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Summary:  I think the market misunderstands (i) two key assets which I estimate together are currently worth >$1.4B out of ~$2B Total Enterprise Value (with all other business segments contributing an additional estimated ~$387M of EBITDA last year), as well as (ii) the company’s strong balance sheet and limited credit risk; at the current stock price are creating what I view to be a top tier growing commercial real estate services firm, with ~44% inside ownership for ~1.7x normalized EBITDA and ~3x trough EBITDA; alternatively, can view as entire company trading for less than 4x normalized earnings

Business:

• Top 5 commercial real estate (CRE) services firm in the U.S.; I believe this is a fundamentally good sector, with the big guys (CBRE, JLL, CWK, NMRK, CIGI) getting bigger and taking share for last decade in part by offering a broad suite of services and cross-selling those services; CRE can be cyclical but I believe generally has tailwinds with lot of dry powder, increasing institutional ownership and natural churn in leases, asset sales, financings/refinancings, etc.
• NMRK has 1,800+ producers/brokers, ~6K employees, covering 110 cities (as of May 2020)
  • 50-66% of revenues are recurring/quasi-recurring (parts of leasing, loan servicing, asset/property management, valuation/advisory) and rest transactional (asset sales, mortgage financing, etc.)
  • ~100% domestic exposure; asset light, highly variable cost structure (~70% of revs are commission based at a ~50% compensation payout ratio to producers); solid organic and M&A driven growth as have both bought up smaller firms and poached talent; only ~1.2x levered based on LTM Adjusted EBITDA as of 3/31/2020 (see pg 14 of May 2020 IR deck)

• Berkeley Point (BP) is a key asset: 
  • Bought for ~$875M in 2017 (paid ~13.7x adjusted pretax income of ~$64M, see original deck filed on BGC Partners (BGCP) investor relations site, BP has grown significantly since and, in my view, is likely worth much more now than the purchase price; BP is multifamily Delegated Underwriting and Servicing (DUS®) loan originator and servicer for Government Sponsored Enterprises (GSEs) (Fannie Mae, Freddie Mac, Ginnie Mae) who grant a limited number of such licenses; I believe BP’s model is asset light, low risk and a very good business
  • Accounting is complex, but in summary, BP gets paid fees (i) to originate and warehouse multifamily loans for the GSEs up front and (ii) on a recurring basis to service these loans over their term; as of 3/31/20, are servicing ~$63B loans with weighted average life 8yrs; importantly these loans are different than single family loans in that they have limited prepay/callability, thus providing a long term recurring fee stream
  • The NPV of this stream is valued on the 3/31/20 balance sheet as a ~$412M MSR (Mortgage Servicing Right), but I believe this is conservative, as these are tradable financial assets and BP’s largest competitor, Walker & Dunlop (WD), estimates the fair value of its comparable servicing asset at ~27% higher than book (see pg 36 of WD’s February IR deck); pg 9 of NMRK’s 1Q20 investor deck shows $142M of LTM servicing fees alone, which are also the company’s highest margin revenue stream 

Thesis/Why Opportunity Exists:  

• NMRK was formerly a subsidiary of BGC Partners (BGCP) which is controlled by Howard Lutnick/Cantor; NMRK was IPO-ed and then spun out of BGCP in 2017/2018, and was, in my opinion, not properly marketed or distributed and became somewhat of an orphan in the CRE broker space; has since traded at a discount compared to larger/vanilla CBRE and JLL and the levered CWK, despite strong results and faster growth
• NMRK did very well through 2019 and was proving/trying to simplify the story, the stock price almost hit $14 (prior to 2019, high was >$16) before bottoming at $2.49 in the COVID sell-off; I believe the issues are: (i) orphaned stock with complex structure, (ii) people worried about CRE-related companies, (iii) Bloomberg numbers are incorrect and well overstate both debt outstanding (see below for more on this) and minority interest (double counting partnership interests which are already included in the fully diluted share count), and (iv) misunderstanding of the low risk inherent in BP’s business model
• I believe NMRK’s core brokerage/services business is very straightforward, doing well, and shows real organic growth; company is managing through COVID and announced on its 1Q earnings call that they are taking ~$100M of costs out of the business over the remaining 9 months of 2020; my view is that the recurring revenue portion of the business plus a highly variable cost structure provides material earnings cushion (this is a key point and very well laid out on pages 15-16 of the COVID supplement deck released concurrent with 1Q20 earnings)

