Does Realogy Contain Real Value?

by: Kevin Kelly

Realogy (NYSE:H) is an integrated real estate services company. It operates in four different real estate-related segments: Real Estate Franchising, Company Owned Real Estate Brokerage, Relocation Services, and Title and Settlement Services. The company has some excellent brands including Century 21, Coldwell Banker, ERA, Sotheby’s International Realty, The Corcoran Group, Citi Habitats, Cartus, NRT, and TRG. Through the network various real estate-related services, clients often use more than one Realogy branch when making a real estate transaction. For example, in 2005 50% of the company’s EBITDA came from cross selling within the value circle.

The company franchises some of the most familiar brands in the industry. According to the investor kit I received, during 2005 roughly one-in-four single family home transactions included a Realogy sales associate. With over 5,000 franchises in many different areas throughout the country, no individual franchisee represents more than 1% of the company’s franchise royalties. The company’s relationship with franchisees is strong enough to boast 99% retention rates. As a result, the company enjoys a stable, consistent revenue stream at high operating margins from the franchising business.

The company’s in-house real estate brokerage operates through the subsidiary NRT Incorporated. This subsidiary operates brands owned by Realogy but not currently franchised to outside buyers. The company purchased NRT in 2002 and has since purchased more than 90 brokerage firms, substantially growing the company’s owned-brokerage business. Realogy leverages NRT to promote their relocation and title and settlement businesses, and in doing so helps the value circle.

Cartus is the company’s relocation services subsidiary. The subsidiary offers a wide range of world-class employee relocation services that help to manage all aspects of the person’s move and provide a smooth transition through a difficult process. Cartus is clearly the best relocation services company in the United States, not only the largest, as its best clients (Top 25) have an average tenure of 15 years with the subsidiary. Active clients include nearly 65% of the Fortune 50, in conjunction with various government agencies and membership organizations. This business also has its spot in the value circle as clients who need to relocate often utilize Realogy’s real estate brokers (either franchised or company-owned) and title and settlement services.

Title Resource Group [TRG] is the company’s title and settlement services subsidiary. The company assists with the closing of a real estate transaction because it provides full-service title and settlement underwriting of the title insurance policies in connection with the transaction. The business makes money through fees charged in real estate transactions for other settlement services in addition to title insurance. As stated before, this business benefits from the value circle, as approximately 50% of the customers using the company owned-brokerage business ended up using TRG for title services during 2005.

In my opinion, this company has several tip-offs that it is be undervalued. First, it’s a recent spin-off from Cendant and it’s down $3.30 per share from a starting price of $26 per share. In addition, the company is in a sector that’s currently out of favor with the investment community as a whole – real estate. While growth will slow down in the short run, it’ll likely persevere in the long run due to the company’s operating advantages such as the value circle and the company’s diversity of businesses.

Henry Silverman will be running the company. While Henry Silverman’s performance at Cendant is often criticized due to the falling stock price and extreme compensation, he’s invested in the performance of Realogy with more than 2.3 million shares. This is the primary negative I can find.

Due to the nature of this business (conglomerate structure, sector currently out of favor, etc.) it is hard to make the estimations I usually do as to normalizing operating earnings, free cash flow, net income, or EBITDA. Therefore, I modeled earnings and cash flows to come up with a future, intrinsic value. I found this to be $28 per share using an 11% discount rate and various operating margins and sales growth assumptions. If any readers have valued this company or have ideas as to how to value the company please comment!

H offers an interesting opportunity to purchase a recent spin-off in an unpopular sector at a discount to my intrinsic value. In addition to the valuation, the company’s operating businesses are interesting and compliment one another. However, I haven’t yet purchased the stock because I haven’t done enough valuation analyses (Discounted cash flows is only one key method, others are certainly necessary) and I believe Silverman is a questionable leader due to his ridiculous overcompensation received at Cendant.

Disclosure: Author has no position in stocks mentioned