Description

Long CBRE: Toll Taker on Real Estate Activity Trading at 10x Normalized Earnings

Thesis Overview

We believe CBRE is an increasingly dominant toll-taker on global real estate capital markets and leasing activity trading at <10x 2026 P/E. CBRE’s current valuation fails to reflect the long tenured management team’s execution on progressively upgrading predictability via organic and inorganic growth - Highly recurring contractual businesses now represent ~70% of revenues vs. <50% 10 years ago. Notably, CBRE management have executed on a transition away from reliance on (1) cyclical revenue streams and (2) the office asset class.  At the same time, earnings derived from CBRE’s cyclical businesses are near trough lows - CBRE’s Brokerage Sales / Mortgage origination businesses are just a combined 11% of sales currently. The combination of continued recurring earnings growth and nascent recovery in CBRE’s cyclical business lines underpin its ability to return to peak earnings just 2 years after significant revenue declines.  We believe this demonstrates the durability of the business model and underlying FCF.

Pressure on activity levels in commercial real estate leasing and capital markets activity induced by (1) higher interest rates and (2) retrenchment in office footprints by corporates has created fear around the earnings trajectory of the real estate brokers generally over the last 24 months. We find this pessimism to be misplaced and believe CBRE is a dominant toll-taker on global real estate activity across property types (i.e. not simply a ‘bet’ contingent on activity in office sales/leasing inflecting)with a structurally improving competitive position.. Further, we don’t think investors recognize the durability of the current earnings power and the potential upside for CBRE on a 3-5 year view (We believe CBRE has largely been overlooked by many value investors despite it checking many of the “compounder” boxes).

We believe CBRE’s capital allocation record has been overlooked. In particular, CBRE’s clean balance sheet and highly opportunistic capital allocation have enabled $3Bn buybacks (8% of float) over the L3Y, while forward FCF should enable a continued reduction of shares outstanding (we see between 3-6% CAGR reductions through 2028). Underpinning this inflection in CBRE’s fundamentals are the strong secular trends driving further consolidation behind the scaled platform with attractive currencies (e.g. CBRE and JLL) and ever-growing advantages for scaled, global players vs. their regional and vertical-focused competitors. .

At this price, investors are creating CBRE at de-risked earnings levels, with a clear path to sustainably surpassing peak earnings next year (and further upside if transaction activity picks back up in the near term). Today, CBRE is trading at a consensus 20x forward P/E (on depressed earnings) vs. L10Y avg. of 18x and high of 25x (was trading ~24x as of Dec 2023). We expect CBRE will achieve to high teens EBITDA margins over the next two years, with further opportunities for EBITDA margin expansion to ~20% over the long term.

We see a path to $230 per share on 2028 consensus assumptions combined with our views on share buybacks (Dec. year-end; built-in multiple compression), corresponding to a >20% IRR on a 4 year view. Incremental upside can be driven by share repurchases above our assumptions, CRE transaction activity recovering, multiple expansion as investors realize the quality of the earnings stream, and continued M&A activity in the property management space.

CBRE was last written up in 2009 by Bubs; there have been more recent write-ups of JLL (2016 / LuckyDog), CWK (2022 / hawkeye901) and NMRK (2023 / ka8104)

Business Introduction

The real estate brokers have historically been cyclical businesses tied to the vicissitudes of the real estate capital cycle. This was most evident during the GFC when sales transaction volumes declined peak-to-trough ~90% (CBRE EBITDA declined ~50% from 2007 to 2009). Despite this boom-bust backdrop, CBRE has never been FCF negative. What is even more interesting is the strategic shift, post-GFC, to focus on more durable lines of business vs. historical transaction driven revenue streams. These incremental business lines (GWS is the primary segment) have grown from a nominal % of sales pre-GFC to a majority of sales mix today (2023: GWS ~49% of sales / broader “Resilient” bucket is 68%). This evolution has created an interesting capital allocation setup for CBRE. The durability in earnings power amid transaction-related slowdowns underpins the ability to be opportunistic in deploying capital to buybacks (Post-COVID CRE sell off enabled CBRE to repurchase $3Bn of stock / 8% of float the L3Y), while providing ever-increasing ability to continue consolidating the industry (CBRE have averaged $200mm of M&A p.a., while 2024 should be ~$1.1Bn). At the same time, CBRE continues to execute tuck-in acquisitions to augment its offerings – The most recent being Direct Line Global, which provides front end (design and installation) and ongoing (maintenance and management) offerings to the data center ecosystem.

