CoStar Group: The Making of an Intelligent Real Estate Investor

Aug.12.11 | About: CoStar Group, (CSGP)

Real estate is at the core of almost every business, and it’s certainly at the core of most people’s wealth. In order to build your wealth and improve your business smarts, you need to know about real estate.” -- Donald Trump

As Trump says, real estate is a core ingredient for amassing wealth and the key to unlocking successful commercial real estate investments is business smarts. In recent weeks I have written about many of the equity REITs and most have reported growing revenue, strong earnings, and sustainable dividends, all driven by rent checks. In addition, many of the equity REITs have reported improved occupancy levels and increased confidence levels, relative to market driven fundamentals. Like the equity REITs, many of the “fee-driven“ commercial real estate firms have also reported improved revenue and earnings results.

Among the best known sponsors are Jones Lang LaSalle (NYSE:JLL), W.P. Carey (NYSE:WPC), and CB Richard Ellis (NYSE:CBG). CBRE on July 27 reported an 11.7 % quarterly year-over-year increase as the company’s revenues increased by around 19.5% to $1.59 billion to $1.02 billion – another signal of growing confidence in the fee-driven sector. Jones Lang LaSalle also reported higher profit for the second quarter as revenue showed growth that provides an integrated real estate and investment management platform. As reported on July 26, Jones Lang LaSalle’s revenue rose 25.4% to $849.4 million from the year earlier quarter and the global commercial real estate advisor has enjoyed double-digit year-over-year percentage revenue growth for the past five quarters.

As evidenced by the continued improvement in the REIT and commercial real estate sectors, the global recovery is continuing and, as a result, consolidation and expansion are driving forces. With increased investor confidence levels, the recovery process is improving as many smaller REITs and commercial real estate firms are being absorbed into more efficient and well-capitalized investment platforms. As an example, JLL recently announced as part of the company’s Q2 results the successful completion of the King Sturge acquisition. King Sturge is a highly regarded international consulting firm whose 1,600 employees in the UK-based based platform closed on May 31 for $ 319 million. In addition, Jones Lang LaSalle and most of the globally- and domestically-recognized institutional platforms are reporting story acquisition and advisory services pipelines. As Colin Dyer, CEO at Jones Lang LaSalle stated during the company’s Q-2 earnings call, “Our basic view of the market, as I said right from the beginning, is that this global cyclical recovery which normally runs sort of three-, four-, and five-year cycles are only about 18-24 months old. So we’re still in the recovery process …”

So the global commercial real estate sector continues in its recovery phase, and as Trump explained the “core” to successful investing is to “improve your business smarts." As a leader in intelligence, CoStar Group (NASDAQ:CSGP) is a leading provider of commercial real estate research and the intelligently innovative CoStar platform is well on its way to being considered what some have described as the “Google of commercial real estate."

Like the REITs and commercial real estate sponsors, CoStar Group is also benefiting from consolidation in the sector. As authored by Steve McLinden in the August 2011 issue of Shopping Centers Today, “If information is king, then the acquisition of LoopNet (NASDAQ:LOOP) by rival CoStar Group may signal the establishment of a data and property-listing dynasty that could rule the retail real estate realm for decades to come.” The $860 million pending acquisition was announced in April of this year and the LoopNet shareholders approved (75% of LoopNet’s aggregate voting powers) on July 12.

When current CEO Andrew Florance launched CoStar in 1987 from his Princeton dorm room, he never imagined the combination of two of the most powerful commercial real estate data and property-listing firms. And today, as Florance concludes, “CoStar revolutionized how the industry researches commercial real estate and LoopNet revolutionized the way the industry markets commercial real estate.”

