Realogy: Whether Wall Street Has Worked Out The Coming Real Estate Renaissance
- Based on synthesizing lots of market information, I am betting on a 'Real Estate Renaissance', and Realogy is among the best ways to play it.
- Realogy owns marque real estate brokerage brands including: Century 21, Coldwell Banker, ERA, Sotheby's, and Better Homes brands.
- COVID-19 will create a catalyst for people to move from cities to the suburbs and grandparents to move closer to children and grandchildren.
- Looking for more stock ideas like this one? Get them exclusively at Second Wind Capital . Get started today »
Today, I decided to share one of my Fab 5 ideas that I have kept under wraps since May 23, 2020. The company is Realogy Holdings Corp. (RLGY). I started buying it on May 26th and the more work I did, the higher my conviction level got. My current conviction level is pretty high and I think the move is just getting starting as Wall Street isn't paying attention, at least not yet.
Source: Snapshot of my long position and cost basis in RLGY shares
Moreover, since I still think there will be another big leg up, I decided it was better to share with the broader SA audience. My thought process for sharing is simple, I worked this idea out well before Wall Street, similar to my United Natural Foods (UNFI) thesis, so I don't want to read headlines or watch a CNBC interview where some sell sider shares his/her 'Real Estate Renaissance' thesis and RLGY is then $10 per share. In the interest of not having my thunder stolen, I am sharing my current best idea with the broader SA audience.
Before we dive in, I want to share some context and my investment process. Since late March 2020, I have been actively looking for compelling new waves to surf as COVID-19 has changed everything. Fast forward to late May 2020 and the first derivative stuff has already caught a big bid. From an investing standpoint that is yesterday's news.
Think camping companies like Thor Industries (THO), Camping World Holdings, Inc. (CWH), or deck company Trex Company (TREX), or lawn and garden companies like Scotts Miracle-Gro Company (SMG), and Central Garden & Pet Company (CENT). I am just naming a few.
Source: Yahoo Finance
My point is that as a value investor, I don't fall into the trap of becoming a momentum chaser. I like to be a pioneer and trend-setters not fashionably late and required to pay up for a last-minute ticket to the show or an expensive cover charge at the door (or an expanded/ rich multiple if we are talking about stocks).
As such, morphing into a second level thinking mindset is a prerequisite.
Therefore, today, I write to discuss an idea that I am really, really excited about.
Today's idea is Realogy Holdings Corp. The stock closed at $7.59 on Friday, June 5, 2020. Despite the rally since originally recommending it to my Second Wind Capital members, on May 23rd, I still rate it a 'strong buy' and think $10 (or higher) is very possible.
Per its 10-K, Realogy is largest U.S. real estate brokerage and franchise firm. The company operates marque real estate brands like Century 21, Coldwell Banker, Coldwell Banker Commercial, Corcoran, ERA, Sotheby's International Realty and Better Homes and Gardens Real Estate (see Exhibit A).
RLGY's stock struggled mightily since its 2012 IPO listing.
Source: Yahoo Finance
However, from September 2019 through early March 2020, the company's stock caught a bid and moved from the mid $4s to $13. Then COVID-19 occurred and all hell broke loose.
Source: Yahoo Finance
Addressable Market And Market Share
The total addressable for U.S. residential real estate was $1.9 trillion in 2019. Per Realogy's 10-K, the company has 15.3% market share, as of 2019. Existing home sales represent 89% of the 6 million total home sales in 2019 (or 5.3 million) (see Exhibit B).
Realogy operates the Century 21, Coldwell Banker, ERA, Sotheby's, and Better Homes brands.
What They Do And How They Make Money
The company operates a company-owned brokerage business (Realogy Brokerage Group), a franchised real estate business (Realogy Franchise Group), and ancillary businesses (Realogy Title Group).
Enclosed below are the key operating statistics for the segments.
Source: RLGY FY 2019 10-K (pg. 57)
The company generates the lion share of its EBITDA dollar from its Franchise Group. In 2019, inclusive of corporate allocations, Realogy Franchise Group generated 95.2% of EBITDA. This is a capital lite business and very valuable.
Source: RLGY FY 2019 10-K (pg. 68)
In a concerted effort to de-lever, on November 6, 2019, the company announced a $375 million deal to sell its Cartus Relocation Services business to an affiliate of private equity firm, Madison Dearborn Partners. Upon deal closing, RLGY will receive $375 million upfront and can earn an additional $25 million earn out (see Exhibit C). As of June 5, 2020, the deal hasn't yet closed, but Realogy sued Madison Dearborn to enforce the deal on April 27, 2020. If/when it closes, proceeds will be earmarked to deleverage Realogy's balance sheet.
