agents, trading as Agents’ Mutual. It was set up in January 2013 by a small group of agents to provide an alternative route to market, and a more attractive commercial proposition, to the large portal providers, in particular Rightmove and Zoopla. It was felt by the agents that these two firms were taking advantage of their strong market positioning in internet portals to their detriment as suppliers of the inventory. The original plans drawn up in March 2014 were for the portal to carry the content from 1,500 branches, rising to 6,500 by the end of year five of the business plan. When OnTheMarket launched in January 2015, it had 4,600 branches, which had risen to 6,000 two years later.

The Agents’ Mutual proposition was for a portal that was controlled by agents themselves and that would provide an enhanced user experience to consumers searching for property while charging fair prices to agents. This concept was generally well received, particularly by a broad segment of leading UK independent and group agents, which funded the venture through loan note subscriptions and committed to listing properties with the portal once it went live on five-year contracts. These loan notes converted to equity on flotation, leaving the group in a pro-forma net cash position. There is no sell down by existing shareholders. Post listing, there will be a free float of 41%, of which agent shareholders will hold 11%. The prospectus indicates that, on admission, agents will own more than 70% of the enlarged share capital.

Fees are paid by agency branch, rather than by number of listings (with online and hybrid agencies working with a ‘branch equivalent’ definition, based on the relative number of listings). Agencies often commit to long-term (five year) contracts, meaning a good level of recurring income (although the absolute proportion is not yet calculable). As part of the reorganisation, member agencies were given the opportunity to enter into new five-year contracts, underpinning future revenue streams and facilitating the next stage of growth. As at the date of the publication of the prospectus, 3,039 branches had signed new five-year contracts, 1,253 were on earlier contracts with more than two years left to run, with the remaining 1,208 on shorter-term rolling contracts.

The IPO is intended to provide the opportunity for a transformational step-change in the portal’s position and for development of new consumer and agent products and services, new segments of the property market and new strategic partnerships. The reasons for the flotation are 1) to raise £30m gross (£27m net) of new funds to scale up the group; 2) to facilitate the use of equity to encourage agents to join and increase levels of inventory, in turn driving traffic; and 3) to raise the portal’s profile with the house-buying public, both of which should help to gain market share against the two market majors. The proceeds are also intended to be invested in increasing sales/account management resource and to expand the technological capabilities in platform and product development.

After two years of full operation, OnTheMarket (OTM) had become the third-largest UK property portal provider, after Rightmove (the clear market leader) and ZPG. The portal’s market penetration varies nationally, reflecting the geographic distribution of its founding members. A snapshot of comparative numbers of listings in various locations and property types is shown in Exhibit 1 below.

The business models of OTM, Rightmove and ZPG obviously overlap and they all operate portals that enable estate agents to publish their inventory to a broad, online audience. Although we would not normally discuss competitor business models in our reports, in this instance an understanding of the market dynamics is essential to a proper review of OTM’s positioning and potential.

Rightmove is a pure play portal business, which has successfully grown its agency base to 17,589 (20,358 including new home developers) at the time of its interims to end June 2017. Its market dominance has enabled it to move its ARPA ahead strongly – the CAGR over the last seven years is 18% and the last published number was £911 for H117 (up 10% from £830 in H116). ZPG is the holding company for assets including Zoopla and PrimeLocation. Over the years it has expanded its portfolio to include other comparison websites and consumer services of interest to householders, notably uSwitch. Property accounted for 48% of revenues in its financial year to November 2017, of which two-thirds related to property marketing, with the balance split between software and data services provided to participants in the property market. ZPG generates a lower ARPA than Rightmove in order to attract the inventory that will in turn attract the web traffic and generate leads across the service offer. This gives it a somewhat different relationship with the agency partners and it was from ZPG that OTM attracted most of its early agency partners when the ‘one other portal’ rule was imposed (see section below). At its recent AGM, ZPG stated that it has “signed multiple new long-term portal listing and data services agreements with some of the UK's largest estate agents and mortgage lenders” since its September year-end. ZPG’s ARPA was £359 in FY17, up 3% from the prior year.

Listing property on Rightmove or ZPG portals allows those providers to take ownership of the data generated, giving a further commercial advantage to the arguments for using OTM.

Purplebricks is a hybrid estate agent, as opposed to a portal, so is not directly comparable in terms of business model. Online estate agents and hybrid agents (that use a combination of online operation and local offices, but often covering very large areas) are actual or potential customers rather than competitors.

Exhibit 4 above shows the distribution of estate agency groups and also shows how fragmented the overall UK property market remains. A substantial number of the branches being targeted are either entirely independent or operating in groups of three or fewer, with only 4% in organisations of over 125 branches.

