Description

Note: A further discussion of minority interests follows below

Valuation Overview

Colliers benefits from the following characteristics: i) large addressable market; ii) fragmented industry with room for M&A; iii) track record of operational excellence.  Founder Jay Hennick, now CEO of Colliers, is a proven business leader: Jay’s First Service Group delivered a 20%+ compounded annual return to shareholders for 20 years – an investor in 1995 would have made 35x their money by 2014. Until the Colliers spin-off in May 2015, FirstService Corporation was comprised of both FirstService (FSV) and Colliers (Colliers represented two-thirds of the combined EBITDA in 2014). (Aaron16 pitched the FSV standalone business as a long on VIC in June 2015.)

Colliers has proven itself to be a reliable growth business: since 2010, revenue has compounded by double-digit annual rates – constant currency growth was 25% in Q3 2015 – while EBITDA growth has been nearly twice as high. Colliers margins remain 200-300bps below its peers, but as it builds geographic density (like in the United States), margin accretion will follow.
 

Source: Colliers November 2015 presentation

Colliers’ historical and future growth owes much to the acquisitive nature of the brokerage business. The top four firms control less than 20% of the global transaction market -- developed geographies, like the U.S., are more consolidated than developing markets -- leaving Colliers with many years of future M&A potential. Local brokerages, made up of teams from 2 or 3 to several hundred – based in places like Morocco; Germany; South Florida; or Atlanta – approach Colliers once they’ve amassed a credible book of business. But rather than acquire 100% of these businesses, Colliers typically encourages the senior partners to retain a minority stake of the cash flows. This induces retention and production amongst the senior partners and newly integrated team. Colliers retains the right to call in this minority stake – typically at 4 – 6x EBITDA – and usually does so within a few years. The minority interest is marked at the call value on Colliers’ balance sheet. This arrangement has proved immensely productive over time, and Colliers helpfully provides detailed exposure on organic and inorganic growth over time:

Colliers Revenue Growth

Source: Company filings and transcripts

Alongside secular growth, Colliers’ management thinks there’s room to expand margins over time. Colliers’ EBITDA margin of 10.0% is 260 and 210bps below JLL and CBRE. Management recognizes this gap, originally targeting a 10% margin, which they’ve already surpassed.  Since 2010, the firm has already expanded its EBITDA margin by 600bps: from 3.2% to 9.4%. The opportunity is more obvious when comparing Colliers’ Americas margin of 8.5% vs. ~14% for JLL and CBRE. We expect the gap will narrow as Colliers continues to amass breadth across the Americas, and in the U.S. in particular.

Summing these considerations up, we’ve constructed a DCF that implies 45% upside, based on a scenario where Colliers doubles revenue over the next 10 years and grows margins to levels that are comparable with JLL and CBRE. Given the fragmented nature of the market and strong growth Colliers has seen the past few years (24% constant currency growth YTD), we think our case will prove conservative. We’ve also excluded future M&A growth, from which Colliers has benefitted immensely in the past.

The treatment of minority cash flows pose another wrinkle in the model. The sell-side generally treats the minority interests as callable debt. However, we assume that the underlying cash flows are shared between Colliers and its minority partners. As such, we model a FCF split of 25% to minorities and 75% to Colliers – historically, profit sharing could register higher than 25%, but management has indicated that 20-30% should be an expected range going forward.

Despite these assumptions, we think the stock is worth at least $65, and likely more over time as management continues to prudently allocate capital for accretive bolt-on acquisitions.

Globally Diversified Business Mix

Colliers is a global business, with roughly half of its revenue in the Americas – that includes the U.S., its home market of Canada, as well as South America -- 25% in Europe, and 25% in Asia. Real estate prices, leasing demand, and transaction activity fluctuate across cities and countries, but Colliers can insulate itself against this backdrop: for example, its YTD revenues have grown 8% in the Americas (15% local currency), 45% in Europe (65% local currency), and -4% in Asia (9% local currency). Through a robust recovery in German and U.K. leasing and sales markets, Colliers offset the temporarily correction in Asia, leading to consolidated YTD revenue growth of 12% (24% local currency).  

The chart below – which doesn’t capture trends in leasing or property management activity -- subdivides CRE investment activity by geography. Of course, Colliers isn’t insulated from a temporary earnings decline should global liquidity markets freeze, like they did in 2009. But in more normal markets, Colliers’ geographically diversified business mix leads to less volatility than generally assumed.
 

In conjunction with its core brokerage and leasing businesses, Colliers runs the second largest real estate outsourcing platform in the world – a highly-recurring business with similar market fragmentation and growth potential. Recent acquisitions include IDB Management, a leading property management firm in Belgium. The property management division marries well with the brokerage business, and were it to trade on a standalone basis, we think its high retention rates and absence of cyclicality would warrant a premium valuation.

Fragmented Market with Multi-Year Consolidation Opportunity

Colliers was split from First Service Group for several reasons, but the most notable was to provide Colliers with the capital and added mandate for continued value creation through bolt-on acquisitions. Since 2004, Colliers has deployed $650m towards acquisitions, generating a return on investment north of 15% (company figures) and contributing 30% of Colliers’ overall growth. This M&A machine functions through the cycle, so even in the doldrums of 2009-2010, Colliers continued to pursue attractive deals, closing several through the period.
 

