Value Investors Club / Countrywide Plc (CWD)

Description

Countrywide was written up almost exactly one year ago by nilnevik at almost exactly the same price at

which it trades today. While shares rose nearly 33% in the 6-8 months following his write-up on the

back of housing market optimism (partially fueled by a favorable election outcome), the stock has given

back nearly all of the gains as:

a) Interim results were weak – while this was largely expected for the transactional portion of the

business, growth in the lettings business was below expectations.

b) Countrywide hosted its first ever investor day earlier this month – management tempered its

enthusiasm for a medium-term housing market rebound citing a reduced propensity to

purchase on the part of millennials coupled with more stringent down payment requirements

relative to decades past.

While the housing market rebound and associated benefits of operating leverage hoped for by many

bulls has not materialized (nor does it appear imminent), I believe CWD continues to represent an

attractive opportunity for long term investors as it has limited downside but offers the prospect for solid

returns even absent a housing market recovery.

Investment Thesis

Countrywide Plc is a BUY with 30% upside (and expectation of a 16% annual return over 4-5 year

horizon). Countrywide is a good business selling below intrinsic value.

1) Over the past 7 years Countrywide has developed the largest lettings business in the UK. Unlike

the cyclical transaction business, lettings provides a very stable revenue/CF stream. Today,

lettings represents 25% of total EBITDA (inclusive of Lettings EBITDA included in ‘London’

segment). Countrywide has grown the lettings business rapidly (both organically and via

acquisition) and will likely double the business over the next 5 years. Lettings will grow

irrespective of whether or not the UK housing market ever rebounds.

2) Countrywide has a clean balance sheet with net debt of just 0.7x EBITDA. The company is highly

cash generative and expects to return cash to shareholders via buybacks and dividends.

Buybacks are highly accretive to long-term shareholder value at today’s price.

3) Countrywide trades at 13x 2016 estimated EPS (8.7x EV/EBITDA) assuming no rebound in

transactions (or increase in prices). With the continued growth of the lettings business,

Countrywide could earn ~50p in a slightly better housing market, implying 40% upside

(discounted back to today; equivalent to a 20% compound annual return over the holding

period). With the lettings business comprising an increasing share of CWD’s EBITDA, I believe

investors are likely to reward the company with a higher multiple (given recurring nature of

earnings here).

4) At today’s price, downside appears limited. Assuming no recovery in the housing market, I

believe Countrywide can earn 45p per share in 2018 EPS (and be nearly debt-free). Were

transaction volumes to plummet to 2008/09 levels, I estimate Countrywide will achieve 2018

EBITDA of ~L100 million and EPS of 30p as the company continues to build the lettings business.

It is worth reminding readers that Countrywide’s business has been significantly improved over

the past decade. Despite transaction levels being ~30% below 2007 levels (and ~20% below

normal), Countrywide delivered EBITDA +20% in 2014 vs. 2007 as the company has cut costs and

developed new income streams.

5) While mgmt has tempered the market’s enthusiasm for a housing market recovery, ultimately I

believe we will see an upside surprise given favorable demographics and my belief that life

events (marriage/children) will cause the housing market to mean-revert.

Countrywide shares have fallen over 30% from their all-time high (1H14) as the market is concerned

about whether or not a UK housing transaction market recovery will ever occur (and the market

narrowly views the company as being a play on the UK housing transaction market – brokers have been

tripping over themselves to downgrade over the past few months). What I find most compelling about

investing in Countrywide is that the company is likely to show strong free cash flow growth irrespective

of whether the UK housing market rebounds as the lettings division continues to execute a value-

accretive M&A lead growth strategy. Not only will this drive free cash flow growth but as the market

begins to pay more attention to this portion of the business, it should eventually award Countrywide a

higher earnings multiple given the stable, cash generative nature of this growing business.

Further, while the UK housing market recovery has slowed and management has walked back its

housing market expectations, as a long-term investor I believe it is a matter of when (rather than if) the

market returns to its long term average level of transactions given favorable demographics (unlike the

continent, the UK has persistently shown/is expected to continue to show population growth and

household formation). On the flipside, in the event that another macroeconomic calamity occurs and

UK housing market transactions collapse to 2008/09 levels, with a solid balance sheet, I see fundamental

downside as being limited. Various downside scenarios are explored on the ‘Downside’ section. With

multiple ways to win, and limited downside, I believe Countrywide is an asymmetric investment

opportunity.