Source: Independent Research; Company filings

CBRE has four segments:

• Advisory Services (46% of 2023 total net revenue / 61% of EBITDA): which is built up through Leasing (19%), Property Management (10%), Advisory Sales (9%), Valuation (4%), Commercial mortgage origination (2%) and Loan Servicing (2%). Advisory contains many of the traditional business lines attributed to the brokers and is largely transactional in nature.
• Global Workforce Solutions (“GWS” / 49% sales / 45% EBITDA): which is Facilities Management (32%) and Project Management (17%). GWS provides outsourcing for both managing facilities (e.g. F100 company managing their HQ) and project management manages outsourced capital spend planning across facilities (e.g. cost consulting, implementation, etc). The sales are recurring and made up of long-term contracts. This segment has a bunch of secular tailwinds as large multinationals continue to drive outsourcing across their cost structure (25% sales CAGR since 2017).
• Real Estate Investments (“REI” / 5% sales / 11% EBITDA): which is their investment management business (3% / $145Bn AUM) and development services (2%). REI is levered to market conditions with its asset management economics. ~80% of the AUM is in private investments, making it a bit stickier than other alternatives.
• Other (-16% drag on EBITDA): Corporate costs and eliminations.

Why we like the business?

CBRE is the demonstrably best business in its competitive set and the #1 market leader in real estate services. It is #1 in every category it competes in, with 90 of the 100 F100 companies as customers. CBRE is an advantaged scale player, who will continue to gain share as customers are now looking for a one-stop-shop to simplify their business. Being fully integrated provides advantages for bigger customers who want both a dynamic and high touch offering.

• Limited tangible capital requirements given negligible capex and working capital requirements
• Earn fees against transaction and leasing activity without deploying their own capital: CBRE have consistently generated high teens ROCE’s (we expect the go forward to be >20%).
• Consolidation post-GFC has led to the top firms taking a larger piece of the pie (5 largest firms at ~30% of the total market today / ~5% of outsourcing market), while there is still large runway for further consolidation.
• Local market dynamics drive brokerage deals & the winners are those that have the best data and the best brokers. The larger firms have a much larger set of data to draw on and, likewise, the best brokers want to work for the top firms to get access to the best pipeline and data (commission structures are standard across the industry at 50/50 splits). This provides a feedback loop to be more intelligent in winning new deals and having the best people providing the best service. Likewise, customers want to work with the best brokers who can get the best prices.
• Service capabilities are critical for large multinationals, while switching costs are high as a high degree of the stickiness is relationship and CBRE providing greater bundles of service through one platform.
• Sales mix shift underpins earnings power: During the GFC, CBRE global transaction volume declined ~90% peak-to-trough. It remained ~55% down in 2012 vs. Peak. 2023 vs. 2021: Sales transaction revenue down ~42%; Mortgage origination down ~40%. Unlike the GFC, these businesses only make up a 20% of sales at peak levels vs. 70% during the GFC. See Appendix 3 for charts.
• CBRE benefits from network effects (largely seen in their cross-selling efforts) and scale advantages that help reinforce their market position.

Key Thesis Points

1. Industry structure and consolidation drive go-forward wins for the bigger players

CBRE is the prime beneficiary of market forces, which are driving consolidation of the real estate services / brokerage industry. Scale, data and cost efficiency coupled with the local touch are the critical differentiators today vs. historically where having a local touch was the only thing that mattered to a customer. Larger customers are looking for singular partners to streamline their operations and simplify the number of relationships with indirect partners (e.g. CBRE won Brookfield’s portfolio management of 65m sq ft). Additionally, unlike the regional players who are forced to fight after Class B/C properties on the sales transaction side, CBRE’s transaction revenues are 2/3 from Class A. The owners of the best properties want to work with the best representatives, whether that be traditional brokerage or an outsourced property management relationship.

CBRE can continue to acquire providers to augment its current suite of offerings, while utilizing the CBRE brand to drive increased market share with the new acquisitions.

Source: Cushman & Wakefield Company Overview (Feb 2024)

A few “big” competitors have messy balance sheets (e.g. CWK / NMRK), which plays favorably for CBRE in creating a robust M&A pipeline. For investors looking to create exposure to a cyclical recovery an opportunistic basket trade might be interesting. However, we view the entry multiples for the basket trade as less compelling than owning the industry leader with the best balance sheet at <10x multiple of recovered earnings.

2. CBRE’s sales mix shift creates durable earnings power potentially misunderstood by investors

CBRE’s sales mix shift since 2017 has optimized the future earnings power to be driven by recurring, contractual revenue vs. the historical cyclically driven brokerage / advisory earnings. GWS has gone from 25% of sales in 2017 (nominal pre-GFC) to the largest segment at 49% in 2023 (and likely higher in 2024), while the advisory business has shrunk from 75% to #2 at 46%. Their total contractual (“Resilient”) revenue has gone from 29% in 2006 to almost 70% in 2023 (up from 50% in 2012). Likewise, the “Resilient” operating profit has gone from 32% in 2011 to 60% in 2023 (6x total increase; 3x growth vs. transactional business lines).

The continued outsized growth of this highly recurring business sets up CBRE to be able to compound earnings at high rates over the next 3-5 years.

Source: Independent Research; Company filings

Source: CBRE Q4 2023 Earnings Presentation

3. CBRE can buyback a material amount of stock over the next 5 years

Management have demonstrated a willingness to be aggressive with capital allocation (e.g. M&A/Buybacks) during market declines while simultaneously managing to maintain a clean balance sheet (will end 2024 at 1x Net Debt/EBITDA; L5Y have been below target range of 1-2x Net Debt/EBITDA).

