Real Estate Investar — Update 31 March 2016

REV has evolved from providing online information and editorial comment for residential property investors in 2005 to providing an integrated set of tools to assist investors to purchase, manage, analyse and report on property investment. The tool set has been developed over eight years, is offered online in the Australian and NZ markets and is sold on a SaaS subscription basis. At 31 January 2016 there were ~155,000 members and ~2,700 paying users at an ARPU of A$97 per month. Our forecast for growth in members and subscribers is set out in Exhibit 13. A key plank to REV’s marketing strategy is partnering with third parties with the capacity to drive membership. One of the key relationships is with the Fairfax Media (FXJ) owned Domain Group and APM (Exhibit 1). Fairfax is a 12.5% shareholder and the CEO of Domain is the Fairfax board member representative. In our view, a key positive is the role of the chairman, Simon Baker, who was CEO and managing director of REA Group (REA) in its formative stages.

REV is an early-stage company and, although FY15 revenue of A$4m provides some proof of the business model, it is difficult to be definitive on its revenue growth and time frame. Our approach to valuation is to develop base-case forecasts using the directors’ 2016 forecasts (included in the REV Prospectus dated 16 November 2015) as a starting point and make our own assumptions about market penetration and ARPU thereafter. These forecasts result in a 10-year DCF valuation of A$0.26 per share and assume 9,950 subscribers (paying users) (1.19% of the one-property market) paying A$82/month (revenue A$13.4m) in FY18 and 12,350 paying users by 2022 (1.26% of one property market) paying A$86/month (revenue A$18.3m). Our sensitivity analysis shows that if the conversion of members to paying customers falls from 2.5% to 2.0% the DCF value decreases from A$0.26 to A$0.15. If the ARPU falls by A$10/user per month the valuation decreases from A$0.26 to A$0.22. We have further stress-tested our assumptions and note that the current share price implies that paying users will reach ~7,400 at ARPU of A$81 per month by FY18.

Management’s FY16 forecast net loss of A$1.2m is a function of investing in growing REV’s share of the residential property investment market in Australia and NZ and in developing new products and new markets. REV forecasts an increase in membership from 150,000 to 250,000 by December 2016. Conversion rates at December 2015 were 1.8% but the company is forecasting conversion rates of 2.5% for the year ending June 2016. The 21-day free trial offer is an important part of the conversion strategy. Our forecasts post FY16 include transaction revenues generated from sales and brokerage commissions, resulting in a small profit in both FY17 (A$0.5m) and FY18 (A$1.5m). We are forecasting ~398,000 members and ~9,950 paying users by 30 June 2018 at ARPU of ~A$86 per month. Although it will be driven by a mix of casual users and subscribers, our forecasts of ARPU take into account the company’s strategy of offering incentives for subscribers to sign for longer periods.

REV is exposed to the key drivers of the property market, which include population, interest rates and taxation policies. The government’s forecast CAGR for Australia’s population to 2023 is 1.2% and NZ is expected to experience growth rates of ~1%. A sudden spike in interest rates could have a negative impact on demand for residential property. A favourable income tax policy is also an important driver of demand. Other factors such as FX, slower than-expected user growth and China’s investment restriction could all have a negative impact on our forecasts and valuation.

REV was established in 2005 and initially provided online property investor focused magazines and editorial content. In 2008 the focus changed to online search, analysis and tracking solutions offered on a subscription basis. It now has 19 employees located in its Gold Coast and Melbourne offices and it services the Australian and New Zealand markets. It listed on the ASX on 10 December 2015 following a successful capital raise of A$5m (25m shares at A$0.20 per share).

REV has developed an integrated software package designed to assist property investors through all stages of the residential property investment process. This includes finding properties that satisfy investment criteria, tracking the relevant movements in the property market, flagging opportunities to increase rentals or opportunities for a gain on sale. The software package also handles the preparation of accounting and tax information, which can be integrated with third-party accounting and tax applications. The online tools are accessed through the cloud and offered on a SaaS basis. REV operates in Australia and NZ and intends to extend the offer to other markets in due course.