Background

Countrywide came public in 2013 after seven years as a private company. Countrywide was previously

listed on the London Stock Exchange until 2007 when it was purchased in an Apollo lead buyout. While

this was very near the top of the UK property market, the rationale for the buyout was three-fold: 1)

that Countrywide had been built through a series of acquisitions (starting in the late 1990s) but had not

done a good job of integrating (branch closures, IT systems, implementation of best practices, etc) which

could provide meaningful upside to operating margins (2) the business was/is highly cash generative and

could service cheap debt (assuming normal levels of housing transactions) and (3) the UK residential

housing market offered ample opportunity for continued consolidation at attractive prices. While this

was a reasonable premise for the MBO, the UK property market saw transactions levels fall 50% and

home prices fall 20+%. This lead to a collapse in revenue and operating losses. Teetering on the brink of

administration (bankruptcy) the group underwent a debt for equity restructuring which made Oaktree

(OAK) its largest shareholder in 2009. From 2009-2013, the company followed through on the

restructuring it had planned at the time of its LBO, taking over L200 million out of its cost structure (of

which about half are permanent; the other half are likely to return as the UK housing market rebounds).

Today Countrywide is the leading realtor in the UK with ~1400 branches and a 6% market share, roughly

twice the size of LSL Property Services (LSLPF). While Oaktree and Apollo sold down their stakes in a

secondary offering, Oaktree remains Countrywide’s largest shareholder with a 27% holding.

Lettings

Countrywide’s lettings business has grown rapidly (both organically and via acquisition) over the past 5

years and is expected to be a meaningful growth engine going forward. In the lettings business

Countrywide provides landlords with some or all of the following services: 1) setting rents and finding

tenants (2) perform credit/background check and execute rental agreement (3) interface with tenants

(i.e. register complaints and collect rents) (4) coordinating property maintenance & repair (5) providing

legal documentation and accounting for owners. On average Countrywide receives 10-11% of rent for

providing these services though this ranges from 8-13% depending on services purchased (at a minimum

landlords use Countrywide to find tenants – on a standalone basis this costs about 8-9%). Size and local

density are an advantage in this business as regional management (clustering of showings for instance)

and most of the back office functions (accounting, tenant repair hotlines, etc) are highly scalable – this is

evidenced by the growth in the lettings segment EBITDA margin which has increased from 19% in 2011

to over 25% in 2013 (on track to do 27-28% in 2014). Similarly, as Countrywide has gained clout in the

property management business it has attracted a larger pool of prospective renters to its

website/agents which increases its ability to quickly fill vacancies making it the manager of choice to

landlords.

While property management represents a cost to the landlord, Countrywide estimates that in most

cases, a portion of the cost of their services is offset by 1) higher rents and lower vacancy and to a lesser

extent (2) lower procurement costs (passed through) for repairs and maintenance. Providing

nationwide services allows property investors to purchase properties anywhere in the UK while having a

trusted manager (allowing investors to focus only on the investment and not have to worry about ‘who

will manage this?’). It is estimated that there are ~4 million rental units in the UK with only 50-60% of

landlords (not great data here) using professional management so there is an opportunity for continued

organic volume growth (1-2% pa) in addition to upsell of services (1-2%) and annual rent hikes (1-3%

with -Countrywide sharing as it receives a percentage). Landlord clients tend to be sticky – Countrywide

has 85% retention. Most organic volume growth comes from cases where the owner was self-managing

the property (or has become a new landlord, having purchased from someone who had self-managed)

and has decided to outsource these tasks. To supplement organic growth Countrywide has been an

active acquirer of lettings businesses. While individually these deals tend to be small (I believe all have

been sub L8 million and many are sub L1 million), in aggregate deals have added significantly to top-line

growth and fueled margin expansion as Countrywide has significantly improved scale. The economics of

transactions are very attractive. Historically Countrywide has paid 1-1.2x revenue (and 7x pre-synergy

EBITDA). After factoring in synergies (removal of duplicate costs, some revenue synergies as

Countrywide has a broader asset management services offering) such that on a post synergy basis these

deals are done at 5x EBITDA (implies a 16+% return on invested capital). The industry remains very

fragmented with Countrywide holding only a 5-6% market share which should allow the business to

continue to grow at a solid double-digit rate (inclusive of acquisitions) while growing margins.

