The following is my investment thesis for Jones Lang LaSalle (JLL). It in no way constitutes investment advice. It is for educational and informational purposes only. Nothing contained here should be construed by anyone as an invitation or solicitation to buy or sell any security. It does not contain personalized legal, tax, investment, or financial advice.
Chicago based Jones Lang LaSalle (JLL) is a financial and professional services firm specializing in commercial real estate. Jones Lang LaSalle, LaSalle at that time, had its IPO in 1997 and merged with Jones Lang Wootton of London in 1999 to become the current version of the company. The parent companies have a long history prior to becoming a public corporation - LaSalle was founded in the US in 1968 and Jones Lang Wootton has been in the real estate business in the UK since 1783. Since the late 90s, JLL has been consolidating the highly fragmented commercial real estate services market. In just the last seven years from 2005 to 2012, JLL has acquired 45 companies.
Industry Trends and Catalysts: What are the catalysts for the business?
The real estate market is emerging from the depths of the 2008 financial crisis and real estate bubble. With interest rates at historic low levels and improved perception of the global macro outlook, investor activity in the real estate market has increased in early 2013 and investment volume is expected to grow 10-15% in 2013. However, the office leasing markets are still subdued and leasing volume is expected to grow by less than 5% in 2013. Most traditional office space using sectors are still focusing on efficiency and productivity gains to contain cost. Overall, on a global level, both capital value stock and rental prime offices are in the growth phase of the business cycle.
The Business: What do they do?
JLL provides real estate and investment management services for owner, renters, property companies, and investors. The wide array of real estate services provided by the company include agency leasing services, tenant representation, property and facilities management, project management, property sales and acquisitions, real estate financings, private equity placements, property valuation, and managing money for institutions and individuals.
In the highly fragmented real estate services industry, JLL is the second-largest firm. Only one competitor, CBRE Group (CBG), has the comparable global footprint as Jones Lang. To put the size of the firm in perspective: JLL employs more than 48,000 employees across 200 offices in 70 countries and provides services to half of the Fortune 500 companies. JLL's one key competitive advantage is the combination of local knowledge, which is an important factor in real estate business, and global footprint. So, the company is able to service large multinational firms and at the same time leverage their local knowledge of the real estate market across the world.
Segments: JLL's business can be divided into two buckets:
1. Real Estate Services (RES) that includes five categories:
- Property and Facilities Management
- Capital Markets and Hotels
- Project and Development Services
- Advisory, Consulting and Other Services
2. LaSalle Investment Management: As of December 31, 2012, LaSalle Investment Management managed $47.0 billion of public real estate securities and private real estate assets.
- Reliance on major customers or suppliers: Low. Due to a wide range of services, geographical diversification, and nature of real estate business, JLL doesn't have a significant exposure to any single customer. So, concentration risk in customer or supplier base of the firm is low.
- Threat of substitutes: For real estate services segment, there aren't many substitutes for the services that the company and its competitors provide. In the investment management segment, the business dynamics might change if asset allocation of large institutional players changes in response to market conditions.
Competition: Barrier to entry: High: Though JLL has many local competitors, the barrier to entry for any new comer to reach the global scale is pretty high. It takes decades to build a wide network similar to that of JLL.
Competitive advantages: Medium: Given the duopolistic structure of the global commercial real estate market, both JLL and CBG have significant competitive advantage for integrated global transactions. However, the advantage is tampered a bit in local transactions, as there are a lot of competitors in every local market.
Related companies: At the top end, CBRE Group is the only competitor in this duopolistic industry. However, at the local level there are numerous small competitors.
Experience in the industry: High: Both the parent companies that formed JLL have a long history in real estate. LaSalle has been in business since the 1960s and Jones Lang Wootton has been in business for more than two centuries.
Pricing power: Medium: Pricing power is limited in real estate markets due to significant competitions. However, in case of complex global transactions, JLL has the advantage of scale that can be a source of pricing power.
Labor relations: Low Impact: employees are not members of any labor unions with the exception of less than 3% of total employees who are directly reimbursable property maintenance employees in the United States.
Financials: How is the financial health?
In 2012, total revenue was $3.93 billion - a 10% increase from prior year. International operations were responsible for 57% of the revenue. On a global basis, leasing and property and facilities management contributed to almost 60% of the revenue.