The recruitment of agents will also vary by region, but the priority will be given to targeting high stock branches in areas that are already the strongest for the group, leveraging the existing brand awareness. The sales team is being increased by about four-fold post-flotation to around 60 people, with central organisation for analysis of targeting and organisation of appointments.

The property listings service offered by OTM is currently not significantly different from those of Rightmove and Zoopla ie the ability to search by region, postcode, number of bedrooms etc. They also all offer participating agents broadly similar reporting tools, which is unsurprising given that the OTM platform was built by the same people who built the PrimeLocation platform.

The ‘new & exclusive’ listings, which appear at the top of the search results grid, are valuable in driving traffic from high quality leads – benefiting from the ‘fear of missing out’. While this is not a contractual obligation, it is to the advantage of participating agents and many keep properties in this category for longer than the typical 24 to 48 hours before releasing to other portals. Around 20% of all listings on OTM first appear on the website in this form.

OTM intends to add comparables and valuation reports in the current financial year and has identified revenue opportunities in additional branding products and valuation-lead products. Given the mutual benefit between a strong performance by OTM and by its participating agents, there is potential to develop market intelligence reports through sharing of data that might otherwise be closely guarded. Other support services may also be developed.

Up to this point, OTM has not carried listings of new properties being marketed directly by property developers. This is an obvious contiguous extension of its offer that can be added easily, subject to suitable agreements being struck with the developers.

Longer term, it may be appropriate to extend to commercial property and some categories of overseas real estate.

The flotation of the group will inevitably increase its visibility in the market – both with partner agencies and with the property-buying public, which in turn should generate increased levels of inventory and therefore traffic to the web portal. However, throwing ‘marketing muscle’ behind the effort should make the impact more robust and encourage vacillating agents and agency groups that their objectives will be best served by joining. The removal of the ‘one other portal’ rule also removes a key obstacle to stepping up recruitment.

Management has outlined its media strategy within the supporting material. The intention is to spend up to £25m in each of year one and year two in order to maximise the impact, dropping to approximately £20m the year after. We have incorporated these figures into our modelling.

There are three elements in the mix (rough split of anticipated spend given in brackets); digital (50%); national campaigns (25%); and local campaigns (25%).

Individual participating agencies are required to display OTM marketing materials in their marketing collateral, in window displays, in branch and on their websites. In addition, some go much further on a voluntary basis by carrying the logo on car wraps and/or on sale boards.

In order to build share in a competitive market with larger incumbent players, agents joining OTM committed to list with OTM and a maximum of one other competing portal – effectively a choice between Rightmove and Zoopla. This rule was challenged by an agent, Gascoigne Halman, on the grounds that it limited competition in the market. The Competition Appeal Tribunal (CAT) examined the issue closely and issued a comprehensive judgment in July 2017. The crux of the judgement was that, given the effective duopoly in the existing market, the arrangement was actually likely to lead to an improvement in the competitive landscape rather than being a restriction. Gascoigne Halman applied for leave to appeal on competition issues but this was turned down by the CAT in October 2017, whereupon they applied for leave to appeal the judgement in the Court of Appeal (which must be on grounds of point of law). The pursuit of this case occupied a considerable amount of management time, as well as the potential costs overhanging the allocation of capital to growth plans. In August 2017, the CAT returned £1.83m of court deposits to OTM, of which around £1m was spent on marketing soon after.

With the group now raising additional funds to accelerate the agent recruitment programme, the restriction is being rescinded. New contracts that have been negotiated no longer contain this stipulation. Hybrid and online agents are now also able to participate, as well as developers of newbuilds. As the relative competitive positions play out, it may be that branches choose to limit their portal partners to two anyway on economic grounds.

CEO Ian Springett founded PrimeLocation in 2000 and managed its sale to DMGT in 2005 for £48m. He remained with the business until 2008 when he left to pursue other interests. He joined the Agents’ Mutual venture at the start of 2013. Previously, Ian was managing director of Lombard Bank following a number of senior roles within NatWest Group.

Commercial director Helen Whiteley joined Agents’ Mutual in August 2013, having previously been sales & marketing director and part of the founding management team at PrimeLocation. Before that, Helen was marketing director at Lombard Bank, having previously worked at Citibank.

CTO Morgan Ross was originally hired at PrimeLocation (working for an outsourced company) as technical director in 2002, being brought in-house as technical director the following year, and finishing as group IT director at The Digital Property Group (2008). In 2009, he joined James Villas as IT director, where he stayed for four years before moving to be global CTO at World Trade Organisation. Morgan joined his former colleagues, Ian Springett and Helen Whiteley, at OTM in November 2013. He is responsible for portal development and operations, as well as for the technical support team.

Brand director John Milsom was also part of the PrimeLocation and OTM-founding team, joining OTM in February 2014. He previously ran his own marcomms business, as well as working for larger advertising agency groups.