Going forward, Countrywide is focused on continuing to roll up the lettings business while improving

processes and procedures. Specifically, Countrywide is seeking to improve landlord retention. The

company is using predictive analytics to more proactively target landlords it expects are at a higher risk

of churn.

Countrywide is in the midst of launching a UK residential property fund which will invest in apartment

buildings and possibly single family homes. Inclusive of its L20 million seed investment, Countrywide

has raised L95 million thus far (as of October trading statement) and seeks to raise L1 billion (not sure if

this is levered or unlevered basis) over the next several years. This is an emerging asset class in the UK

(on the one hand great growth opportunity, on the other hand have to educate investors as to why they

should be involved here). In addition to receiving advisory fees (which will be shared with Hermes which

is assisting in the fund raising effort), Countrywide will generate business for the lettings division (as well

as the estate agency brokerage and the small commercial business discussed below) as these properties

will be self-managed.

Estate Agency

Housing market overview - Housing turnover over the past 20 years (housing transactions / households)

has averaged 5.1%. Applying this number to the current level of households, we can see that

normalized transactions should be somewhere around 1.3-1.4 million (+30-35% vs. 2013 actual

transaction levels and +25% vs. 2014 expected transaction levels). The average level of transactions for

the past 20 years has been 1.25 million homes (and 1.3 million for the past 30). Unlike the US, there is

no large government buyer of mortgages in the UK. Banks tightened lending standards following the

2008/09 financial crisis – further the securitization market is much less developed in the UK than the US

– mortgages stay on the balance sheets of banks. As such, buyers are required to make a down

payment of 15-20% when purchasing a home and consequently housing transactions have recovered

slowly in the UK (relative to the US). While this may forestall a return to normality, ultimately, I believe

that people will continue to purchase homes at levels no dis-similar from history as life continues to

happen – people graduate from high school/university and move out on their own, marry and have

children, divorce, and retire/die. Further the UK continues to experience population growth. Given that

the aforementioned drivers of housing transactions have not changed (at least not for the negative), I

believe housing transaction levels should mean revert.

As for home prices, on an all-in basis, home prices relative to household income is 5x which is 15-20%

higher than the 20 year average. This is a bit distorted as the price/household income for the red-hot

London market is north of 7x (which is 30+% higher than its historical average). Excluding London, I

estimate UK home prices are ~10% above their long-term average (relative to household income; w/ low

interest rates affordability is at/near an all-time high).

Structurally, the UK residential agency model faces fewer long-term threats than the US model. In the

US, Redfin, a discount brokerage is a significant threat as it undercuts full-service brokerage fees by 15-

30%. However, in the UK, lower commission rates coupled with a market where only typically the seller

uses an agent means the total commission bill in the UK is less than half what we see in the US (where

commission levels are higher and the seller pays both the seller and buyer’s agent). If a buyer wishes to

use an agent (again this is rare) in the UK, the buyer pays the agent out of pocket. Given this greatly

reduced total commission pool, it is unlikely that Redfin/other discount brokers will make a meaningful

push into the UK market (haven’t seen anything so far). As for the threat of brokers being

disintermediated by online competitors, it is important to understand that Rightmove, the leading

online portal with 80% market share, has been around for 14 years (and had a dominant position

virtually the entire time). During this period, we have not seen any meaningful shift toward for sale by

owner. Note that Rightmove was originally owned by Countrywide (spun off in 2004) and never

accepted for sale by owner properties. With fees from estate agents representing the bulk of

Rightmove’s revenue it would be a very risky to embark on such a strategy without alienating estate

agents. The risk to Rightmove in attempting such a strategy is exacerbated by the emergence of Zoopla

(has ~15% market share) which was funded by both Countrywide and LSL (and came public earlier this

year) to keep Rightmove in check. If Rightmove upset agents by soliciting property owners directly,

agents could withhold listings (while steering more listings to Zoopla). Seems unlikely that Rightmove

would take this kind of risk. That said, there is no Multiple Listing Service in the UK which gives

Rightmove and Zoopla much more power than Zillow/Trulia have in the US which has been evidenced by

their ability to increase ARPU at a double digit rate over the past several years. To some extent,

Countrywide has taken some power back through Propertywide.co.uk, its proprietary site which now

generates nearly 1/3 of leads.

