Description

Business Summary

Realogy is the biggest residential real estate company in the world and has an established, well-respected management team. It contains Century 21, Coldwell Banker, Coldwell Banker Commercial, ERA, Sotheby's International Realty, NRT, and Cartus (and many others) all under one umbrella. The company has very strong market share. It is the largest global real estate firm by a large margin - its market share is three times that of its nearest competitor. Its brands attract the best brokers, and these brokers get the best listings. There are a few different businesses for the company. Real Estate Franchise Services (RFG) is the company’s real estate brokerage franchisor arm, with about 313,500 sales associates. It also has a corporate relocation service, and a mortgage venture with PHH. The company has been successful at cross-selling all of these businesses.

Financials

Realogy has investment-grade debt ratings – BBB stable and Baa2 stable. In 2005, Realogy (as part of Cendant on a historical basis) had revenues of $7.1 billion, EBITDA of $1.2 billion, and net income of $627 million, representing a CAGR of 60%, 25%, and 23%, respectively, since 2001. With an estimated EBITDA of $1.033 billion for 2007, and an estimated $750 million of debt (assuming the Travelport sale is closed and proceeds are used to pay down $1.475 billion of debt), Realogy’s debt-to-EBITDA ratio turns out to be 0.8x (highly underleveraged). This provides the company with a large amount of financial flexibility. On the Cendant 2Q06 earnings call, management said that after the Travelport sale they expected to repurchase approximately 20% of the company’s shares. In addition to the low leverage, the EBITDA-to-interest coverage ratio would be approximately  22.9x. This is also very attractive considering the company has few capex needs and estimated free cash flow of $500million. The company’s franchise model allows it to keep an EBITDA margin of over 16% for 2005, with the RFG business having an EBITDA margin of close to 75%.

If Realogy decided to repurchase 50% of the outstanding shares of the company, the cost of roughly $3 billion would take its debt-to-EBITDA ration up to 4.2x, which is still a comfortable ratio for a company with $500 million of estimated 2006 free cash flow. Additionally, repurchasing half its shares would still leave an EBITDA/Interest-coverage ratio of about 3.5x–4.5x, depending on interest rate assumptions.

Current Issues

One overhang on the stock is investor concern regarding a slowdown in residential housing. However, to partially counter this, the company's expense base is highly variable. In the company's owned brokerages, commissions make up 73% of expenses. Therefore the company is protected in the event of a revenue slowdown as its expenses also decrease markedly. Additionally, the company has exposure to existing home sales, not new homes, so they do not have to deal with a glut of new homes flooding the market.

Valuation

Using a low 8x multiple on EBITDA, the company could be valued at $26 per share, using an average 12x multiple, the company could be valued at $37 per share and using a high 18x multiple, the company could be valued at $53 per share. As shown, the company is significantly undervalued at this point. There are many ways investors could realize value, either through a buyout or multiple expansion once the market becomes comfortable with the business. Management has stated their willingness to entertain offers of buyouts from private equity, although this would not take place until a significant share buyback.

Catalyst