Updated from 9:06 A.M. to reflect the fact that Zillow does not require agents and brokers to manually update listings in the tenth paragraph. TheStreet regrets this error.
NEW YORK (TheStreet) -- Concerns about Zillow's (Z) business model should give investors pause about buying shares of the Internet real estate listing agent, which is scheduled to report fiscal second-quarter fiscal earnings after the close Wednesday.
Zillow will release earnings just two days before the chief financial officer is set to resign. Analysts expect a quarterly loss of 26 cents share on revenue of $168.7 million, with gross margins at 89.6%.
It is hard to understand how a company with an 89% gross margin can't generate an operating profit. For the years 2011 to 2014, Zillow generated total revenue of $706.3 million but posted a net loss of $49 million.
Zillow's largest expense is sales and marketing. During that time, the company spent 49% of its revenue, or $351 million, on sales and marketing.
Zillow brings to mind Yelp (YELP) in that the business model has no leverage. In order to increase revenue, the company has to spend more on sales and marketing.
One would think that the profits would roll in, especially considering that Zillow claims to control 60% of the spending in the real estate portal industry.
In May, Zillow reported that it had 110 million pro-forma unique users. Although the number of users expanded 56%, organic growth slowed sequentially to 35% in the first quarter from 58% in the fourth quarter.
Investors should avoid shares of Zillow until it becomes clear that the company can generate operating leverage from what amounts to free user-generated content.