Why The Opportunity Exists
In the words of Albert Einstein:
Everything should be made as simple as possible, but not simpler.
In the spirit of keeping it simple, RLGY's stock struggled mightily for three reasons.
- COVID-19 fears: (think high unemployment, lower real estate transaction, lower sales velocity)
- High debt levels: (as of March 31, 2020, the company had $628 million of cash and long-term debt of $4 billion including $803 million of short-term debt)
- Fear of creative disruption and innovation from new more tech savvy entrants (think Redfin (RDFN) and other low cost disrupters)
Let's address these hurdles in chronological order:
In a nutshell, I would argue that the real estate market is about to enter a 'renaissance period', as COVID-19 will prove the catalyst for more supply to come onto the market (as many major markets have been supply starved for years now) and there will be major migration patterns away from cities back to suburban locales. Retirees might consider listing and downsizing and moving closer to their families. This movement creates transaction volume. Remember, Realogy makes its money based on transactions, so more volume and higher selling prices equals major operating leverage and earnings power. Plus mortgage rates are super low, which is supportive of activity. If my hunch is right about this coming 'real estate renaissance', which is completely counterintuitive to first level thinkers, readers are going to make a lot of money on this bet.
Check out this juicy commentary from RLGY's Q1 2020 earnings conference call: Can you say leading indicator?
So fundamentally the data we've seen in late March and April is probably better than I personally would have guessed heading into the crisis especially the mid-April peaking we've observed in new open transaction volume declines. While we're excited to see the improvement since mid-April, we're not running away with our excitement because it's only a few weeks of trend that could obviously change, and as I already told you, the decline in new open transaction volume in the second half of April is still significant.
So let me now shift to what we're seeing on the consumer side. Consumers are clearly still engaged in housing and demand still seems to be out there even if some of its pent-up for a while given the crisis. While both new listings and new contracts are down in April, consumer searches are actually up substantially on our websites and have been reported up on other public-facing housing websites.
Searches and viewings have shifted to more to single-family homes and you've all seen multiple articles about the increased interest in suburban living. While we are not sociologist, a shift to a more dispersed living could be an enduring change from COVID that would trigger us and contribute a substantial number of housing transactions.
High Debt Levels
As of March 31, 2020, the company had $628 million of cash and long-term debt of $4 billion including $803 million of short-term debt. I will not argue that this a lot of debt. On the Q1 2020 conference call, this topic, of course, came up.
We exited the quarter with $628 million in cash and cash equivalents, inclusive of regulatory cash and the $400 million we proactively drew down on our revolver in March, amid COVID. Our total net leverage ratio was 5.2 times and the senior secured leverage ratio was 3.06 times, as of March 31 2020.
On the sell side Q&A: Here is how management responded.
Moreover, to mitigate this leverage risk, the company took aggressive actions to cut costs.
First, we moved very aggressively to implement crisis level cost savings through multiple people cost levers, marketing reductions, select investment deferrals and real estate options. The cost savings actions we took in the last two weeks of March and throughout April are expected to lower our operating costs by $80 million to $100 million each full quarter they are in effect.
Here is Realogy's term structure of its debt
Source: RLGY FY 2019 10-K
Fear of Creative Disruption
The most wellknown disruptor in this space is Redfin. Per its 10-K, its market share is as follows: 0.93% in 2019, 0.81% in 2018, and 0.67% in 2017.
Although Redfin has experienced a lot of top-line growth, the company had negative operating income even excluding movements in working capital! Yet, Mr. Market places a market capitalization of $3.43 billion, versus RLGY's ($876 million market capitalization and enterprise value of roughly $4.3 billion).
On its Q1 2020 conference call RLGY's management suggested that COVID-19 might actually expose these high growth, money losing business models for what they are (unsustainable).
Third, we benefit from this business decisions we made before the crisis began. In particular, we talked with you about how we are only focused on profitable growth even at the expense of market share. That choice should benefit us during this crisis, especially compared to those who have been making unprofitable choices, those trying unprofitable new business models or those trying to disrupt the industry with new capital-intensive, but unprofitable ideas.
And at a higher level, one of the things, I've learned from past crises is that there's often both a flight to scale businesses and to quality brands like ours. Crises also often expose unprofitable business models or unprofitable attempts to disruptions, creating new opportunities for established players. So we're working hard to be a beneficiary of both of those phenomena, especially given our demonstrated Q1 momentum. We look forward to navigating this crisis and to taking advantage of opportunities that will occur in our industry.
