Description
SIRVA appears to be a case of a good business obscured by bad news. Despite a terrible 2005 – which saw poor financial controls, accounting problems, an SEC investigation, the meltdown of their insurance business, and a stock price collapse – 33% owner Clayton Dubilier has kept the company’s CEO in place.
The CEO has spent $60m on forensic accounting to scrub the books, and has been selling businesses that SIRVA acquired as part of a 2002-2004 roll-up strategy. The forensic accounting has kept SIRVA from filing anything but fragmentary information for periods after 2004, which obscures what looks like strong growth in the company’s core relocation and moving businesses.
These businesses have good market shares and throw off lots of cash. In addition, the relocation business has a “better mousetrap” fixed fee product that has been taking share from incumbents, whose response is hindered by structural issues. The numbers are opaque, but guesstimating suggests that the current stock price is an opportunity to buy a low capital intensity business at an attractive FCF yield – and with decent growth to come.
The Relocation Business
When a company decides to move an employee, a number of things need to happen. The most important is the sale of the employee’s home. Since the home is such a large chunk of the typical employee’s net worth, getting this transaction right is critical keeping him humming the company song in the morning.
Other relocation services include buying a new house, moving van services, language instruction, identification of schools and elder care services for young and old relatives, visa services, and advice on expatriate tax issues. But the key to happy employees – and ½ of the dollar value – is the home sale.
The relocation industry has developed because most companies choose to outsource their relocation activities to third parties who can deliver low cost services due to volume and relationships with real estate brokers and moving companies. Also, third party firms are good at providing an experienced manager for employees to call with questions and problems. This is valuable to an employee stressed out by the challenge of moving his family to Shanghai or Peoria.
The industry’s trade association – the Employee Relocation Council – estimates that a relocation costs approximately $70K. They also estimate the following number of relocations of current and new employees by US companies (in thousands):
Year Current New
2000 237 129
2001 204 104
2002 191 85
2003 208 83
2004 209 91
2005 233 94
Industry people describe the business as dependent on corporate confidence and profits, and also say that cyclicality is sector driven (i.e., in a given year, auto companies might be hurting, but retailers might be doing OK). The 2002-2003 period is described as a general trough driven by 9/11.
Industry Structure
The industry is dominated by Cendant Relocation, part of Cendant’s Real Estate business, which also includes the country’s largest network of real estate brokers (240,000 of them) under the Century 21, Coldwell Banker and ERA brands. Hank Silverman has described Relocation as comprising 10% of Real Estate’s EBITDA, or about $120m. Several industry people have put Cendant’s market share at 40-50%.
The number two player is Prudential Relocation, which is part of Prudential’s real estate business (44,000 brokers - the second largest in the U.S.). Good numbers are not available (these businesses are reported as part of Prudential’s corporate segment), but industry people suggest perhaps 20% market share. Prudential has been losing share due to poor execution. Anecdotal examples include consolidation of regional offices into a Phoenix headquarters, which lost local relationships with HR departments, as well as bad billing systems, which have led to embarrassing requests to clients for year old expense reimbursements.
SIRVA is either #2 or #3 depending on whom you ask. Then there are several smaller players, including Weichert, GMAC and Primacy. Like Cendant and Prudential, Weichert and GMAC relocation grew out of real estate brokerage operations.
For SIRVA’s key competitors, relocation is a critical piece of keeping their networks of real estate brokers happy. Any decent sized Century 21 office looks to do a lot of business with companies relocating executives – after all, these are affluent customers with a sense of urgency.
So the relocation heads at Cendant and Prudential report to their respective heads of real estate, all of whom spend a lot of time in auditoriums giving pep talks to brokers.
The Traditional Relocation Product
Anyone considering investing in SIRVA should take time to talk to industry people and/or read the white papers posted on the Weichert and Prudential Relocation websites. (This is a pretty technical subject, and I am happy to answer specific questions in the discussion thread.)
That said, a simple outline of the traditional product is as follows:
- The employer has a contract with a relocation company like Cendant. (Contract length is usually 30 days, but rebids are typically every 2-3 years with pretty good retention due to stickiness of being tightly integrated with HR.)