• I believe that BP is misunderstood (see pages 18-20 of the COVID supplement deck for more detail as well as comparable disclosure from competitor Walker & Dunlop (WD))
  • Debt:  NMRK warehouses the loans for the GSEs on its balance sheet pre-securitization for a short time (generally 30-45 days); these loans are 100% presold to and guaranteed by the GSEs, NMRK has minimal risk during warehousing; the loans are funded at a 100% advance rate and are non-recourse to parent company NMRK (this debt shows up incorrectly on Bloomberg as NMRK’s debt, overstating leverage)
  • Loss sharing risk:  for Fannie Mae loans only (~$21B of the ~$63B serviced by NMRK/BP as of 3/31/20), as the originator, NMRK/BP has ~29% pari passu wavg loss sharing with Fannie Mae in the event of defaults and losses
    • Mitigants:  in my view, multifamily is among the best CRE asset classes + the risk is spread across thousands of loans with a weighted avg loan-to-value (LTV) of 64% (e.g. there is ~$12B of equity below the ~$21B of debt or ~$21B of debt on ~$33B of assets) + strong debt service coverage
    • In the 13 years from 2007-2019, this business had a total of only ~$52M in credit losses; in an extreme scenario where BP’s $21B of Fannie Mae loans serviced had a 20% default rate at 40% severity, this would equate to estimated losses of ~$487M ($21B loans * 29% loss share * 20% default * 40% severity); any losses would likely be taken over several years, and even in this extreme scenario, I think such losses would be very manageable and covered by cash, liquidity and NDAQ stock (see below)
    • Stats for all GSE multifamily loans are public and trackable, Rich Hill of Morgan Stanley puts out a good weekly summary report; as of 6/4/20 there are <1% of total DUS loans in forbearance (not default) up from close to zero at the beginning of the year
  • Servicing advances:  if a Fannie Mae loan is granted forbearance (this is NMRK/BP’s choice to grant after receiving proof of distress), as servicer, NMRK/BP must front Principal & Interest (P&I) payments to securitized bondholders for ~4 months after which the payments are 100% guaranteed and fully reimbursed by Fannie; while there is some worry about how NMRK/BP would fund the P&I if COVID resulted in material forbearance (which again, has been <1% for all of DUS and less for NMRK), in an extreme scenario where 20% of the $21B Fannie loans serviced by NMRK/BP were in forbearance, this would create an estimated ~$70M working capital need ($21B * 20% * assumed 5% loan constant * 4/12 months); given that these payments are 100% GSE guaranteed, I believe this receivable would be very financeable at high advance rates (both NMRK and WD have commented that they are putting such facilities in place)
• I believe the company’s NASDAQ position is another hidden asset that is underappreciated;  in 2013, BGCP sold an asset called eSpeed to NDAQ; in addition to the cash portion of the purchase price, there was an earn-out paid in the form of ~1M NDAQ common shares per year through 2027; this asset receivable was put into and is currently fully held by NMRK; has been monetized in portions over time (full details on pg 20 of the May 2020 IR deck); the estimated value this asset is >$500M NPV which equates to ~$2.01 per NMRK share
• Up-C-corp partnership structure:
  • Complex structure with several different types of LP units but my summary view is that, when cut through, it is similar to other public Up-C structures (see ownership table below and the full organization chart in NMRK’s latest 10K); public shareholders hold ~55.8% economic interest, Lutnick holds ~16.8% (via controlling stock and LP units) and the producers/other employees hold the remaining ~27.4% (via stock and LP units)
  • I believe the structure is advantageous and unique (as the comps are all normal c-corps) and allows NMRK to offer a differentiated economic package when hiring new producers than its competitors; it is also tax advantageous to both the producers as well as shareholders (when certain units are exchanged for stock it creates a material step up tax shield)
  • When producers are hired, NMRK signs them up to a 5-7yr contract with a signing bonus in form of equity (stock or LP units) and a forgivable loan with cliff vesting; the loan is fully repaid and equity forfeited if the producer is fired/quits prior to term; contracts also come with non-competes; example: if a $1M producer is worth $5M of revenue over 5yrs = $2.5M to company and $2.5M to the producer at a 50% commission, when NMRK hires the producer will give a signing bonus of $1.25M upfront (in the form of 50/50 loan/stock) and rest is earned over time
  • Accounting adjustments related to the Up-C equity structure are complex and take time to understand/diligence and IR does a good job explaining and laying it out in the public decks; I also believe that most of the sell side inconsistently mismodels the adjustments; ultimately, I have gotten comfort that the various stock comp-related addbacks are appropriate and adjusted earnings is a good proxy for cash flow; I’m also comfortable with how the company distributes earnings to both LPs via distributions (plus conversion ratio adjustments) and shareholders via dividends (the company has historically had a ~25% payout ratio to common, this was suspended due to COVID, would expect reinstatement and some point in future); note that the forgivable loans are effectively prepaid compensation and these charges hit the P&L and are, in my view, appropriately deducted in the company’s presentation of Adjusted EBITDA
  • One knock in the past has been a materially increasing fully diluted share count due to the continued hiring of new producers and their related equity grants; NMRK has recognized this and has stated on recent earnings calls that going forward, it will issue largely vanilla Restricted Stock Units to new hires rather than the more complex LP units and will target limiting dilution to ~2% per year
  • Overall while complex for a public company, I view NMRK’s structure as a net positive due to hiring advantages and the long-term contracts that come with it, a lower tax rate and most importantly, the alignment of Lutnick, NMRK’s CEO Barry Gosin (who built the company and also is a large shareholder) and the producers, who collectively have a ~44% economic interest

