Realogy Holdings Announces Agreement to Acquire ZipRealty (Transcript)

Jul.16.14 | About: ZipRealty, Inc. (ZIPR)

ZipRealty, Inc. (NASDAQ:ZIPR)

Merger and Acquisition Call

July 15, 2014 04:30 PM ET

Executives

Alicia Swift - SVP

Tony Hull - CFO

Richard Smith - CEO and President - Realogy Holdings

Lanny Baker - CEO and President - ZipRealty

Analyst

Mike Dahl - Credit Suisse

Tony Paolone - JPMorgan

Brandon Dobell - William Blair

Will Randow - Citi

David Ridley-Lane - Merrill Lynch

Operator

Good afternoon and welcome to the Realogy Holdings Corporation Conference Call via webcast. Today's call is being recorded and a written transcript will be made available in the investor information section of the company's website later today and in a filing with the Securities and Exchange Commission.

At this time, I would like to turn the conference over to Realogy's Senior Vice President, Ms. Alicia Swift. Please go ahead, Alicia

Alicia Swift

Thank you, Manny. Welcome to the Realogy conference call to discuss today’s announcements about our agreement to acquire ZipRealty, Inc. On the call with me today are Realogy’s Chairman, CEO and President, Richard Smith; and Chief Financial Officer, Tony Hull. In addition, Lanny Baker, ZipRealty’s President and CEO also is on the call and he will be available to answer questions.

Starting with slide one, Realogy will be making statements about its future results and other forward-looking statements during this call. Statements about future results made during the call constitute forward-looking statements. These statements are based on current expectations in the current economic environment.

Forward-looking statements and projections are inherently subject to significant economic, competitive and other uncertainties and contingencies many of which are beyond the control of management. The company cautions that these statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements.

For a list of factors that could cause Realogy’s actual results to differ materially from those described in the forward-looking statements, please refer to Realogy’s Form 10-K for the year ended December 31, 2013 and its Form 10-Q for the first quarter 2014. In addition, the tender offer to be described in today’s presentation has not yet commenced and we are not making any offer to purchase or solicitation of an offer to sell any shares of the common stock of ZipRealty or any other securities. When the offer is commenced, relevant materials relating to the offer will be filed with the Securities and Exchange Commission and we urge you to read such materials when they become available.

A copy of Realogy’s press release together with any accompanying slides, are available in the Investors section of the realogy.com website. Please note, Realogy will be releasing Q2 results on August 4th, and we will not be answering any questions related to Q2 on this call. Now I will turn the call over to our Chief Financial Officer, Tony Hull.

Tony Hull

Thank you for joining us this afternoon. We are excited to tell you about the ZipRealty acquisition we announced earlier today. I will discuss the transaction and then turn the call over to Richard, who will review the strategic nature of the acquisition and its expected positive impact on Realogy’s company-owned franchise and title business segments.

The aggregate value for acquisition is about $166 million based upon an agreed purchase price of $6.75 per share for ZipRealty which consists of a $147 million to purchase ZipRealty’s outstanding shares and $19 million to satisfy the exercise of outstandings of realty options.

The transaction will be (effected) [ph] through a cash tender offer that we have agreed to commence within the next five business days and which is expected to close in the third quarter subject to the satisfaction of customary closing additions including receipt of regulatory clearance. The ZipRealty Board of Directors has unanimously approved and will recommend the transaction to its shareholders. While ZipRealty’s real estate brokerage and its technology platform are inextricably linked in how they operate and how they should be valued, we generally think of the purchase price in three components.

First, a $100 million to $120 million with ZipRealty’s brokerage operation, which is a five to six multiple of the $20 million in EBITDA, we expect this operation to earn annually within the next three years. Second, ZipRealty has significant NOLs which we believe have a present value to us of up to $21 million and third, approximately $25 million to $45 million which we are investing in a strategic technology platform that we will roll out to our franchisees to make them and their affiliated sales associates more productive.

Thus for an amount in the range of what we would have otherwise spend on similar technology development across the company over a two to three year time frame, this acquisition will accelerate our pace of implementation and we will do so with the benefit of improving technology solution. While deleveraging our balance sheet remains a very high priority, this unique transaction represents our opportunistic approach to enhancing shareholder value.