- The employer does everything possible to have the employee sell the house himself, for reasons of time, expectation management and risk.
- At some point, if the house is not sold, the relocation company buys it from the employee, and then remarkets it. But – here is the key point – the employer indemnifies the relocation company against loss on the remarketed sale.
The economics of the home sale transaction to the employer look roughly like this (expressed as a percentage of the home’s value – and note that this excludes moving and other services):
- Fee paid by employer to relocation company 0.2%
- Fee to sell side real estate broker 3.0%
- Fee to buy side real estate broker 3.0%
- Closing expenses (title, legal) 2.0%
- Loss on inventory houses (20% of homes, 8% loss) 1.6%
- Carrying cost of resold homes (20%, 2% cost) 0.4%
- Total cost to employer 10.2%
The economics of the transaction to the relocation company look roughly like this:
- Fee paid by employer to relocation company 0.2%
- Referral fee from sell side real estate broker 1.0%
- Referral fee from buy side real estate broker 0.4%
- Total revenues to relocation company 1.6%
So the deal given to the employer by the relocation company is this: “We can do it cheaper because we do this a lot. We charge you little directly because we make most of our money on referral fees to real estate brokers (ours are the best, by the way). And, if the broker we choose doesn’t get the price you guaranteed (based on the broker’s quote), it’s your nickel.”
Several people at the traditional product companies say that there is no conflict here, but call me skeptical.
Another flaw with the traditional product is its tax treatment. This also is a technical subject, but a simplified version is as follows.
There are two tax issues with the traditional product. First, to the extent that an employer attempts to reduce the risk of houses in inventory – for example, by asking the employee to market his home for 2 months before getting an underwritten price, which aligns his expectations with the market (and maybe also gets the home sold) – the IRS is likely to declare the brokerage expenses and any loss on sale to be taxable income to the employee (because there have not been two separate sales). To keep the employee happy in this instance, the employer has to gross up for income taxes, which can make the 10% quoted above cost more like 13%.
Second, the IRS has taken the position that reimbursement of an employee’s home sale loss is a capital loss to the employer, which requires offset against a capital gain. Some companies do not have enough capital gains each year to do this. Many companies claim the loss as ordinary income, but face audit risk.
(Note that ERC is very pleased that it got the IRS to opine on relocation issues in November 2005, though the IRS refused to rule on the capital gain issue, and clarified only ½ of the employee income issue. If you love reading about tax rulings, look at www.erc.org/coalition/tax_legal/coalitionalert_amdahl_120105.shtml. If you don’t, the short answer is that ERC is ½ for 2, despite their happy presentation to the people who pay their dues. And you should get your own tax guy to look.)
So to recap, employers get moral hazard, tax issues, and risk of houses in inventory. They also complain that keeping track of employee expenses that require tax gross-up is a pain. Traditional relocation is a bargain only because it beats managing relocation themselves (what HR manager wants to take calls about Junior’s new school, or be responsible for keeping 15 unsold houses free of termites?).
The SIRVA Fixed Fee Product – A Better Mousetrap?
Ronald Reagan’s administration began to require relocation companies to offer a fixed fee product in order to do business with the federal government. In the mid-1990s, a company called Corporate Relocation Services introduced a fixed-fee product aimed at the corporate market. In May 2002, SIRVA acquired CRS, and now has a relocation business that is more than half fixed-fee by units.
Under the fixed-fee product, SIRVA assumes all of the risk of resale of the houses. To do this, SIRVA focuses on how to minimize the risk of houses staying in inventory too long, or selling for too little.
- SIRVA refers business to third party real estate brokers based on their performance – in particular, on sale price relative to quote.
- SIRVA has negotiated a reduction of the standard 6% brokerage commission down to an average of 5.8%.
- Employees are required to market the house themselves for 60-90 days before the broker referred by SIRVA is allowed to provide them a quote.
- SIRVA’s contracts with employers qualify their assumption of risk in the event of an extraordinary change in real estate market conditions.