CFO Clive Beattie joined OTM in March 2017 to help shape the forward strategy and prepare the company for its IPO. He was previously CEO and CFO of both Croft Associates (a developer of packaging, storage and transportation solutions for radioactive waste) and ThruVision (a manufacturer of security screening products). Clive is ACA qualified and spent over 12 years at UBS Investment Bank following three years at PricewaterhouseCoopers.

The two independent directors are chairman Chris Bell and NED and audit chair, Ian Francis. Chris was CEO of Ladbrokes, a director of Hilton and had senior roles at Allied Lyons. Since 2015, he has been senior independent director at The Rank Group. His non-executive roles have included the chairs of XLMedia and TechFinancials, both successfully listed on AIM, alongside various other senior independent director and NED appointments. Ian is an accountant, having spent most of his career in various roles at Ernst & Young. He is an NED and audit chair at Paysafe Group and performed the same role at Umeme.

There has been much written regarding the health of the UK housing market and, in particular, levels of affordability. The longer-term and more recent patterns of trading volumes are shown in the Exhibits above.

The number of market transactions does not have a direct impact on OTM’s financial performance, its income being a reflection of the number of member/participating agencies, rather than the number of listings that they carry or their success in driving website views to completed transactions. However, it does have an indirect impact – particularly if the stagnation is sustained. As demonstrated above, the market is highly fragmented at a national level but can also be fiercely competitive at a local level. Having an effective and efficient funnel to deliver high-quality leads should prove a competitive advantage. It is even possible that a difficult underlying market may represent a more conducive environment for growing the OTM market reach.

Our financial modelling makes key assumptions regarding the level of marketing spend and the success in growing the branch agency network. Varying any of these metrics would clearly affect our earnings and balance sheet projections. Given the competitive nature of the market, pricing strategies of one of the main portal operators will have repercussions for other players in the market, including OTM. Our model assumes an initial reduction in ARPA as branch agencies are recruited to the platform in FY19, with growth from the following year moving towards the current level charged by ZPG. This growth in forecast ARPA will be allied with offering additional functionality to participating agents, particularly through the intelligent use of data.

We have also made certain assumptions regarding the success of the marketing spend in recruiting new agencies and agency networks to the OTM portal, which may or may not be reasonable. Because of the plethora and complexity of possible outcomes, we have also made the assumption that new agency partners are attracted by discounted or lower portal listing fees. In reality, there is likely to be equity issued to some, or possibly many, new partners. The important balance will be between the inherent dilution from additional shares versus the benefit to operating profit from the additional volume/ revenue.

We have also included the growth in ‘Other’ revenues within our modelling, comprising add-on products for agents, revenues from advertising new homes from property developers and third-party advertising on the website attracted by increasing levels of traffic.

Outside of the sensitivities from our modelling assumptions, there are a number of internal and external potential factors that may affect the financial performance and the share price. The former would include:

External factors could relate to:

Given the early stage of the group’s development, traditional valuation metrics are not especially useful. With the scale of the planned increase in investment in personnel, IT and marketing spend, OTM will generate substantial losses at the EBITDA level over the next couple of years as the investment goes through. This effectively leaves the only income-based valuation metric it the EV/sales ratio, where OTM sits at a considerable discount to the more established players, as would be expected. OTM at flotation price is valued at an historic EV/sales ratio (based on our estimate of revenues to January 2018) of 4.4x, compared with 16.9x for Rightmove and 6.6x for ZPG. Looking at the broader global context (which, like ZPG, includes some peers with more diverse business models), the sector is trading on average multiples of 10.4x EV/sales and 21.1x EV/EBITDA.

While it is possible to extrapolate further and make comparisons once OTM has moved into profitability (which we estimate to happen in FY21), the degree of flex in the forecast assumptions would make any derived valuation unreliable.

We have also looked at the narrower UK market in terms of the value that the stock market accords to market reach, for which the proxy is the number of agency partners (note that this calculation is done on ZPG’s number of agency partners, as opposed to its number of property partners). The discrepancy in the EVs is obviously substantial and it would be unwise to assume that OTM’s EV/agency partner ratio would converge towards the others in the short term. However, the direction of travel should be clear. Even if the EV/agency partner were not to change, our modelled increase in the average number of agency partners to 8,500 and 14,750 for FY19 and FY20 respectively (NB year-end is January) works back mechanistically to a theoretical future share price of 224p and 351p respectively.

Given the problems inherent with earnings-based methodologies expressed above, we have also looked at valuation based on discounted cash flow. Again, this is highly dependent on the modelling, particularly with respect to the marketing spend and the return earned on it in terms of agency recruitment.