Financial Services

The Financial Services (cross-sell of mortgages and insurance), Survey (appraisal), and Conveyance (legal

+ title search) businesses are all linked to the level of housing transactions. In the financial services

business Countrywide has mortgage brokers operating within its estate agency branches. The company

brokers 5-6% of all mortgages in the UK and has a cross-sell conversion rate of about 60%. Countrywide

also does remortgaging (refinancing) transactions (discussed below) and sells insurance (both life &

home; in the UK a life policy is typically purchased at the time a customer takes a mortgage to ensure

the mortgage is paid off in the event of death). These are fee-driven businesses where Countrywide

does not assume any lending/mortality/property risk.

Conveyance

In the Conveyance business, Countrywide provides legal services to both buyers and sellers of homes.

Conveyance is the process by which legal title is transferred from seller to buyer. Lenders generally

require conveyance prior to transferring funds to the seller (risk of fraud). During the conveyance

process a process akin to a title search in the UK is conducted to verify that there are no unknown liens

against the property. Like the survey business, Countrywide uses a panel management approach to

maintain flexible capacity. While the conveyance market is fragmented, over time, it is possible that

Countrywide will take share as lenders prefer working with a known commodity here (again, reduced

incidence of fraud). Countrywide sells conveyance services directly to home buyers (45% cross sell rate)

and to lenders.

Survey

In the Survey (appraisal) business, Countrywide holds roughly 30% of the market (comparable market

share to LSL Property Services). Connells and Colleys hold the bulk of the remainder. Here Countrywide

provides property appraisal services to lenders who want to verify the value of the property prior to

granting a mortgage. Virtually all lenders have outsourced this business as 3

parties are able to benefit

from scale (and better ability to cluster jobs closely) and focus which allows 3

parties to do the job

much more efficiently. From 2004-2008, Countrywide lost market share (market share fell from the mid

to the low 20s% at depth of the crisis) to LSL which had a more efficient structure. LSL uses a panel

management strategy whereby lenders outsourced the job of allocating jobs to surveyors. This lowers

the cost to lenders (complete outsourcing) and allowed LSL to cherry pick jobs (cluster – target 6 surveys

per day per surveyor). Countrywide was a bit late to introduce this strategy but has since replicated the

LSL model, recouping most of the lost market share, while boosting margins. As LSL sought to use its

favorable cost position to take market share and volumes plummeted (as not only housing transactions

but also remortgage transactions) and each company had excess capacity, pricing became more

competitive as work was rebid (contracts w/ lenders are 1.5-3 years). The market has since become

more rational as 1) cost positioning is equivalent (2) companies have each seemed to accept that 30% is

the natural market share – rather than compete for large jobs, they sometimes bid together and share

the work (3) rebound in housing has increased demand while each company downsized their workforce

bringing supply and demand closer to parity.

Note that Countrywide and LSL each experienced significant losses (~L40 mn; show up as extraordinary)

in 2009-2012 related to the survey business. This resulted from liability to the lenders for inaccurate

valuation work – in no small part due to the significant decline in property prices. Countrywide (and LSL)

have both taken steps to prevent this from recurring (on such a large scale at least), including: 1)

modification of contracts in an attempt to reduce liability (2) paneling out appraisals which have been

shown to be more prone to claims (these include high value properties, properties in certain

neighborhoods, etc). The offset of this is that Countrywide and LSL were not alone in being liable to

lenders for bunk surveys – as a result, many smaller players were forced to exit the business (lenders

wouldn’t put business with them as they didn’t have capacity to make good on claims).

In addition to serving home buyers, the survey business has upside potential when interest rates rise. A

rise in interest rates will prompt UK borrowers to refinance their mortgages (in contrast to the US).

Given the absence of a Fannie/Freddie, there are no 30 year mortgages in the UK (as the banks don’t

want this interest rate risk on their balance sheets), the standard term length is five years. Typically the

first 2-3 years are at a fixed teaser rate and then after 2-3 years switch to floating rates (historically this

caused an increase in costs to the borrower) leading to frequent refinancing. However, refinancing

transactions have been well below normal since the financial crisis as 1) the decline in home prices

coupled with tougher lending standards made it more difficult for homeowners to qualify for refinancing

and (2) the 0% interest rate policy lead to homeowners actually saving money as rates switched from

fixed to floating. Today, the vast majority of UK borrowers have floating rates. As home prices have

recovered (only somewhat outside of London), more homeowners are able to qualify for mortgages.