LoopNet, a San Francisco based provider of CRE marketing and technology solutions announced on June 29 that it surpassed 5 million registered members, including one of the largest membership community of brokers, investors, tenants, appraisers, and other commercial real estate participants. In addition, LoopNet’s website traffic engines record around 1.5 million monthly visitors (source: Google Analytics) and 7.4x the visitor traffic of the next closest website (source: comScore Media Metrix). With its primary focus on property listings, LoopNet’s revenue results are more appealing as a marketing-driven model. Here are the most recent income results for LoopNet:

Revenue & Income 2010 2009 2008
Revenue 78,002 76,487 86,074
Net Income 15,726 11,753 18,278
Source: Yahoo Finance
All numbers in thousands
Click to enlarge

In addition, LoopNet’s balance sheet has also grown into a cash marketing cow:

Balance Sheet Data 2010 2009 2008
Cash 88,773 125,571 61,325
Total Assets 171,990 174,249 108,210
Long Term Debt 0 0 0
Shareholder Equity 104,679 111,295 92,451
Source: Yahoo Finance
All numbers in thousands
Click to enlarge

CoStar Group’s subscriber base is more data-oriented and the LoopNet merger should provide the combined platform with in excess of 2 million active listings. Data research and marketing are highly complimentary platforms and the integration of these two “best in class” companies should create some meaningful opportunities for investors. As Chris Macke, CoStar’s senior real estate strategist, explains, “We’re continuing to enable small and mid-size businesses to compete more effectively, just as we are giving our larger clients more efficiency.” Recently CoStar Group increased its common stock by 3.75 million new shares priced at $60.00 per share. The proceeds of around $259 million will help fund the contemplated $860 million acquisition cost. CoStar’s stock price climbed to around $73.43 in mid May 2011. Also, CoStar recently announced record revenue as its second quarter revenue increased 11.3% to $62.1 million and it raised its full-year revenue forecast to $250 million. Quarterly earnings decreased from $3.3 million (Q2-11) as a result of the approximate $5 million impact relative to legal and administrative costs associated with the pending LoopNet merger, set to close by year-end 2011. As a research-centric model, CoStar’s revenues are over 3x the size of LoopNet; however, G&A costs are much higher at CoStar as margins are impacted with higher expenses and as evidence by the historical revenue snapshot below:

LoopNet & CoStar
Combined Data 2010 2009 2008
CoStar Revenue 226,260 209,659 212,428
LoopNet Revenue 78,002 76,487 86,074
CoStar G&A 100,231 86,756 81,593
LoopNet G&A 32,478 35,741 37,564
CoStar Net Income 13,289 18,693 24,623
CoStar Net Income 15,726 11,753 18,278
Source: Yahoo Finance
All numbers in thousands
Click to enlarge

CoStar has become a “must have” tool for many commercial real estate brokers, developers, investors, and lenders. The innovative service provider recently unveiled a highly sophisticated iPad (NASDAQ:AAPL) application. As Chris Macke adds, “We’re basically going to give everyone the mobility of taking 900-plus researchers with them.” This “on the go” tool will be a valuable investment resource and many real estate deal-makers spend a significant amount of time out of the office. As Nick D’Argenzio, Financial Analyst at Faris Lee Investments, describes:

The synergies created by CoStar are mapping/satellite capabilities and vast property database along with its customized research abilities allows us to analyze any property nationwide on a street and submarket level. It (CoStar) is an excellent tool for getting familiar with a property and its submarket when visiting the site and driving the trade area unfeasible. It also allows me to be creative and detailed as I want in searching for comparable transactions and micro and macro economic information.

Wrapping It Up

As Trump and Warren Buffett have demonstrated, research and business smarts are essential to investment practices. With its upcoming LoopNet acquisition, CoStar Group should continue to expand its marketing and intelligence capabilities and provide its subscribers with valuable, real-time data. By utilizing the resources at CoStar, investors and real estate providers will benefit from the consolidated expertise of over 2,000 employees in markets across the US and UK.

As the global recovery unfolds, I expect the commercial real estate sector to continue to perform steadily. As capital investments in the commercial real estate sector convert from pipeline opportunities, investor confidence will continue to grow. As a combined entity (with LoopNet), CoStar Group should provide some economies of scale and the dominating CRE search engine should become more efficient, driving revenues to around $350 million after the first year of integration. Once that unfolds, I expect that CoStar will continue to grow revenues by around 20% and annual net income should hit $40 million by year end 2012. As CoStar’s announced merger with LoopNet integrates, I expect that the company’s stock price will grow to around 20% over the next 12 months. The stock closed on Aug. 11 at $ 48.32.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.