Why I am buying CoStar Group
I have started a ~3% position in CoStar (CSGP) at $71/share and would like to increase the position to ~5% if the stock goes down to ~$60.
I wrote a Deep Dive on CSGP back in January 2024, so I would suggest reading my Deep Dive for a more comprehensive discussion on the company. I will mostly highlight a couple of points in this piece.
While many like to depict CoStar as “Bloomberg for CRE” (Commercial Real Estate), I liked the way Brown Advisory described it, “it’s like Bloomberg, if FactSet did not exist”. While that is perhaps an apt description of CSGP’s offerings and its competitive advantages within CRE market, CoStar suite and information services are only ~45% of their revenue today. ~45% of their revenue comes from online marketplaces (LoopNet, and Multifamily), and the rest ~10% comes from the nascent residential segment and other marketplaces and services. One of the things that I really like about CSGP is while CoStar’s information & analytics segment is more procyclical, online marketplace segment is a bit countercyclical which subdues the overall cyclicality of the company. From my Deep Dive:
“Looking at the dire situation in commercial office space during post-Covid era, an understandable concern that one might have is whether CoStar is also going to feel indirect pain of their CRE customers. Given CoStar’s revenue declined by 1% during GFC and their almost entire business was information & analytics back then, we can sense their vulnerability in this segment in a potential, secularly challenged environment for office space. Nonetheless, it is perhaps also somewhat impressive that even during GFC, their revenue declined by only ~1%. It likely indicates that unless their customer is going out of business (bankruptcy may just mean restructuring the capital structure and not necessarily shutting down the business), CoStar’s CRE information business is likely to remain (and was) resilient in the last 2-3 years.
What’s different from GFC now is ~55% of CoStar’s revenue comes from online marketplaces such as LoopNet, Apartments.com etc. During boom economic period, PMCs may have very little vacancies in a low unemployment environment. For example, during 2021-22 period rental vacancies came down to almost 30-year low. In such environment, you simply don’t have much need to sign up for an annual advertising subscription product of CoStar. On the other hand, when vacancies rise during recession, you not only feel the need to advertise your rentals but also feel tempted to upgrade to a different tier to fill up your rentals. Given the low vacancy rate in 2021-22, CoStar’s multifamily segment revenue only grew by ~13% and 10% in 2021 and 2022 respectively whereas it was consistently growing at >20% before that. It started growing at >20% in 2023 as rental vacancies started to rise again in recent quarters.
Such countercyclical dynamic makes it much more likely that even in a “GFC” scenario, CoStar’s revenue may continue to increase.”
I also recently read Speedwell Research’s Deep Dive on CSGP and came away with more confidence that even though CoStar suite and information service business may be procyclical, even this segment is very unlikely to be too volatile. From Speedwell:
“In 3Q08, Andy noted that firms that had been with them for more than 3 years had a 95% renewal rate versus those who were with them for less than 3 years having 70%. This difference was explained by a larger number of new firms and brokers that entered the market during the frothiest years of the real estate boom. For those that stayed in business, as CFO Brian Radecki points out below, no matter how bad the industry was, their product was still in need.”
Andy Florance, however, is not the kind of CEO who would be content with ~70% retention rate. So, CSGP incentivized salespeople based on usage of their product, not just on new users/seats even though CoStar products are not priced based on usage. They correctly figured out that one way to increase retention is to increase usage of the product. So, salespeople were highly incentivized to make sure their customers are using the product regularly to build habit using CoStar products. By 3Q10, retention of customers who had been with CSGP for less than 5 years increased from 74% to 87%. Today, their overall retention rate is ~90% (~95% for customers with CSGP for >5 years). So, even their procyclical part of the business may do just fine even during recessions.
CSGP is one of those rare companies that grew its revenues double digit for each of the last 51 quarters. CSGP guided for $5 Bn revenue in 2027 even though consensus estimates today is $4.5 Bn in 2027. Led by its founder Andy Florance, CSGP has been a public company since 1998. As a result, we have track record of their past long-term guidance and how they fared afterwards.
Back in 2012, CSGP had ~$350 Mn revenue. In early 2013, CSGP guided $800 mn annualized revenue in 2016. Their actual revenue (not annualized) in 2016 was $840 Mn.
In early 2014, CSGP guided $1 Bn annualized revenue in 2018. Their actual revenue (not annualized) was $1.2 Bn.
So, at least looking at historical precedence, it does not seem CSGP comes up with their long-term revenue guide out of thin air.
CSGP also guided for $2 Bn EBITDA (~40% EBITDA margin) in 2027. Let’s go back to GFC again. From Speedwell:
“…despite the worst economic crisis since the great depression, CoStar not only pulled through unscathed, but actually hit their ambitious U.S. EBITDA margin target of 30% by the end of 2008—a quarter early. In 3Q08, their U.S. business hit a 33% EBITDA margin, showing the leverage in the model.”
Having said that, I do acknowledge that it is more likely that CSGP will hit 2027 revenue target than their EBITDA target; Florance is not the type of CEO who would necessarily optimize for near-term profit targets. They are currently in the middle of a massive bet in US residential segment. Just as they spent ~$1 Bn on advertising after acquiring Apartments.com, they are going for the same playbook in residential segment with Homes.com. Today, apartments.com/multifamily segment is their largest revenue driver of the overall company (an incredible feat given it was only launched just ~10 years ago). Replicating success of multifamily will not be easy given the entrenched incumbents here (i.e. Zillow to be specific), but if anyone can disrupt these perennially barely profitable/unprofitable incumbents, it is Andy Florance’s CoStar.
The good thing is I don’t think we are quite paying much for CSGP potentially hitting it big with Homes.com. At current $25 Bn EV (with ~$4 Bn net cash on balance sheet), the company is currently trading at ~20x NTM EV/EBITDA multiple (ignoring residential losses which really mask the profitability of the core business). This is capex light business, so EBITDA can be considered a reasonable proxy for FCF here. Paying ~20x multiple for a founder led, highly competitively advantaged business growing at LDD rate for the next 3-5 years seems quite reasonable to me, especially when a major optionality is largely uncaptured in current valuation.
Thank you for reading.
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