So overall kind of based on what we're seeing, we believe there's going to be pent-up inventory and consumer demand post-COVID-19. Since housing is not a perishable good, we believe the listing and transaction volumes will improve in geographies as they reopen. We are seeing a bit of green shoots already in our weekly data from select geographies and there have been some public articles to that effect also. Now all of this will be subject to what happens with the macro but those are the consumer trends that we're seeing in this crisis.
Incidentally, on June 2, 2020, Taylor Morrison CEO was on CNBC around 5:45am. She very optimistic and shared many 'green shoots'.
Taylor Morrison continues to show remarkable resilience amid this painful period in our nation's history," shared Palmer. "Despite the COVID-19 pandemic and the senseless violence that's resulted in unruly protests taking place across several of our markets, we finished the month with a 17 percent increase in net sales orders year-over-year," shared Palmer. "These sales numbers resulted in a sales pace per community of 2.7 for the month, a pace equal to or greater than what we delivered in May for the last three consecutive years.
I'm delighted with how well our team members-and the consumer in general-have adapted to our enhanced virtual selling capabilities," added Palmer. "In fact, over the last 60 days, we're averaging 2.5 sales per day completely virtual-meaning no physical interaction with the customer whatsoever.
I tried to cut to the chase and make cogent arguments. I am not going to waste your time with glossy IR slides decks uplifted from corporate websites. My job is to synthesize and find inflection points. This is an imagination game, so we need to look around the corner and positioned ahead of the crowd.
I am really, really excited about this RLGY idea as I sense a 'real estate renaissance' and, at least not yet, the broader market hasn't yet worked it out. Given Realogy's highly leveraged balance sheet and roughly 15% market share, I would argue this is the horse to ride if you are betting on a 'Real Estate Renaissance'.
Exhibit A: Formal business description:
We are the leading and most integrated provider of residential real estate services in the U.S. We are the world's largest franchisor of residential real estate brokerages with some of the most recognized brands in the real estate industry, the leading U.S. residential real estate brokerage (based upon transaction volume), and a significant provider of title and settlement services.
The core of our integrated business strategy is to grow the base of productive independent sales agents at our company-owned and franchisee brokerages and provide them with compelling data and technology products and services, including high-quality lead generation programs, to make them more productive and their businesses more profitable.
Our revenue is derived on a fee-for-service basis, and given our breadth of complementary service offerings, we are able to generate fees from multiple aspects of a residential real estate transaction. Our operating platform is supported by our portfolio of industry leading franchise brokerage brands, including Century 21, Coldwell Banker, Coldwell Banker Commercial, Corcoran, ERA, Sotheby's International Realty and Better Homes and Gardens Real Estate.
We also own and operate company-owned brokerages primarily under the Coldwell Banker, Corcoran and Sotheby's International Realty brands.
Our multiple brands and operations allow us to derive revenue from multiple segments of the residential real estate market, in many different geographies and at varying price points.
Exhibit B - Addressable Market and Market Share Backup:
U.S. Gross Commission Income. Residential real estate brokerage companies typically realize revenues in the form of a sales commission earned from closed homesale sides (either the "buy" side and/or the "sell" side of a real estate transaction), which we refer to as gross commission income. We believe that the level of gross commission income generated in the U.S., which is generally estimated around $70 billion, represents a substantial addressable market. Our company-owned brokerages and franchisees earned approximately $12 billion in gross commission income in 2019, as compared to $13 billion in gross commission income in 2018.
Market Share. As measured in a comparison to the volume of all existing homesale transactions in the U.S. as reported by NAR (regardless of whether an agent or broker was involved in the transaction), we estimate that our market share in 2019 decreased year-over-year to approximately 15.3% compared to 16.1% in 2018. Our estimated share of all U.S. existing homesale unit transactions in 2019 decreased from approximately 13.5% to approximately 13.0%.
$375 Million Sale Of Cartus Relocation To Private Equity:
We entered into a definitive Purchase and Sale agreement with a subsidiary of SIRVA, Inc. ("SIRVA") on November 6, 2019 (the "Purchase Agreement"), pursuant to which SIRVA will acquire Cartus Relocation Services, our global employee relocation business. Under the terms of the Purchase Agreement, we will receive $375 million in cash at closing, subject to certain closing adjustments set forth in the Purchase Agreement, and a $25 million deferred payment after the closing of the transaction. SIRVA is a portfolio company of Madison Dearborn Partners (MDP), a leading private equity firm, and the deferred payment will be paid upon the consummation of MDP's monetization of its investment in Cartus Relocation Services or such earlier date determined at the discretion of MDP. The sale of Cartus Relocation Services is expected to close in the next couple of months, subject to the satisfaction or waiver of closing conditions described in the Purchase Agreement. We intend to use the substantial majority of the net proceeds from the transaction to pay down corporate debt.
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I actively invest my own capital and for a few family members.
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