REV uses a freemium model to attract users by offering free online property acquisition and management tools, resources and news services designed to attract membership. Once members are attracted by the free service, REV has the opportunity to convert them to subscribers or engage with them on a casual basis for non-subscription services. REV had 155,414 members at 31 January 20161 and expects to increase total membership to over 250,000 by 31 December 2016.2 REV is expected to earn an estimated 73%3 of FY16 forecast revenue from the sales made on a subscription basis (for periods of one to two years) of the two premium products, Portfolio Builder and Portfolio Manager. The price ranges are:

The balance of revenue is generated from casual services from a range of pay-per-use services offered either directly or via a partner (FY16 management estimate is 16% of total revenue) and from referral fees from property transaction services (11% of total FY16e revenue).4 Property transaction services are limited to referral fees but there are plans to earn commissions from off-the-plan developer sales and to expand the service offering to include online mortgage broking so that REV becomes a ‘one-stop-shop’ for all residential investor needs. REV has the necessary licences and systems in place to extend its offering to include mortgage broking. Our forecasts include sales agent commissions and mortgage broking commissions from FY17. This results in improved gross profit margins from 46.9% in FY15 to an estimated 57.5 in FY18 because the ‘add-on’ services will be offered by the same team with minimal additional costs.

REV markets its free services using search engine optimisation (SEO), search engine marketing (SEM), promotions through business partners who recommend the REV service and are paid a commission when a member becomes a user, and direct-branded webinars and roadshows.

REV’s freemium offer includes a free 21-day trial during which REV monitors the level and type of engagement the potential customer has with the site, offers free training and free Xero set up to facilitate the process and integration of Xero with Portfolio Tracker. For the six months to June 2015 there was an average of 369 free 21-day trials per month and a conversion rate of 30-45% (39% conversion rate for the 12 months ended 30 June 2015). Once the members sign up for either monthly or longer-term contracts (one or two years), fees are collected monthly.

The integrated, unique product suite has been developed and refined over the last eight years and now comprises:

REV has aligned with several key business partners, that promote REV products and services to their own customers. These business partners are highlighted in Exhibit 1.

REV is not aware of any direct competitor offering a fully integrated online residential property investment and management solution. It does, however, face competition from a range of free services including property portals, property data providers, property developers, mortgage brokers and professional service and software providers.

The key barriers to entry enjoyed by REV’s business include first-mover advantage, partnerships with key data providers, counsel from the chairman and substantial shareholder Simon Baker, who has built successful large public companies that operate in the property sector, and a membership base of 155,414 (January 2016) or 24% of those owning more than one property and 7.0% of all property investors in Australia and NZ. A competitor may emerge but the development of the platform, the access to data and negotiations with partners could take one to two years and an investment of at least A$5m.

REV commissioned Frost & Sullivan to conduct an independent market survey for inclusion in REV’s Prospectus issued on 16 November 2015. Based on a survey of 257 residential property owners in Australia and New Zealand, the report concluded the potential market for REV membership was ~500,000 from a total addressable market of 2.182 million. This survey showed that of the potential membership pool of 500,000, 25% were potential paying users. It also found that in Australia, annual expenditure on property expenses excluding mortgage interest and agents’ commission is about A$11bn, of which A$1bn is in the ‘sundry’ category that costs such as a REV subscription are likely to fall. The survey results are summarised in Exhibit 2:

Other key findings include:

The most likely users of the software and the ultimate customers are those who do not undertake property investment as their ‘day job’. The company advises that current user statistics show about 45% of REV users are first-time property investors and 47% already own one or more properties. The balance of ~8% are professional investors who already manage a property portfolio. In our view, the most likely subscribers will be those owning more than one residential investment property and those who value the use of data to inform their investment decisions.

Our rationale for this is that we believe:

We diverge from the company’s view on this point. We acknowledge that REV has products (such as Portfolio Manager, which costs A$29.95 a month) that may appeal to one-property investors but we have excluded these potential users from our forecasts. Uptake by investors in this category is potential upside to both our earnings forecasts and valuation.

Our view also contrasts with the Frost & Sullivan report included in the REV Prospectus, which defined the addressable market as all property investors including those who are single-property owners, a total of 2,182,000. However, if we define the more likely addressable market for subscriptions from the membership base as those owning more than one property the addressable market declines by 68% to ~698,000. In our view this, plus the one-property market from which casual users are likely to be sourced, is still large enough to justify the market share assumptions implicit in the company’s forecast of 250,000 members by December 2016. The company has not provided forecasts of paying subscribers. We are forecasting the number of subscribers at 30 June 2017 as 7,536, which is 1.08% of the two or more properties (residential property investment) market of 698,000 and 0.03% of all residential property investors in Australia and NZ.6 We outline the addressable market in Exhibit 3 below.

