ZipRealty Inc. announced preliminary revenue results for 4Q09.  You can read the full release here.  Overall, the company topped consensus revenue estimates by more than 10% and indicated 4Q09 revenues would be approximately $33-$34 million. Interestingly enough the company’s 4Q09 revenue results imply a 2-5% sequential decline from the third quarter.  Historically, the company’s revenues have declined as much as 15-20% from third quarter to fourth quarter.  The more modest sequential decline for 4Q09 can be attributed to a surge in transactions in advance of what was suppossed to be the expiration of the home buyer tax credit in November.  It is also clear from ZIPR’s preliminary 4Q09 revenue guidance that the company continues to gain market share and improve agent productivity.

In our first report on ZIPR in May 2009, we argued that the stock was a “forgotten microcap” that was well positioned to benefit from a stabilization and eventual recovery in housing.  Here is what we wrote at the time to summarize our investment thesis:

1. ZIPR is well positioned in California, now the fastest growing residential real estate market in the country.
2. ZipRealty is gaining market share. The company has increased the number of closed transactions YOY for each of the past three-years. Ziprealty.com generates approximately 2.0 million unique visitors a month and traffic has increased in excess of 50% YOY during 1Q09.
3. We expect operating losses from the company’s operations in new markets to decline over the next 12-24 months as housing volumes stabilize and recently hired agents increase productivity.
4. ZIPR has an outstanding balance sheet. As of 12/31/08, ZIPR has $49.4 million in cash and no debt. Stated another way, the market has afforded a total enterprise value to ZipRealty of $7 million (At that time ZIPR shares traded at $2.79/share), despite the company’s huge presence on the Internet and its track record of profitability in established markets.

ZIPR Is On Track for Positive EBITDA in 2010

Over the course of 2009, ZIPR continued to benefit from transaction growth in California, gained share nationally, and improved operating profitability in its newer markets.  In short, our thesis continues to come to fruition.  As we outlined here, ZIPR heads into 2010 on the verge of profitability based on improved operating performance in the company’s newer markets.  As part of the company’s preliminary revenue announcement this morning, management provided financial guidance for FY10 for the first time.  The company expects to generate 10-20% revenue growth and generate positive EBITDA for the first time since 2005.  In the table below we have outlined our forecasts for ZIPR for FY10 and FY11.  Here are some of our key assumptions:

• A full year 2.0% YOY increase in revenue/transaction in 2010 (we forecast a low single digit YOY decline in the first half offset by a mid-single digit increase in the 2nd half).  For 2011, our revenue estimates are based on a 4.0% YOY increase in revenue/transaction
•  A 0.25x and 0.60x increase in agent productivity (as measured by transactions per agent) in FY10 and FY11.  In our view, agent productivity is the single most important metric to gauge ZIPR’s operating effectiveness.  It is the only operating metric that is truly in the company’s control and not necessarily the result of market factors
• 300 new agent additions in FY10 followed by an additional 240 in FY11. Our expectations for new agent additions could prove to be  conservative given ZIPR’s growing national brand awareness and the level of new agents that have been added to the network over the past two years.
• Gross margins of 42.6% and 43.5% in FY10 and FY11, respectively. 
• We have assumed the company generates substantial operating margin leverage off both G&A spend and sales and marketing expenditures over the next two years.

ZIPR Remains A Good Way to Play a Housing Recovery

Over the past 6-9 months it appears that a tenuous bottom has formed in housing.  Stated inventories continue to drop and new and existing home sales have started to increase off depressed levels. However, the impact of mortgage option-ARM resets, the magnitude of “shadow inventory”, and high unemployment suggests that a full-fledged recovery in housing is likely to be a long, tough road.  However, we think ZIPR remains one of the better ways to play the ongoing stabilization and eventual recovery in housing.  The company benefits from traditional, foreclosure, REO, andshort sale transactions.  We anticipate the company could start to generate revenue growth from home price increases as early as the second half of this year.  ZIPR ended 4Q09 with approximately $44 million in cash ($2.15/share) and no debt.  The stock currently trades at 11.5x our EBITDA estimate for FY10 and has a free  cash flow yield of 3.5%.  Based on our assumptions that housing could slowly recover in 2011 and ZIPR will continue to gain market share, the stock trades at 3.3x our FY11 EBITDA estimate and 10.5x our FY11 EPS forecast.

We think ZIPR has finally reached a critical inflection point.  The company appears to have achieved the scale and profitability in new markets that should enable ZIPR to achieve positive EBITDA in 2010 and positive earnings in 2011.  Structurally, the company’s business model is poised to generate strong free cash flow.  Based on our estimates, the company will end 2009 with more than $40 million in cash, or $2.00/share.  We expect the company to generate positive free cash flow in 2010, which would position the company to repurchase shares.  ZipRealty is a top ten residential real estate broker, gaining market share and on the brink of profitability.  At an enterprise value of $40 million we think ZIPR shares are highly attractive.  We see upside to the $5.00-$6.00 range and think the company could also be an increasingly attractive acquisition candidate as the housing market stabilizes.

As always, please act accordingly…

Disclaimer: The author of this report owns shares of ZIPR