However, at this stage homeowners aren’t incented to refinance as base rates (the rate which

determines payment) are so low. An uptick in interest rates would likely stimulate refi demand (which

hovers near all-time lows) as borrowers would seek to lock-in relatively low rates.

LSH/Small Commercial

In 2013 Countrywide acquired LSH, a small commercial property services company (serving smaller

clients/buildings than a Jones Lang or CBRE or even Savills) operating with 864 people across 21

locations. The business provides commercial customers most of the services Countrywide provides to

residential customers. Countrywide paid L34 million for the business (~7x 2013 operating profit, <6x

2014 expected operating profit).

Assumptions & Valuation

Estate Agency Revenue: Housing market assumptions. I value Countrywide by assuming that the

housing market returns to 1.2 million transactions by 2020. This is effectively the midpoint between

management’s downbeat outlook (of between 1 and 1.1 million transactions per year for the next five

years) and a mean reversion approach (taking 5.1% housing turnover * estimated 2020 housing stock =

1.35 mn transactions), .

I assume slight housing price appreciation over the period. As mentioned above, I think that the UK

housing market (ex London) is ~10% overvalued relative to its history (using price/income). Assuming

that household income grows at 2.5% over the forecast period, this gets us back to the multiyear

average. I assume that the average fee declines ~10% during the forecast period. Simplistically, average

fee declines in strong markets and increases in weak markets. This sounds counter-intuitive but in the

UK estate agents introduce upfront fees in weak markets as competition exits the market and homes are

tougher to sell. By contrast, in better markets, homes are easier to sell and agents are more willing to

cut fees (as they expect to sell the home quickly). I assume that Countrywide gains 5 bps of market

share per year. This comprises an organic share loss of 5 bps but a 10 bp gain from acquisitions. In

periods of a strong increase in transactions, a large agency like Countrywide may shed organic market

share (as agents become more confident and open new agencies) whereas the company is likely to gain

market share in a down market (as competitors retrench). My forecast includes L10 million of non-

lettings M&A spend (which is likely to more than offset any market share losses during the upcycle).

Over the medium and long term, I expect organic market share to be fairly stable.

Estate Agency Operating Margin: Despite the low level of transactions, due to cost cutting efforts,

Countrywide is still producing strong earnings in its transaction related businesses – the estate agency

segment earned an 8.2% EBITDA margin in 2013 (with transaction levels 20-30% below normal). A

rebound in housing transactions will not only drive revenue higher but will also lead to a meaningful

increase in operating margins given that there is substantial operating leverage in Countrywide’s

business. Unlike the US, agent compensation is more biased toward fixed salaries than commissions. As

such, in a normal market, total compensation paid to staff is on the order of 50-55%, well below the

~68% we see at the leading US realtor Realogy (which earns only 6-7% in its owned branch network;

consolidated margins are higher due to the inclusion of the franchise business). There other reasons

that margins in the UK are higher than in the US (despite lower commission levels) is due to better cost

sharing. The UK branch is home to not only the estate agency business but also sells financial services

and conveyance services discussed above (in the US the agency does not capture much, if any, revenue

here). I expect slight improvement in operating margins by the terminal year (+100 bps vs. 13.5% last

year).

For the Financial Services, I assume that revenue increase in line with housing transactions (without the

fee pressure suffered in the EA segment) in 2015-2018. It is important to note that the financial services

segment will likely see faster growth if interest rates increase, driving re-mortgaging (opposite of the US

due to the dynamics described in the survey description above) and has the potential for some

additional growth via cross-selling. The financial services segment shares infrastructure with the estate

agency segment (shared office/advertising). Financial Services should see incremental operating

margins in-line with the estate agency segment (40%). As volumes recover, this drives segmental

EBITDA margins from 19 to 23%.