In the Australian and NZ marketplaces the key property market drivers include:

As the following exhibits demonstrate, housing finance by investors has grown rapidly over the past few years but has been tempered in the last six months by the banks’ deliberate cooling measures to halt a rampant property market, particularly in the key capitals of Sydney and Melbourne.

The strong growth in property values in both Australia and New Zealand has encouraged investment. As the following two exhibits demonstrate, property values have grown markedly since the global financial crisis.

A further stimulus in the Australian market was the change in September 2007 to the rules governing the operation of Self-Managed Superannuation Funds (SMSF), which means the 534,000 SMSFs in Australia are now able to gear property investments using non-recourse loans.9 Most lenders lend up to 90% of the asset value.10 In 2013 only 7% of SMSF held residential properties,11 which is a reflection of the average SMSF asset value of ~A$1m and the price of properties in the major capital cities in Australia. Major capital city median prices range from A$0.5m in Hobart to A$1m in Sydney.12 Other stimuli to the property market include:

We have highlighted REV’s strengths, weaknesses, opportunities and threats in Exhibit 8 below.

The company’s strategy for growth includes:

The plan to increase penetration of the Australian and NZ markets revolves around a more intense relationship with Fairfax Media and Xero, as well as developing new partnership arrangements with third parties that have residential property investors as clients. The Fairfax-owned Domain website is ranked number two (for number of users) in the real estate category and REV plans to provide investor-centric content and events information for jointly promoted investor events and services in an attempt to make better use of Domain as a source of potential customers. APM (owned by Fairfax) provides property data that is integrated into REV’s subscription services and REV directs investors back to the Domain website for specific listing information.

REV will also use internet search tools to improve awareness of it. Awareness of REV is low but the Independent Market Report prepared by Frost & Sullivan and included in the Prospectus noted that interest in REV’s services was high once the potential users were told what they were.

Deeper knowledge of the customer base will also be a focus, using technology and dedicated marketing teams.

REV sees an opportunity to offer transaction services to investors purchasing new properties from developers. It will offer members preferential terms (such as lower banking fees), which will encourage membership and offer REV the opportunity to earn commissions ranging from 2% to 8% with minimal additional cost.

REV plans to exploit its international opportunities by:

Reduction in migration: migration is a key driver of population growth in both Australia and NZ. A reduction in migration would have a negative impact on the demand for residential property and would be likely to depress housing prices, making a proposed investment in residential property less attractive. Reduced demand for housing would increase the rental stock, which, in turn, would reduce rentals.

Changes to tax laws: residential property investment receives favourable tax treatment in Australia via negative gearing and a reduced rate of capital gains tax. In NZ there is no capital gains tax. Any change to the tax rules is likely to have a significant negative impact. In the Australian market a significant proportion of residential property investments would be uneconomic if interest and depreciation were not deductible from other forms of assessable income.

Interest rates, Chinese restrictions on investment: one of the key factors in increased interest in residential property investment has been low interest rates. In Australia interest rates are the lowest they have been for 60 years and in NZ they are at their lowest since 1998. An increase in interest rates would have a direct impact on the economic viability of residential property investment. In July 2015, three of Australia’s big four banks increased the interest rates on investment properties by 0.3%, in response to changes to capital adequacy ratios by the Reserve Bank. This resulted in an immediate slowdown in investment property loans, as signified by the decline shown in Exhibit 4. It is possible that the market has peaked, particularly as China has recently moved to restrict investment outside the country, which will have a direct impact on demand for residential housing in the major Australian and NZ cities. In our view, this will be particularly negative for residential apartment sales and prices.

Liquidity: the tightly held nature of the share register and the relatively small market capitalisation means that the stock tends to ‘trade by appointment’.

The board and management team has deep experience in property and online businesses.

Our DCF valuation uses the directors’ FY16 forecasts included in the REV Prospectus issued on 16 November 2015. Post FY16, we have developed a base case that assumes the number of investment properties in Australia and NZ grows by ~2% pa, that the conversion rate (from members to subscribers) remains at 2.5% throughout the forecast period, and that ARPU is A$82 per month. We assume growth thereafter reflects GDP growth. We have not included expansion into new markets. We have included both mortgage commissions and sales commission from FY17.