• Other good slides for reference: (i) pg 8 from 4Q19 earnings deck, (ii) pg 8 and 23 of May 2020 IR deck, (iii) 2018 investor day

Summary:

• I think the market misunderstands (i) two key assets which I estimate together are currently worth >$1.4B out of ~$2B Total Enterprise Value (with all other business segments contributing an additional estimated ~$387M of EBITDA last year), as well as (ii) the company’s strong balance sheet and limited credit risk; at the current stock price are creating what I view to be a top tier growing commercial real estate services firm, with ~44% inside ownership for ~1.7x normalized EBITDA and ~3x trough EBITDA; alternatively, can view as entire company trading for less than 4x normalized earnings
• I view the business as strong, growing, large (~$467M total adjusted EBITDA in 2019) and underappreciated; I think Lutnick should take advantage of the stock’s dislocation and buy back substantial shares of NMRK to his/his producers/remaining shareholders' benefit; he and CEO Gosin also fundamentally need a higher stock price in order to continue attracting/signing/poaching producer talent; alternatively, they could buy in the rest of the company
• I believe management is aligned and very incentivized to a higher stock price; I also believe that if they continue to execute and better explain the complexities of the business and structure, the stock could double or triple on reasonable assumptions; for example, if we assume just 9x trough 2020P earnings of 79c + $2 for NDAQ = ~$9 per share, and 10x pre-COVID earnings of $1.30 = $2 for NDAQ = ~$15 per share; downside protection comes from the BP+NDAQ assets which alone are worth close to ~$3 per share (giving zero value to the rest of the business)

Catalyst

Continue to execute and better explain the complexities of the business and structure, the stock could double or triple on reasonable assumptions; for example, if we assume just 9x trough 2020P earnings of 79c + $2 for NDAQ = ~$9 per share, and 10x pre-COVID earnings of $1.30 = $2 for NDAQ = ~$15 per share; downside protection comes from the BP+NDAQ assets which alone are worth close to ~$3 per share (giving zero value to the rest of the business)