We expect this investment to drive incremental revenue and profitability. And there are significant synergies in the acquired brokerage operations. In addition, we believe that the upfront investment and approximately $8 million to $10 million in estimated ongoing annual costs mostly associated with the enhanced technology made available to our franchisees will be more than offset by their increased productivity overtime.

Now, I will turn the call over to Richard Smith.

Richard Smith

Thank you, Tony. And again, thank you for joining us on this call. We are very excited about the growth potential that acquisition of ZipRealty will mean for Realogy and we look forward to working with the ZipRealty team. This acquisition represents a unique opportunity for our company. ZipRealty is a leading technology based national real estate brokerage that utilizes innovative technology and comprehensive online marketing, linked to an intelligent customer relationship management system to service customers and drive its business.

Importantly ZipRealty recently unveiled its private label solution for brokerages seeking to digitize their business. This new product offering which is based on ZipRealty’s proven and time tested brokerage and lead management system makes this an opportune time to capture the current and future value of this technology asset and product team for the exclusive benefit of our franchisees and company-owned operations.

We believe ZipRealty is a great fit for our business on two fronts, residential brokerage operations and an integrated technology platform. In a single transaction, we are gaining ZipRealty’s residential real estate brokerage operations in 23 offices across the United States, six of which are new market entries for NRT. And most importantly we are acquiring ZipRealty’s leading edge real estate technology platform which we expect to leverage across all of our brands and company owned offices. Put simply, ZipRealty has a terrific technology product and we have the largest distribution network which makes for a perfect marriage.

We fully expect that this acquisition will strengthen the competitive advantages of our Realogy brands by ensuring they are equipped with a productivity platform that will not only drive more customers their way but that will provide those customers with more personalized service to strengthen relationships and convert more home shoppers into home buyers.

ZipRealty’s scalable technology platform makes this far more impactful than a typical brokerage acquisition. It was designed from a broker’s perspective with real time feedback from thousands of sales associates in the field. The platform offers a fully integrated end to end solution for developing web based leads and in managing the lead to a close transaction. The technology platform is based upon years of investment and field research. It is a turnkey fully integrated technology solution that satisfies virtually every requirement a broker or sales associate may have to develop and manage Web based home buyer leads or to serve clients in their circle of influence in a highly responsive and efficient way.

The platform uses both proprietary and third party technology and it offers a comprehensive suite of tools including an intelligent CRM customer relationship management system that is fully integrated with both web based and mobile applications, a transaction management program, email, training, comprehensive website support and service, lead management, sales associate recruiting and broker business reporting tools to name just a few. It drives relevant real estate data in a timely fashion directly from the most complete and authoritative multiple listing service sources and surrounds that with other content from valuable sources including the informed comments of local sales associates who are also connected to the system.

What is most important is that the platform is as close to plug and play as you can get in our industry. It is the one stop solution for sales associate and broker technology which in our view is not otherwise available. It would have taken us several years to build a comparable end to end solution not to mention making a significant investment. It is particularly important that this technology is well known to us. NRT has been field testing the ZipRealty platform in four separate locations for approximately a year. In parallel with the e-agent lead management strategy that we discussed at our Investor Day on May the 9th.

We also have a larger number of our franchisees who have tested the platform in their markets. The results of those tests give us a high degree of confidence in the effectiveness of the technology. Once we became aware of ZipRealty’s private label solution we realized the potential this solution could represent to our franchisees. By enabling Realogy’s affiliated brokers to deploy ZipRealty’s integrated end to end technology offerings so there are approximately 170,000 independent sales associates in the United States, our expectation is that those sales associates will capture more business while simultaneously enhancing the transaction experience for consumers. When implemented locally by our franchisees the private label technology has the power to increase broker and sales associate productivity, sales associate recruiting and broker and sales associate retention.

This acquisition is also an acceleration of our strategic efforts to provide more internet leads to the sales associates in our company owned operations, and facilitate a higher conversion rate. We believe that the unique ZipRealty lead generation and management process can be expanded as a product to virtually all of the NRT owned operations. NRT will add 1,800 independent sales professionals across 23 offices in the Unites States. ZipRealty has offices in 17 locations that will be welcomed into existing NRT Coldwell Banker operations and its sales associates will continue to leverage the ZipRealty system while benefiting from the considerable support and tools of the full NRT value proposition.