Total fee paid by client (as percent of home value) 11%
Less: brokerage fee to 3rd party brokers 5.8%
Less: closing expenses (title, closing) 2.0%
Less: loss on inventory houses (4% of 11%) 0.4%
Less: carrying cost on houses (2% of 11%) 0.2%
Profit to SIRVA 2.6%
According to SIRVA’s 2004 10-K, only 11% of homes are taken into inventory, and the loss on sale is just 4% plus 2% carrying costs during the average 2-3 months they are on the books. When I checked these statistics with executives at competing relocation companies, I was told that SIRVA was falsifying the data.
That is a possibility, but given that the 2004 10-K was released after $60m of forensic accounting, I think it is a remote one. It’s more likely that a business designed to minimize houses in inventory will have fewer houses in inventory than a business designed to maximize broker referrals. This creates value that can be shared with the employer, or kept as profit.
Plus, the tax treatment of the fixed fee product is clear. The employee has sold his house to SIRVA, which is a capital transaction for the employee. And the employer’s 11% fee is an ordinary loss. No deadweight loss from taxes, so more value for the employer and/or profit for SIRVA.
Relocation is slow growth business, but SIRVA’s unit volume grew 69% in 2003 and 23% in 2004 (the 2003 figure is inflated by the CRS transaction, which closed in May 2002, but the Q3 2003 unit volume was 40% higher year over year, and the third quarter is the most important quarter seasonally).
These volumes reflect very rapid growth in the fixed fee product. Fixed fee unit volume was up 99% in Q3 2003, and 35% in 2004. The growth rates for SIRVA traditional volumes were 5% and 11%, respectively.
SIRVA’s clients have included P&G, J&J, Dow Chemical, Dell, Delphi, the United Nations, CSX, Adobe, JetBlue and Valeo. Industry people say that the fixed fee product does better with smaller companies attracted to the idea of zero inventory risk. But the SIRVA client base includes some big names.
The industry’s quality is tracked by a firm called Trippel Research, which conducts an annual survey of employer and employee satisfaction. SIRVA’s business has ranked #1 for 9 of the past 10 years. (This includes Employee Relocation Services, a company acquired by SIRVA in December 2004.)
Conversations with industry sources suggest that though the competitors have all introduced corporate fixed fee products, their emphasis is on selling the traditional product because fixed fee is risky enough to require a higher price.
No competitor we talked to believes that SIRVA’s inventoried house numbers are correct – which adds to the evidence that theirs are higher, and would make it hard for them to match SIRVA on fixed fee pricing.
The Moving Business
SIRVA was originally a Clayton Dubilier roll-up of the moving industry. The company owns the Allied and NorthAmerican brands, which are the #2 and #3 brands in the US. SIRVA also owns the #1 mover in the UK (Pickfords), the Benelux countries, and Scandinavia. There are also some Asian moving assets.
A key point is that the US moving business is asset light, whereas the international businesses are not. In the US, SIRVA owns the brand and runs a dispatch center. Use of the brand is contracted by 735 independent agent truck drivers who own their own equipment, or may even own several trucks. Calls for business come into the agents or into SIRVA’s central dispatcher. SIRVA’s value-add is to match agents and orders to avoid the nightmare of an agent – a no-cargo trip back home.
This is a good business, since the agents sign multi-year contracts, and no agent is more than 4% of revenues. They do intrastate business themselves to keep their utilization rate high, but do interstate business exclusively through SIRVA. Everybody wins – the agents get to be entrepreneurial, and SIRVA transforms capital intensive activity into $40-45m of annual EBITDA with $5-6m of cap ex.
There may be synergies with relocation. SIRVA claims – though competitors dispute – that having strong relationships with guys driving trucks allows SIRVA to reserve for corporate relocation customers good moving capacity during June through August, which is when most execs want to move in order to minimize impact on kids.
There is also the opportunity to cross-sell. SIRVA had 2,000 moving clients in 2003, and 500 relocation clients. Only 100 used both services.
In Europe, SIRVA has been selling assets in order to move more towards the asset light model, which has been a big part of the likely debt reduction at the company (see below). The ultimate profitability of Europe is not clear, but EBITDA ranged from $28-47m during 2002-2004, and cap ex from $12-21m.
Woes Aplenty During 2005
When it rains, it pours. Here is a timeline.
