Description

Douglas Elliman (DOUG)

I like ideas so simple they can be confined to a cocktail napkin.  DOUG is a spin of Vector Group (VGR), it is a high end real estate brokerage.  It is the 6th largest brokerage in the country.  The spin ratio was 1 share of DOUG for every 2 shares of VGR, so there are 77m or so shares out.  DOUG was spun out with 200m of cash.  Its major market is NYC, but it is expanding to other markets like Dallas.  It has made some investments in technology to enable agents as well.  We also note this spin has happened pretty quickly and between Christmas and New Years, a time when a lot of market participants are on holiday.  

This is not a particularly long-winded idea.  The DOUG investment thesis, at its core, is straight forward. High end real estate is a bet on income and wealth inequality.  High end real estate is also a bet on wealth people using borrowed money to store wealth in property.  DOUG in particular, has a growth story now that it is apart from VGR.  

Old VGR 1+1=less than 2

DOUG was being held back by VGR.  Why?  

I don't think anyone here looking at VGR thought it made sense to have a high end real estate brokerage with a value cigarette company, but I think the tobacco business held DOUG back.  The reason is very simple.  To attract and retain agents, DOUG was unable to use its stock as a form of currency because it was attached to a tobacco business.  I love tobacco, personally, but high performing, high end agents probably didn't see much (if any) upside to taking VGR stock as an incentive to join DOUG.  With the spin, that has changed and DOUG can be a growth story and use its stock as currency to attract high performning teams in markets it wishes to enter.  I believe that it was spun off with 200m to do just that and follow Compass' playbook to a certain extent.  

The valuation at 11 and change is a little over 6.5x ebitda, depending on the price (erratic first day trading), for a little over 100m of ebitda adjusting for stand alone public co costs.  This is a business that generates cash and not capital intensive.  It is a business that was hit by the pandemic but helped by the RE boom.  It also cut costs to deal with the pandemic.  Costs have risen more slowly the revenues in the recovery.  One might be tempted to look at this and think, oh peak earnings and margins.  Or one can say that this is as good as it gets and I'd typically be inclined to agree but for the reasons I cited, I don't think that's the case here.  There's a credible growth path.  Incremental margins are quite high and I think this has the potential to re-rate as DOUG executes on an intelligent plan.  

I should mention the people involved have a reputation.  Phil Frost in particular on the biotech names.  I'm not particularly concerned as it relates to DOUG but its worth noting.  

In summary VGR was owned by a combination of dividend investors and SOTP valuation guys.  They may look at DOUG and say, "Small dividend?  Sell!" or "High end brokerage at 6x?  Meh."  That's a good thing if you believe they separated this to create value that could not be had within VGR.  There's presently a good amount of stock in the wrong hands, so I don't think this needs to be chased.  In my view, high end brokerage is attractive and DOUG is a pure play on that.  

I am going to proactively give myself the coveted "2nd grade book report" and "4th grade book report" tags, though I'm not sure this is worthy of 4th grade.  Thanks for reading, have a Happy New Year.  

Catalyst

- Use stock as currency to acquire high performing teams in new markets

- Wealth inequality continues

- Wealthy people continue to put money in real assets, funded with borrowed money.