In its remaining six locations outside of NRT’s existing footprint, NRT will continue to operate ZipRealty offices on a standalone basis. The new ZipRealty locations for NRT are in Seattle, Portland, Houston, Austin, Las Vegas and Richmond.

In closing we believe the acquisition of ZipRealty represents a unique opportunity to make a strategic investment in the growth of our company. With this single transaction, we significantly bolster our real estate network, capture synergies across our operations and have the opportunity to scale leading edge technology across our enterprise. We firmly believe that this will create significant value for our brokers, our sales associates and our shareholders.

And with that we are pleased to take your questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question is from Dan Oppenheim of Credit Suisse. Please go ahead.

Mike Dahl - Credit Suisse

Hi, this is actually Mike Dahl on for Dan. Thanks for a lot of helpful color on this. I wanted to ask about the expectations for profitability and contribution of this to Realogy. It seems like over the past year this is a business that hasn't generated any EBITDA. So could you help us understand kind of the zero to $20 million within three years, bucket that out into how much is purely cost takeout from consolidating these 17 locations? How much of it is a growth aspect or leveraging it across your existing platform? And what's the trajectory that we should think about in terms of getting to that $20 million?

Tony Hull

Well, just on the 2013 results for Zip, I think that the simplest way to look at it is their O&Os, their brokerage operation is made about $10 million and that was an EBITDA and that was offset by about $10 million of investment in technology as well as their corporate overhead costs. So obviously on the synergy front, a large portion of the corporate overhead costs are going to go away because they need the public company’s support and back-office that they have now because that will all get integrated into our company.

We expect to keep the technology investment going and that's a critical part of this transaction, the most important part of this transaction is to make sure that the technology is there to really marry with our 3,000 franchisees over time and increase their productivity.

So anyway, that's one side of the equation, the other side is just going back to the $10 million that their O&Os made with synergies, cost takeouts, growth and expansion of some of their technology to the markets outside the overlapping markets; the 17 overlapping markets, remember NRT is in 40 markets. We think we can easily double that EBITDA to $20 million within a fairly quick timeframe.

The longer term investment is really going to be on which we think is more exciting side is the, they’re both exciting, but being able to offer this value to our 3,000 franchisees in terms of the platform that they’ve created, they basically broker in a box end to end platform that they’ve created for our franchisees, we think that our franchisees are going to benefit from it, because they’re going to be able to eliminate spending that they are currently doing and replace it with this comprehensive platform. And we think once it’s rolled out to our franchisees, it’s going to make their agents much more productive.

And if you just sort of look at it simply, if a quarter of our agents or their agents do one more transaction per year as a result of this technology being made available to the brokers and the agents and we made about $280 per transaction in royalties alone, that would be $8 million of incremental royalties for our team.

So in addition to the $20 million which we talked about for the O&Os, you can see easily that even if we had modest success on rolling this after our franchisees and our agents became more productive as a result that the EBITDA opportunities are very strong.

Mike Dahl - Credit Suisse

Thanks. And just to clarify on that last point, so then getting that additional synergy on top is that what's actually necessary to get to the $20 million when you take into consideration the $8 million to $10 million in ongoing costs?

Tony Hull

Yes. Well, the $20 million is the O&Os and then there is an $8 million to $10 million investment on the technology side that we’re going to be making annually. So we basically need $8 million to $10 million from the RFG side to sort of subsidize that and anything over that is going to be incremental to the $20 million.

Mike Dahl - Credit Suisse

Okay. And then shifting gears is there any difference in the way that the sales associates are -- the economics of a transaction and commission splits for these versus your current NRT agents?

Richard Smith

This is very much in keeping with the conversation we had on Investor Day. The intent and the way model currently works is it's distributed on a different set of economics. The splits were generally more favorable to the broker because it’s a highly qualified lead and the lead has been generated by the system, delivered by the system and managed by the system. So there are improved economics as a result of the growth of this lead channel. So we’re very -- we didn’t base any of our models on that, this was all upside that is clearly how it works and it’s pretty similar to the discussion we had about NRT on Investor Day.