1/24/05 – CFO Joan Ryan resigns; Ron Milewski now acting CFO (was VP risk management)
1/31/05 – Will not meet guidance; major charges in insurance business, Europe
3/15/05 - 10-K delayed, Goldman hired to sell Insurance, Estimates $35-40m of costs to do forensic accounting
5/3/05 – AM Best downgrades Insurance from A- to B++
6/22/05 – SEC commences official investigation
8/17/05 – AM Best downgrades Insurance from B++ to B
7/28/05 – Hopes to file 10-K in September
9/21/05 – Audit committee releases report - Cleary and Deloitte nearing end of work; $60m cost of restatement; “No scheme”, but “poor financial controls”
10/17/05 – Announces sale of Aus/NZ records management business to Iron Mountain
10/31/05 – 10-K delayed again until November
11/7/05 – Seeking amendment to credit agreement to ease covenants
11/22/05 – Files 2004 10-K (but we are still waiting for Ks and Qs for any subsequent period)
12/6/05 – Hires new CFO, Michael Kirksey
12/31/05 – Completes sale of Aus/NZ business
1/05/06 – Announces sale of Insurance to IAT Reinsurance
Guesstimating the Numbers
The 2005 mess complicates figuring out what the numbers now are. But here is a stab at what the current level of debt looks like. My calculations depend on the 8-Ks filed during 2005, and anyone interested in this should read them for himself.
Debt at 12/31/04:
ST Debt 125
LT Debt 533
Capital Leases 22
Cash / ST Investments (234)
Restricted Cash 31
Mortgage Facilities (77)
Relocation Facilities (43)
Cargo Claims Reserves 25
Restructuring Reserve 18
Aus/NZ sale proceeds (87)
Insurance sale proceeds (72)
UK Records sale proceeds (50)
Forensic accounting 60
Estimated 2005 FCF (30)
Est. Current Debt 221
Estimating current cash flows is also difficult. On the November 2004 earnings call (right before the stuff hit the fan), CEO Brian Kelly forecasted 2005 operating profit for relocation and US moving of $120-124m. This would translate into EBITDA of about $140m.
At the lower end, those two businesses did $80m of EBITDA during 2004, and we should add $15m of EBITDA from the December 2004 acquisition of Executive Relocation, a highly respected company serving Fortune 500 companies in the US.
To make this the lower end, one might assume growth of just 10% from 2004 until today, despite anecdotal evidence that SIRVA’s fixed fee product continues to gain share. This would give $105m of EBITDA.
It’s a conservative assumption that cash flow from Europe balances the losses of corporate activities, which are probably high single digits.
So free cash flow might look as follows:
EBITDA $105-140m
Less: cap ex 15 (was high single digits during 2002-2004)
Less: interest 20 (assuming a 9% interest rate)
Less: 35% taxes
FCF $46-68m
Across 76 million shares, this is 60-90 cents of FCF/share.
But it is possible that CEO Brian Kelly still has his job because he is doing a great job with the relocation and moving businesses. So a high end case would take his $140m of EBITDA for those businesses in 2005, and grow it a bit to account for more share gains, and the apparently higher number of relocations in 2006. Assuming another $30m of EBITDA increases 2006 FCF/share to $1.15.
Given the low capital intensity of the business, and the prospect for more growth, it seems OK to give it a multiple of 15x (particularly once the company actually files current financial statements).
15x would give a price of $9-17/share, compared with the current market of $9.41.
Risks
- A real estate collapse reveals that SIRVA’s fixed fee product does much worse in a down market – note that SIRVA’s inventory of houses at 12/31/04 was $90m, or just about $1.20/share, so even a ½ writedown would be just 60 cents per share. More worrying would be a large increase in the ongoing percentage of houses taken into inventory, which would force SIRVA to raise prices.
- Management and/or Clayton Dubilier screw up some more
Catalyst
- The company finally files some public documents
- Growth in relocation business becomes apparent
- More asset sales as Europe goes asset-light
- Differentiated nature of fixed fee product becomes apparent (SIRVA IR says that no other investor has asked questions about fixed fee tax treatment)