The Seattle Times published a story about Kirkland-based HouseValues’ stock plunging last week, one day after the Kirkland company forecasted 2006 financial results that were far below Wall Street expectations.

Shares of the online real-estate services company sank $3.79, or 28.1 percent, closing at $9.71 on trading volume almost 10 times the recent daily average.

John Cook of the Seattle PI, in his Venture Blog, asks if it’s because of new competitor of online house valuations, Zillow.

Robbie Paplin at Rain City Guide asked some good questions and provides a link to this great website, The Rip-Off Report. Robbie asks : “Does management think an upcoming war with Zillow is going to hurt HouseValues earnings? Is the slowing housing market at fault? Have enough people seen Ardell’s “Bottom feeder post” to cause this market cap hemorrhaging? Can TheLoanPage.com mount a credible threat to LendingTree.com? Can Batman & Robin save us?”

I think the answer may lie in their business model, how they currently generate income, and the possibilities for continuing to do this in the future.

HouseValues started out selling entire zip codes to agents for a few hundred dollars a month. Civilians would click on a link that would generate a lead to an agent. That was a profitable business plan for awhile. But then HouseValues went public and had to generate increasingly more income for stockholders, they had to figure out a way to increase that cash flow. So, they started splitting zip codes. But kept the price the same or increased it for inceasingly smaller geographic areas. In exchange, HouseValues promised a certain number of leads to the agents, sometimes just two or three a month, depending on the amount spent and the geographic area.

The problems for agents are that “bad” leads are still counted as a legitimate lead (as far as the numbers promised), and most of these “leads” are months out, as far as becoming customers or clients. With individual agents spending hundreds of dollars a month, with no clear benefits in terms of listing and sales, agents get frustrated and discontinue service. There are just enough success stories to bring more naive agents into the system, but the pie (the geographic areas being sold) is finite. Unless HouseValues continues to carve up the areas into smaller and smaller geographic slices, and just starts selling certain streets, the number of geographic areas it can sell remains the same.

And some areas will never be viable as far as leads go. Rural areas where the concentration of computers could be small, let alone online shopping for a real estate agent or real estate. Certain suburban areas. Low or middle-income areas. In Seattle, this would mean that only certain zipcodes in the metropolitan area would be “saleable” and again, certain zips on the Eastside. The rest of the area would probably be pretty worthless.

Multiply this by XX across the country, and you’ll see that penetration for HouseValues may take years.