Source: Colliers November 2015 presentation

The opportunity for further deals is immense: the top five global CRE brokers control less than 20% of the market – predictably, the U.S. is more consolidated than developing markets.
 

Source: Colliers November 2015 presentation

Colliers is somewhat unique from the other brokers in its approach to acquisitions. Like JLL and some of the others, it favors small bolt-on acquisitions of talented brokerage and service teams; unlike many others, Colliers prefers equity partnerships with its targets. Rather than acquire 100% of a regional brokerage, Colliers acquires a controlling interest and allows the former management to retain a minority interest. In a typical transaction, Colliers buys a majority stake at 4-6x EV/EBITDA, leaves a 20-30% minority interest for the management of the partner, and retains a call option on that minority stub. This call option allows Colliers to acquire the minority interest – at any time – for the same upfront deal multiple. Colliers normally waits 3-5 years before calling the stake; this not only improves retention and productivity, it allows the partner to integrate itself and its customers with the Colliers brand over time. Today, acquired partners retain roughly 20%-30% of Colliers earnings, but Colliers can call this minority interest for ~$139m.

Commercial Real Estate

Commercial real estate sales and leasing activity show few signs of near-term exhaustion. With falling global unemployment rates, an abundance of yield-seeking equity, and active liquidity in the debt markets, industry followers see consistent growth through 2015 and 2016. We recently met with Jones Lang LaSalle’s CEO, Colin Dyer, who reiterated the healthy trends he envisions for a globally diversified real estate brokerage. (JLL is currently our largest single position in the portfolio, for similar reasons to Colliers). Critically, Dyer stressed that transaction velocity isn’t perfectly correlated to real estate pricing -- that is, CRE prices can flatten, or even decline, and yet firms like Colliers and JLL can grow through higher transaction volume and market share gains. The more relevant data point for transaction velocity is probably liquidity: so long as the financing markets remain open, and equity resides in the asset class, transaction growth should continue. New sources of equity continue to emerge from alternate capital sources, like insurance and pension funds.

Source: HFF Q3 2015 Corp Pres

This growth in equity capital, anecdotally, has led to transactions today closing with far higher loan-to-value ratios than pre-crisis, mitigating some of the industry’s dependence on short-term funding markets. With that said, the brokerage sector has unquestionably benefited from low interest rates, growing risk appetite, and a recovery from the lows of the financial crisis.

Building from trends through Q3, industry forecasts see 2015 U.S. investment sales up 10-15% YoY, Asia flat, and Europe sales flat in constant currency. The leasing markets are even stronger: global absorption forecasts range from 15% (Europe) to 25% (U.S.) growth. Though the brokerage business will always maintain a degree of cyclicality, the addressable market for Colliers is large and will continue to grow.

Source: JLL Q4 2015 Global Market Perspective

The recovery in real estate transaction flows pairs with a steady contraction in industry cap rates, a trend that’s not sustainable in perpetuity. But real estate investors don’t operate in an information vacuum – they realign their investment decisions against the macro backdrop, like any other asset class. So it seems that a rising rate scenario has perhaps been considered by the market, as the chart below illustrates: spreads between CRE cap rates and 10-year Treasuries are generally above long-term averages.

Source: HFF Q3 2015 Corp Pres

Leasing trends appear similarly benign – vacancy ratesare falling alongside an uptick in office demand, a trend that generally coincides with global unemployment rates. 

Source: JLL Q4 2015 Global Market Perspective

If you wish to further research the real estate market, JLL’s full Q4 2015 report is available here: http://www.jll.com/research/157/jll-gmp-q42015.  

Other Considerations

Minority Interest

In our aforementioned capitalization table, we’ve treated the minority interests as callable debt – this is consistent with the sellside’s characterization – but we’ve acknowledged that the underlying cash flows are degraded by the partnership arrangements. As such, an alternate capitalization table would look something like the one below, with 20-25% of Colliers' earnings distributed to the minorities. This leads to 2015E EBITDA multiples two turns higher – up to 14-15x after stock-based compensation expense. While these current multiples appear optically high, we’d emphasize that Colliers margins have room to expand – and further, a low teens EBITDA multiple isn’t excessive for a business with 20%+ EBITDA growth expectations for the next several years.  

Former CEO Transition

Soon after the spin from FirstService, Colliers CEO Doug Frye chose to resign in June 2015. Founder Jay Hennick quickly assumed the CEO mantle, with Dylan Taylor, the Americas CEO, taking the role of President and COO. As described to us by management, Frye had decided he’d made enough money and wished to pursue other challenges, like philanthropy, stepping away from what is a very demanding client-service job. We don't like management changes, but are comforted that John Hennick took the CEO role. CFO John Frederickson and his executive staff have remained in place, and the transition of Frye’s responsibilities were described as “seamless.” Further, Colliers’ M&A pipeline has always been managed by Jay, John, and the Head of the M&A group. The Q3 results suggest that any financial impact is imperceptible.

Conclusion

Colliers combines a strong brand, a very large addressable market, operational excellence demonstrated through organic growth, and plentiful acquisition opportunities. We think shares remain at least 45% undervalued -- management seems to agree: on July 15th Colliers launched a buyback program to opportunistically repurchase up to 8% of shares over the next year.

Disclosure: We are long shares of Colliers and may transact in securities subsequent to publication. This is not recommendation to buy or sell.  

Catalyst

Continued EPS growth