Operator

Thank you. The next question is from Tony Palone of JPMorgan. Please go ahead.

Tony Paolone - JPMorgan

Thanks. And I apologize if I try to clarify a few of these things again that you mentioned in the prior questions. But in terms of I think, Tony you had mentioned maybe in one of your comments that the technology component of the acquisition price, is that -- do you see that as basically being in lieu of other CapEx you would have spent related to technology? I kind of missed that comment.

Tony Hull

Yes, exactly. We would have invested that over the next several years. Based on our annual run rate spend, we would have invested that otherwise either through our brand spending or directly through IT investment that we would have done.

Tony Paolone - JPMorgan

And that would have been spending that was in the sort of CapEx, the annual CapEx numbers that you guys have given out in the past?

Tony Hull

Some in CapEx some in OpEx.

Tony Paolone - JPMorgan

Okay so that is more -- think of that as more or less just being pulled up front here as part of the purchase price?

Tony Hull

Exactly with a proven system as opposed to we could have invest -- it’s a proven system that is fully integrated and fully it’s been rolled out and tested. So, exactly it’s just pulling up that. This is really, Tony this is really an acceleration like Richard mentioned, we talk a lot about this at Investor Day Bruce has talked about this the e-agent efforts and the differing splits and taking pressure off splits that we get from the lead generated, the business we get from leads that we generate for agents. So this is really just an acceleration of that activity.

On the broker side on the franchisee side, it’s really being able to offer them this same kind of technology and lead management and really taking a lead from start to finish to a close transaction and proving conversion rates and making that technology available to our franchisees, so that they can become more productive and obviously if they’re more productive we generate higher royalties.

Tony Paolone - JPMorgan

Right. But that would thus necessitate the ongoing you said $8 million to $10 million a year spend that will be on your P&L I assume?

Tony Hull

Right it will be in the corporate line.

Tony Paolone - JPMorgan

Okay. And then, the splits I just again I may have missed this, the more favorable splits was that to you all or to the agents?

Tony Hull

To us.

Tony Paolone - JPMorgan

Okay, so the ZipRealty agents generally get lower?

Tony Hull

They get similar, it’s just again we went through an Investor Day but they get similar splits to our agents but they pay a referral fee for the lead that we deliver to them to close. So it’s the referral fee that effectively takes down the split rate.

Tony Paolone - JPMorgan

Okay. And is there a way if I'm just looking at the ZipRealty basic financial statement for 2013 where they had $76 million revenue, is there a way to see that $10 million of EBITDA that the brokerage more or less produced that you mentioned?

Tony Hull

Well, I can take you through other things like -- I mean that’s basically the -- it's the revenue minus -- well it’s basically I think there is about $68 million of brokerage revenue, I think about $70 million of brokerage revenue. They had about $26 million of gross profit and that is mostly commission -- obviously agent commissions. And then the fixed costs related to the brokerage side were about $16 million that includes marketing and office costs. So that gets you the $26 million of gross profit less the fixed costs gets you to the $10 million of EBITDA.

Tony Paolone - JPMorgan

Okay. So then if I just think about your spending of $166 million and day-one without any of the assumptions of productivity and cost saves and so forth, you're getting $10 million of EBITDA from the brokerage and you'll lose $8 million to $10 million from annual spend on technology, so it's maybe a marginal, just very simplistic look like return on the $166 million?

Tony Hull

Yes, I think it really will take I think over the next couple of years I think this year it’ll be a flat, next year it will be modestly accretive to EBITDA and then it really starts to kick in after that as we start to see the benefit of the RFG, the investment with our franchisees on the platform. So, it’s really latter part of ’16, ’17, ’18 that we really start to see -- we expect everything to sort of kick in here and the return on investment to generate some significant shareholder value for us. It’s really a long term investment here.

Operator

Thank you. The next question is from Stephen Kim with Barclays. Please go ahead.

Unidentified Analyst

Hey guys, its John filling in for Steve. Just trying to get an understanding of once this deal closed, the cost you're going to incur through the P&L, what integration costs will there be? And then you previously had outlined a number of costs for growth investments that were actually going to run through the NRT segment. Is it right to think that there are no longer going to run to NRT but rather run through the corporate segment like you said a few minutes ago?