The value of the business depends on how many members are converted to paying subscribers, the timeframe for converting members to subscribers, the ARPU and the churn rate, where we are assuming that casual users churn three times a year and that subscribers have a churn rate of 18%. We have developed cases looking at changes in price and volume and a case that calculates the number of users and ARPU reflected in the current share price of A$0.10.

Our DCF uses a WACC of 13.5% and a terminal growth rate of 2%. Our base-case valuation is A$0.26 of which 50% is represented by the terminal value.

The table below summarises the key assumptions underlying our four DCF cases. In all four cases we have left the costs unchanged. Further discussion on the assumptions used in the base-case forecasts are included in Financials below and in Exhibit 15. The volume case, which assumes that the conversion rate will be 2% compared with the base case of 2.5%, results in a DCF of A$0.15. The price case where average revenue per user per month has been reduced by A$10 results in a DCF of A$0.22. The reverse DCF implies ~7,400 users paying A$81/month by FY18.

The IPO conducted in December 2015 resulted in the issue of 25 shares (29.6% of shares on issue at completion of the IPO) at an offer price of A$0.20 per share to raise A$5m. The IPO proceeds are to be used as shown in Exhibit 12.

Revenue is generated from selling subscription services using a SaaS model and selling casual services. Casual services include transaction services, finance, mortgage and insurance brokerage, accounting, financial planning, depreciation reports and courses and education. Transaction services are still early stage but we have incorporated increased earnings from agents’ commissions and brokerage from FY17 onwards. Selling more services to the same customers is a key plank of REV’s growth strategy. REV also earns referral fees from its partnership network.

We assume the conversion rate remains at 2.5% during the forecast period and that the ARPU stabilises at A$50 per month for casual users and A$95 per month for subscriptions. Churn rates assumed are those stated in the REV Prospectus13 of 33% for casual users and 18% for subscribers. Management expects to lower these rates by locking the customer into more services including securing mortgages through its mortgage broking business (to start in FY17). Our membership and revenue assumptions are set out below:

Cost of goods sold comprises sales commissions paid to referring partners (10-20% of revenue), data licensing fees paid to APM in Australia and CoreLogic in NZ and the costs of processing customer payments and providing services to customers. Operating expenses are dominated by employment costs, product development, and administration and premises costs. Our forecasts assume additional sales and marketing personnel, with total staff of over 30 by FY18.

In our forecasts we have used management’s expectations that the gross profit percentage of the existing business will be ~50%14 and will improve further driven by:

The table below sets out the assumptions we have used in our forecasts for FY17 and FY18. FY16 uses the directors’ forecasts included in the REV Prospectus issued on 16 November 2015. Data related to 2015 actual results was provided in the prospectus. In our view, the assumptions used in the directors’ forecasts for FY16 are reasonable. Our forecasts for FY17 use the company’s target of 250,000 members by 31 December 2016. We assume that the annual growth rate in subscriber numbers slows from 63.5% in FY17 to 35.2% in FY18. We also expect membership growth to slow from 56% in 2017 to 32% in FY18.

As Exhibit 16 demonstrates, we are forecasting that REV will generate positive operating cash flow from the second half of FY16, in line with management forecasts. At that point, we forecasting 4,500 subscribers, with 3,623 assumed to be on one- to two-year contracts.

Our forecasts assume that from FY17 REV is profitable with an increasing cash balance. Our forecasts do not include investments in new markets, which could reduce the expected cash balance. In our view it is unlikely that further investments in new markets or new technology would be large enough to warrant further capital raises.

The software platform is well developed and management expects that further investment in the platform will be minimal. No other capital expenditure is contemplated by management.

The prospectus states that dividends are not contemplated in the short term. Our base case forecasts show ~A$7m of cash on hand at 30 June 2018.

The balance sheet includes capitalised product development (related to the website and software) costs of A$1.7m, which are to be amortised over five years.

The free float is 35% and 56% of the shares are held in escrow for one to two years. Fairfax Media holds 12.5%, Simon Baker (chairman) holds 13.5%, Campbell Venning and David Hows (previously CEO of REV) both hold 9.5% each. The escrowed shares comprise a significant potential overhang and could affect the share price.