Under our modelled scenario, with the business moving into profit from FY21, the free cash flows become substantial from that year on. We have assumed a small amount of debt is taken on during FY20e to over the funding gap before the cash flows turn positive again. Based on a WACC of 10.2% and a long-term growth rate of 0.5%, the NPV of the cash flows equates to a share price of 323p, 95.8% ahead of the issue price. A 323p share price would give an EV of £166.3m and an FY18 EV/sales multiple of 10.4x and an EV/agency partner figure of £29k. This is obviously not adjusted for any implementation risk (although it should be noted that there is also sensitivity on the upside). Setting this adjustment at 30% would indicate a share price of 226p, a 37% premium to the issue price of 165p.

We have also looked at the sensitivity of the DCF to changes to the key drivers under three alternative scenarios:

These values are all without any further adjustment for execution risk.

The revenues of OTM simply consist of the listing fees paid by agency partners, with other sources of income (principally listing fees of new properties) starting to build over time. These are the key drivers of our revenue model, as shown below. Revenues in the year just ended (yet to be reported) will be down on the prior year, reflecting the disruption to the business with regards to a) the demutualisation; b) the negotiations of new contracts with existing agencies; c) the absorption of management time in dealing with the litigation; and d) lack of funds / resources.

We have assumed that the number of partner agencies will now rebuild and exceed previous levels, with the first step up already established with the recruitment of three agency groups (highlighted in Exhibit 3, above) contingent on the listing of OTM shares. Between them, they bring an additional 375 agency branches to the group. It should be noted that the estate agency market remains highly fragmented and that there are a limited number of sizeable groups to target, again shown in this exhibit. Once recruited, this income stream is attractive, with high levels of recurring revenues over predominantly five-year listing agreements.

The successes in drawing agencies onto the OTM platform will depend on both the attractiveness of the equity participation (which will help with the ‘stickiness’ of the business brought in) and the return on the deployment of the marketing spend. To date, OTM has spent just under £20m, split 38% on TV and press campaigns, 61% on paid search and digital advertising, with the small balance on local press, radio and posters. Management intends to spend up to £25m in each of the first two years to support the ‘land grab’, reducing thereafter to approximately £20m in year three. We have used these figures in our modelling.

The business model is still at an early stage of development and there is little to be sensibly gleaned from the financial record to date. There was obviously rapid growth during FY16 when the first agency networks came together, followed by year of consolidation. The plan had been to continue to scale up and float the business. The process of demutualisation was a lengthy and intricate process as the participants’ interests were not necessarily fully aligned. This, and the litigation described above, both absorbed a deal of resource (time and money) that would otherwise have been focused in developing and growing the business. Marketing costs were reined in and the group has fallen behind its initially planned itinerary.

We show the revenue and operating margin history of Rightmove and ZPG to put our margin assumptions into context in the Exhibits below.

Scaling up inevitably means additional resource and around a quarter of the flotation proceeds are to be targeted at scaling up the infrastructure, adding to the IT development and to the sales teams. Despite the higher levels of both staff costs and non-staff overhead, our model shows the business remaining EBIT positive pre-marketing costs even in FY19, where the scaling up is likely to be greatest. This investment will enable the group to build a valuable data resource which can be used to benefit both OTM and its clients, the agencies. The level and sophistication of data usage currently should be considerably enhanced, building data products of benefit to partner agencies (so driving up the ARPA by delivering greater value) and through the introduction of relevant third-party targeted advertising to the portal.

Our modelling indicates OTM moving into profit at the pre-tax level during FY21 (beyond our published forecast horizon).

Our cash flow modelling is shown in Exhibit 9, above. The group could choose to conserve cash by reining in the marketing spend, but this may compromise the forecast growth profile and the conversion of agents on to paying (or higher paying) contracts. On the basis shown here, OTM turns cash flow positive at both the gross and net cash level in FY21. At their last reported results, ZPG showed operating profit to cash conversion of 88% and Rightmove 101%. As OTM matures, there should be no structural reason why it should not achieve similar levels – although we have modelled a more conservative 80% in the medium term.

The £30m gross placing proceeds on flotation are below the level that market commentary indicated during the demutualisation phase in summer 2017 (reported to be £50m). We understand from management that the lower raise did not have a fundamental impact on the business plans as a £50m raise had significant headroom to deliver the strategy. OTM has to date been funded by its founding agencies in the form of loan notes, with coupons of between 7% and 15% and, most significantly, by revenues from agents’ listing fees.

The loan notes have been redeemed and converted to equity on the float.

The Edison model assumes that the funding, together with ongoing revenues from agents’ listing fees, is sufficient to cover the additional spending plans through FY19, with the assumption of a modest amount of debt by end FY20, before moving back into a net cash position the following year. The timing and outturn could obviously vary considerably from this scenario.