Tony Hull

No the costs that we are incurring at NRT are still in terms of unifying our websites and improving lead generation and conversion, we’re going to continue to make those investments because we're pretty far down the road on those. So that’s -- we’re going to continue those efforts. In terms of the one-time costs so that there is, they are pretty nominal, there is probably $3 million to $4 million of transaction costs and maybe $3 million to $4 million of other sort of integration costs. So they are not overly significant, so they will be one time in nature this year and obviously non-recurring. As I mentioned to Tony, absent those, this will be about a breakeven for us for the remainder of the year.

Unidentified Analyst

Okay. And as it relates to the consumer websites that you had talked about developing in addition to your NRT unification website, I suspect the plans for that are on the shelf?

Tony Hull

We want to make the net as wide as possible to get lead. So that is definitely still on the target.

Richard Smith

They are actually separate issues. So the consumer website unification project which you recall from Investor Day, that continues and [indiscernible] continues. This will be very complementary to that strategy but it doesn’t replace that strategy.

Operator

Thank you. The next question is from Brandon Dobell of William Blair

Brandon Dobell - William Blair

Hey guys. Is there assumption within your model how you're thinking about the forward look on Zip regarding agent retention or maybe a growth in the agent counts, I know Zip was on a pretty good trajectory to keep adding new agents?

Tony Hull

We think we're going to be in fine shape. As to retention, there will be a very comprehensive communication program that will launch if it’s not our relaunching as we speak, it will definitely be launched by tomorrow. So we will reach out and touch just about every Zip agent. They are going to be suddenly in a position of getting substantial support from to the NRT footprint and the NRT value proposition. So we think they are going to be thrilled with the opportunity to have more resources than they’ve had in the past and we also have made it very clear, we expect to expand that. So they will hear one, a message of here's a lot of support that you probably couldn’t afford in the past. And two, we expect to expand the Zip footprint throughout NRT as we mentioned in our comments and we eventually believe that the Zip model has significant expansion opportunity throughout the franchise network as well. So they should be very happy with this outcome.

Richard Smith

Yes, Lanny if you are there, if you want to add anything to the agent.

Lanny Baker

Sure. Brandon as you know, we’ve been growing our agent count at a pretty good clip over the last 12 or 18 months and I think reflects some of the work that we’ve done over the last two years on our product and our lead gen, our training and the value proposition we brought to the agents. I think that as we put our two companies together, our Zip agents are going to look at this proposition as everything they’ve ever had and a whole lot more in terms of the local branded visible presence of NRT’s offices and Coldwell Banker’s name in the markets. The local office network is something that we have not historically built anywhere near the level of resource and support that NRT has. And I think for our agents, this is going to be a really compelling opportunity to take their business and supercharge it with some of the best brands and best leadership and support the industry. So I think retention ought to be a pretty good picture.

Brandon Dobell - William Blair

Okay. And then a follow on that I know part of the white label thesis that you guys had, Lanny, was offering that service or that product in markets where Zip didn't have a physical presence to try and separate the two from a competitive point of view. Now with NRT having a bigger footprint, is there a risk that that bucket of revenues that was ascribed with a white label product offering is going to see some attrition, is going to see some downside as the current customers look at this transaction and say well now we got a competitor in my market that feels like Zip plus NRT that make it that technology platform as well and I want to be on the same tech platform as the guy next to me or guy down the street? Trying to think about the revenue leakage from now being part of a bigger company relative to how you guys offered that product before.

Lanny Baker

I would say revenue leakage is not something that’s on the forefront of -- my thinking right now, it’s really the revenue opportunity represented by the strength of the RFG franchise network has just a huge opportunity for us. And I think part of the strategy behind the white label product was really so that we could take our technological and web and client incubation and knowhow and systems and offer them in the market under the local brands that consumers think of first when they are thinking of their real estate services.

So the whole effort that we have around white label is really to support much broader, wider, deeper penetration in support of many more brokerages. So I think in the long-term the opportunity here is just -- it’s just -- there couldn’t be a better distribution channel for us, I don’t believe.