The firm generated $328 million in operating cash flows and $233 millions in free cash flows in the last 12 months. Total debt of the company stands at $476 million and it ended 2012 with $152 million in cash on balance sheet. With EBITDA of $391 million for the year, servicing of the outstanding debt is not an issue. The company pays a dividend of $0.40 per share.
Valuation: What's it worth?
Earnings per share for 2012 was $4.63 and analysts expect the company to earn $6.24 per share in 2013. At the current price, that works out to be a P/E ratio of 15, which is not cheap but not too expensive either. Most of the revenues in property management and investment management are recurring in nature, which tend to be less volatile from year to year. Prior to the real estate bust and financial crisis, the earnings per share in 2007 was $7.64. Since that year total square feet under management has more than doubled from 1.2 million to 2.6 million. So, we have a much larger JLL now and the earnings hasn't caught up to the pre-crisis levels yet. Analysts expect the company to grow at the rate of 13.5% for the next five years. So, for patient long-term investors, at 2013 P/E of around 15, the stock doesn't seem to be too expensive and the company has a long runway ahead for years to come as the real estate market and global economy continues its slow recovery.
Discounted Cash Flow: JLL is not an easy company to value in a discounted cash flow model. The commercial real estate in each area across the world follows a different business cycle and, therefore, it is simply too complex to create realistic projections. Additionally, JLL doesn't fit into a typical industry category - it is more of a service company with recurring revenue and cost and not a typical financial or real estate company.
However, a simple DCF model using the 2012 FCF of $233 millions spit out an intrinsic value of $128 per share. For the DCF, I assumed the following:
Growth rate: Started with 15% and gradually drop it to 2% by year 10.
Discount rate: 10% for first five years and 9% for the rest of the years. I could have used beta, risk free rate, cost of equity, and cost of debt to come up with a cost of capital and use that for discounting. But, given the low level of risk free rate (10-year treasury is around 1.7%) these days, that approach typically leads a very low discount rate and, as a result, an inflated intrinsic value. With the size of JLL and state of their balance sheet, I am comfortable using the 10% rate for the first few years and 9% as they grow bigger.
Of course, the trouble with DCF models is that you can make it show any value by tinkering with the input parameters. So, the DCF valuation is just indicative at best to get a sense of the margin of safety and what kind of expectation is baked into the stock price today.
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Some of the catalysts working in JLL's favor are as follows:
- Clients are moving towards centralized, sophisticated global CRE solutions: As one of the only two companies that have a global footprint, JLL is poised to benefit from this trend.
- Recovering markets: The global market is still in recovery mode from the global financial crisis of 2008. With a global footprint JLL will benefit from the recovery of the different markets across the globe.
- Market share trending to established player: As a long established company, JLL is benefiting from the trend towards established players in the market.
- Increased cross-border capital flows: Over the last few years, capital flow across the border has increased to capture real estate investment opportunities. As a global player, JLL is well positioned to benefit from this trend.
Risks: What can go wrong?
- Global economic and real estate market downturn: If the global markets slide back to recession or more severe downturn like we saw in 2008 then JLL will be impacted from the lower demand for its services and the reduced assets under management in its investment management unit.
- Overpaying for acquisitions: In the last seven years, the company completed 45 acquisitions. In a highly fragmented industry like commercial real estate, consolidation and market share gain by acquisitions seems like a good strategy for the company. However, it carries the typical risk of acquisitions: potential overpayment and integration issues etc. We haven't seen any sign of those issues yet.
- Currency fluctuations: Given the wide geographical footprint of the firm, currency fluctuations are going to have some impact on the earnings in USD. However, over a long period of time, currency changes tend to neutralize each other.
- Low insider ownership: Insider ownership in this company is miniscule. I would have preferred to see more insider ownership in a company to make sure incentives are properly aligned between managers and shareholders.
Conclusion: What's the bottom line?
I like service companies with a significant moat around their business. Unlike software or other technology companies, it is very difficult for any new company to build a competing business at the geographical scale of JLL. Business cycles will come and go. But, with a significant moat like that JLL is likely to thrive for years and decades to come and well worth the consideration for a place in the long-term core holding of any equity portfolio.
Additional disclosure: Accounts managed by The Free Investors have a long position in JLL.