I also grow the Survey segment in line with housing transaction volumes in 2015-2016. However, in

2017-2018 I credit the segment with an additional 500 bps of growth. This is because at some point I

expect that remortgaging will pick up (driven by rising interest rates), driving incremental growth for the

surveying business. Margins for the survey business will improve slightly but will not see anything like

the 40% contribution margin segment above as new surveyors are required to produce incremental

revenue (very little excess capacity). I assume a 25% EBITDA margin which is roughly in-line with

competitor LSL.

Similarly, the Conveyance business will see revenue increase in-line with housing transactions while

margins are relatively flattish.

London & Premier – While volumes in London remain below historical averages (15-20%), as mentioned

above prices are inflated. Segmental revenue should benefit from a strong lettings mix (London lettings

are not included in the lettings segment – lettings represents 25% of revenue and ~1/3 of EBITDA). I

assume that total revenue falls 5% in 2015 (inline w/ 1H), and grows 3% thereafter. Margins decline

from an estimated 24% in 2014 to 20% in 2016 before rebounding to 22%, in-line with recent history.

My 22% estimate compares to 31-35% reported by London-focused agent Foxtons from 2010-1H14 (and

slightly below what Marsh & Parsons business earned as a standalone company prior to being acquired

by LSL in late 2011). Over time, I expect that the London segment could see margins expand to the mid

to high 20s as Countrywide increases its mix of lettings revenue (44% of Foxtons’ revenue comes from

lettings).

Lettings – I assume lettings is able to grow revenue at a ~9% CAGR over the forecast period as

Countrywide grows organic revenue ~3% and continues to spend L25-30 mn per annum on acquisitions

(I implicitly expect an increase in price/revenue multiple paid for acquisitions over the forecast). As

revenue expands, I assume an incremental margin of 40% (in-line with company history and at the low-

end of management guidance) which drives EBITDA margin expansion during the forecast period (from

27.6% in 2014 to 32.5% in 2018). It is worth noting that in the lettings business, contracts are generally

structured in a way which allows Countrywide to keep any interest paid on the security deposit. In a

zero interest rate environment, this is of little benefit but could drive EBITDA margins higher than

expected.

Small Commercial (LSH) – I assume the business grows 5% over the forecast horizon. I think there

should be some cross-sell opportunity between the Premier segment clientele and this business which

accounts for the faster than market growth (I’d think the market would grow 3-4% or so pa). I give the

company credit for a bit of margin expansion.

Capital Expenditures – assumed to run at L25 mn in 2015-2017. The most significant item here is an IT

transformation project. In addition, Countrywide is in the midst of refurbishing some branches (and will

continue to expand its estate agency and lettings network, albeit at a modest pace).

Tax rates – I use the 20% UK statutory tax rate (tax rate is 21% until April 2015).

Acquisition spend – I assume L40 million in annual acquisition spend, ~75% of which will go toward the

lettings business (should add ~L24-27 million in lettings revenue, my forecast assumes that the company

‘only’ gets ~L20 mn pa in lettings revenue from acquisitions) with the remainder allocated to estate

agency (though we might see some add-ons in London as well). Note that in its recent investor day,

CWD mgmt. said that it expects to spend closer to L80 mn on acquisitions – most of the differential is

focused on the small commercial business. Should transactions be done at similar multiples to what it

paid for LSH, this could be significantly accretive to estimates/value per share.

Multiple – I apply a 16x multiple to 2020 free cash flow. 16x equates to a 19x FCF multiple applied to

the lettings business (inclusive London lettings portion) and a 13x multiple applied to the remainder of

the business. The multiple applied to the lettings business is reflective of the company’s leadership

position and scale benefits, the recurring nature of the cash flows, and the opportunity for continued

organic/inorganic growth beyond the terminal year. The multiple applied to the remainder of the

business takes into account the company’s leading competitive position but is reflective of cyclicality.

On the whole, a 16x unlevered multiple (assumes FCF = NOPAT) represents a 3% FCF growth rate using a

9.4% discount rate which seems reasonable.

Survey provisions – as noted above, Countrywide (along with LSL) incurred significant charges related to

the company’s survey business. The company upped its provision significantly in 2012 as it saw a higher

rate of new claims. The company is protected by a six year statute of limitations – given that the market

topped out in 2007, I expect that the company’s provision is sufficient.

Cash flows are discounted at 9.4% (10% cost of equity, 4% after tax cost of debt).