Operator

Thank you. The next question is from Will Randow of Citi. Please go ahead.

Will Randow - Citi

Hello, congratulations and thanks for taking my question. Just had two questions, the first on bookkeeping. In terms of when we think about it from a modeling perspective, this all will flow into NRT or will it also be plugged into RFG's network?

Richard Smith

The owned and operated, the 23 ops is better owned and operated that we’re assuming will flow through NRT. To the extent that as our franchisees sign up for the business and revenues are generated from that activity that will flow through RFG and then as you said the technology cost will be a corporate.

And then also importantly there is 7,000 to 8,000, they did it about 10,000 -- they being Zip us, did about 10,000 transactions last year, about 75% of those are buy-side, so that's going to help title as well because we’ll be able to have (really) [ph] get into that business and close those title transactions and we’ll see the benefit of that at TRG as well.

Will Randow - Citi

And then just as a follow-up with the NAR recently launching a campaign for realtor.com in regards to accuracy of information, as I'm sure you and Richard both now, I was just kind of curious how this augments your web presence? And is, from an online perspective, is zero sum game or do you expect to kind of drive more of your own agents to these websites and potentially reducing the fee base that they're paying out for third-party services?

Richard Smith

Well it certainly may, I mean Lanny can speak to the substantial presence of Zip’s website, last I recall and Lanny correct me if I’m wrong, but we had about 24 million web visitors last year and close to 3 million mobile app users. So clearly, it’s an extremely productive website as are the brand websites. So we -- NRT’s initiative if you recall is intended to generate more traffic to those websites and cast a wide net. Capturing those leads and then dispersing those leads to our own agents is a good outcome from an economic standpoint, we’ll continue doing that. So that's not the intent of this, but certainly as we become more productive and more proficient in generating web-based leads and also managing those web-based leads that will accrue the benefit of our franchisees and our company-owned operations clearly.

Operator

Thank you. The next question is from David Ridley-Lane of Merrill Lynch. Please go ahead.

David Ridley-Lane - Merrill Lynch

Sure. If we go back to the Investor Day there's a fair amount of follow along EBITDA from the other segments, the PHH JV, Title and Settlement, just wondering first of all do you see similar scope in the Zip acquisition to sort of the generic acquisitions you presented at Investor Day around those offerings? And then maybe if you could quantify kind of the benefit you would expect through 2015, 2016 from that?

Richard Smith

Yes. I mean the O&O profitability from Zip will be spread among NRT, RFG will get a royalty of 6% off the top and then the Title business I just mentioned will accrue to the TRG segment. So it’s probably, I’d say more than half will accrue to NRT and then the rest will be split between RFG royalty and TRG title transactions.

David Ridley-Lane - Merrill Lynch

Great. And then just so I understand the economics, are you pushing the technology out to the franchisees for all franchisees for sort of the nominal fee or is this, franchisee has to make the decision to purchase the Zip technology?

Richard Smith

It’s a great question. We haven’t made any decisions along those lines. The good news is we have lot of optionality. So one, we are always responsible for increasing value to our franchisees which we will continue to do and this is going to make it possible for us to deliver more value than we contemplated in prior years.

So decisions still need to be made, will be made as to how is price, what will be price if at all and news at 11, but we’re working. We’re encouraged by what we’ve seen thus far and are very encouraged by the feedback we’re getting from our franchisees. So again that will be developed and revealed to our franchisees over the next several months once we close this transaction.

David Ridley-Lane - Merrill Lynch

Great. And just since you mentioned it, I know you’re testing this in four NRT locations, just how many of the franchisees had on their own kind of gone and bought this technology through Zip directly?

Richard Smith

Well remember, private label is a brand new product.

Tony Hull

There were seven of our franchisees using it. And then there are four more who are going on to the white label products.

Richard Smith

Yes, so they’ve been in the test phase. So -- and the test results have been very, very favorable.

David Ridley-Lane - Merrill Lynch

Got it. Alright, thank you very much.

Richard Smith

You’re welcome

Alicia Swift

Okay. With that we’re going to wrap up the call. We thank you for joining us today and we look forward to speaking with you.

Richard Smith

Thanks everyone.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. And thank you for your participation.

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