From 2009 to today, CBRE has demonstrated an impressive capital allocation track record. What is important to note is almost all of the major deployments of capital have happened in the last five years (majority of buybacks in the L3Y). The earnings power has accelerated, and higher incremental margins have enabled FCF conversion. The entirety of CBRE’s buybacks have been made in periods where there has been a market dislocation (e.g. the last 3 years).

Source: Independent Research; Company filings

Source: Independent Research; Company filings

The sell-side has modeled for limited capital deployment to buybacks (exception being UBS) over the next 3-5 years. The income expense headwind in NWC hurt FCF conversion in 2023 and, in our view, the low conversion has been incorrectly extrapolated forward. We believe CBRE will be very aggressive with stock repurchases as FCF continues to convert at a high % of Net Income. In our base case, we assume a ~5% share count CAGR through 2028 (as supported by FCF after M&A).

Chairman/CEO Bob Sulentic is an industry legend and an excellent capital allocator. We are excited to see what he will do over the next few years (Bob also has long tenure with CBRE and was the CFO during the GFC; promoted to CEO in 2012 and board chair Nov 2023).

To provide further assurance that their capital allocation is rational, they have been guided in capital allocation decisions by ValueAct Capital since 2011, with Bryan Boze (partner at VAC) serving as Board Chair from 2018-2023, handing the reigns to Bob but remaining on the board.

Valuation

We believe CBRE’s valuation will be driven by share repurchases significantly above expectations today. To keep it simple, consensus estimates ~$3Bn of Net Income in 2028 (incremental $1Bn vs. 2025 guidance). CBRE has minimal capex requirements (2023 was 1.7% of net revenue), which we expect to increase 5% p.a. to $389mm in 2028.  D&A is always slightly higher than Capex due to amortization related to capital markets loans. After ~$200mm of expected M&A, net FCF is ~$3Bn. Assuming the share price steps up in-line with our estimates, you’re looking at a 4% FDSO reduction CAGR (20% cumulative reduction vs. 2023) and $12.15 of Core EPS in 2028 (2.7x increase over the 2024 guidance)

With its clean balance sheet, CBRE should be valued on a P/E basis and has historically traded at a high-teens, low 20’s multiple. Today it is at 20x NTM EPS on a depressed forward number. If we conservatively assume compression back to 18-19x, you’re looking at $230/sh (20% IRR on a 5 year view).

We still believe this is conservative. This takes consensus estimates (which we believe are too low; they model out the CRE transaction recovery linearly) and applies the FCF bridge math. There is an opportunity for management to be more aggressive and manage the balance sheet closer to their targeted range of 1-2x Net Debt/EBITDA. In this scenario, there would be excess cash for further buybacks or M&A. Ultimately, CBRE’s balance sheet today puts them in a place of strength.

Risks

• Continued interest rate volatility: CBRE’s transactional businesses are highly sensitive to interest rates given the levered nature of the real estate asset class. If the trajectory of interest rates remains uncertain, the current bid-ask spread across most real estate sectors would likely persist.
  • Mitigant: Management still expect peak EPS in 2025 with the current interest rate environment, and the glide-path is much less dependent on a recovery in the brokerage business as compared to CBRE’s peers.
• Access to capital for commercial real estate deteriorates further due to escalation in stress on regional banks and/or loss of access to alternate sources of capital, including Private Credit.
• Bad M&A: CBRE have deployed significant capital into M&A recently (particularly within their GWS segment) and if these deals failed to deliver high teens ROI’s, the earnings forecast would be impaired
• Limited external visibility on the Development segment: ~80% of in-process development as of 1Q23 was concentrated in industrial, multifamily, and life sciences. Each of these sectors has seen (1) material increases in buyers’ going-in cap rate expectations and/or (2) deterioration in fundamentals due to elevated supply deliveries (Most notably in life sciences).
• Development & Investment Management businesses remain at cyclical lows for longer: Management expect significant growth over the next 3 years from recoveries in these two businesses. If this does not happen, CBRE are unlikely to hit management targets.
• Near Term target misses: H2 2024 will deliver the bulk of the earnings/FCF for the year as the GWS pipeline is back-loaded. If management don’t deliver on H2, there will likely be worse sentiment for the business in the near term.

Appendix 1: CBRE Capital Structure, Liquidity and Debt Profile

Appendix 2: CBRE Global Real Estate Sales Transactions Post-GFC

Source: CBRE Investor Presentation May 2013

Appendix 3: Real Estate Volumes / Leasing (2007-Q1 2024)

Source: JLL Q1 2024 Earnings Presentation

Source: JLL Q1 2024 Earnings Presentation

Appendix 4: Revenue/EBIT Breakdown: Resilient vs. Transactional (Q4 2023)

Source: CBRE Q4 2023 Earnings Presentation

Appendix 5: Peer Comparison (business lines and historical industry consolidation)

Catalyst

• Management buybacks
• Recovery in traditional brokerage business segments