This gets me to a L6.15 sell price, which is +30% greater than the 10/28/14 price of L4.70. The expected

holding period return is 16% (4.5 year horizon).

Downside

To me, the most interesting component of the Countrywide investment case is the downside protection.

If we simplistically assume that everything except for lettings (and corporate overhead) remain

unchanged vs. 2014, I estimate that Countrywide would generate L142 million in 2018 EBITDA and 45p

in EPS. Using the same methodology as above (capex, buybacks, multiple, discount rate, etc) gets me to

a L5.20 fair value (present valued) and implies a 15% compound return over a 3.5 year investment

horizon. Of course, in this instance, the percentage of EBITDA coming from the higher multiple lettings

business is greater, implying that the multiple should actually be higher than 15x.

Let’s consider a more draconian scenario – one in which the transaction market looks more like it did in

the depths of the Great Recession. In considering what 2015 EBITDA might look like should transaction

levels revert to 2009 levels, it is important to consider the structural changes which have occurred at

Countrywide including: 1) Acquisition of Hamptons (now London segment) (2) Acquisition of LSH (small

commercial business) in 2013 and (3) organic and acquired growth of the lettings business (which would

likely benefit from a decrease in the housing market) (4) costs of being a public company which are

reflected in the corporate segment.

The lowest level of post restructuring EBITDA for the estate agency segment was achieved in 2012 (not

2009) – 2009 benefitted from 1) abnormally high market share due to several agencies going out of

business (this could recur if we saw a dramatic drop off again) (2) strong performance of repossessions

business (repos were at a 20 year high – repo margins are huge at 40-50%) and (3) benefit of HIPS

(Home Information Packs – HIPs was a government mandated set of documents which were required for

listed properties which provided high margin revenue to Countrywide; since been phased out with an

estimated negative effect of ~L4 million at the EBITDA level). Using the lowest historical number for the

transactions related businesses but factoring in the lettings growth, I get the following:

Even in a horrific transaction market like 2009, I expect Countrywide would be able to generate L95

million in EBITDA by 2018 as it continues to grow the lettings business. While it would likely be an ugly

ride for shareholders, ultimately business value should be preserved (I don’t expect Countrywide would

have to issue equity and think the company would likely be able to make highly accretive share

buybacks during the downturn). In addition, given Countrywide’s solid balance sheet (something it did

not have in the last downturn), if the environment was this ugly, I expect we could see opportunistic

acquisitions (competitor LSL Property Services made a couple of value-accretive deals near the depth of

the downturn) which would create additional long term shareholder value.

Risks

1) Inability to execute the M&A strategy in lettings – there are three easily identifiable reasons this

could occur: (a) not enough M&A targets are available (b) other bidders drive up the price of

acquisitions (there is one other aggressive acquirer in the market, Leaders) (c) operational

execution issues. My forecast for acquisition spend/lettings growth assumes a ~30% hike in

target prices over the forecast horizon which should help to mitigate point 2 (and to some

extent 1).

2) UK property market falls apart – as mentioned in the downside analysis, over a three year time

horizon, I see little fundamental downside even if volumes return to all-time trough levels. That

said, things can always be worse than they’ve ever been.

Upside Case

There is an upside case where we could potentially see a housing market overshoot given how long the

transaction market has been depressed (and possibility of pent-up demand). There is additional upside

should management decide to become more aggressive with the share buyback. Given the stable cash

flows provided by the lettings business, I believe Countrywide could comfortably take on an additional

L100-150 mn in debt (would put ND/EBITDA at 1.5-2.0x base case EBITDA; an alternative way of looking

at this would be ND/lettings-only EBITDA of 4-5x). Using the proceeds from a debt issuance to

repurchase shares at today’s prices would enhance long-term shareholder value. Lastly, it is possible

that the market could become enamored with the lettings business given the company’s leadership

position, the recurring nature of the cash flows, and the likelihood of long term double digit EBITDA

growth. I would not be shocked to see the lettings business eventually valued at 20-22x earnings by the

market.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Execution of lettings roll-up

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			2015	2016
Price:	470.00	EPS	32	36
Shares Out. (in M):	220	P/E	14.7	13
Market Cap (in $M):	1,034	P/FCF	15	13
Net Debt (in $M):	135	EBIT	95	105
TEV (in $M):	1,170	TEV/EBIT	12	9.8