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A Word (or Two) About Realogy

November 19, 2008

Noah Rosenblatt over at Urbandigs notes potential huge problems over at Realogy (H/T: 4Realz):

According to Crain’s “Seven area firms make endangered list“:

The most vulnerable, according to S&P, include Realogy, the Parsippany, N.J.-based owner of such brands as Century 21 and Corcoran Group. The firm, which was taken private last year by Apollo Management in an $8.8 billion leveraged-buyout, has struggled mightily amid the housing crisis. Last week, the firm warned that it’s at risk of violating the terms of its bank loans and is trying to swap $1.1 billion of bonds for new debt at a discount.A default does not necessarily mean the end of a company. Traditionally, many companies in default have been able to negotiate new debt terms with their creditors. But with so many defaults looming, experts warn that fewer companies will be able to restructure their debt. As a result more of troubled firms could wind up in bankruptcy court and being liquidated.”

I think Noah is right to point out that this was likely a foreseeable event given the state of the financial markets back in mid-2007:

I discussed the LBO Buyout Boom as a Reason To Worry way back in June of 2007, as cov-lite (great for borrower, bad/riskier for the lender) deals were being done as LBO deals started to dry up after an unsustainable buyout boom:

My Point – Forward thinking. I am by no means an expert of leveraged buyouts, credit risk, derivative products, cdo/abx markets, etc.. However, it doesn’t take an expert to see how the industry adapts to continue to be able to lend to support such massive buyouts in the private equity sector. I’ll repeat this again –> Right now you are seeing an environment that is a result of years of ultra cheap money and tons of liquidity. What is yet to be seen is the effect of globally rising interest rates to levels we see today; that will take 1-2 years. For the near future, I don’t think the end result will be that bad, in fact I think the environment will remain bullish for some time. However, red flags are waving for the years to come when we will be able to look back at how many of these massive buyouts were successful, and how many caused major problems to banks and other lenders”

However, I think in this case, Crains (and others) are hyperventilating just a wee bit at least as far as Realogy is concerned.

The reason isn’t that I know something others don’t about the strength of Realogy or any such thing.  The reason mostly has to do with incentives for bankers and bondholders to allow a default and the consequences of such.  There is next to zero incentive for any creditor of Realogy to force the company into bankruptcy.

Realogy has next to no assets.  Really.  If you think about their business model, as a franchisor of service businesses, their main assets are the brand names and the people who work at their various company-owned stores or franchisees.

In the case of some of the other firms named by Crains, such as JetBlue or Hovnanian Enterprises, they own real assets that can be auctioned off or sold off to raise a fair amount of money.  Airplanes and real estate are both real assets.  In those cases, it might make a lot of sense for creditors to push those companies into Chapter 7 liquidation proceedings and recover their losses that way.

But Realogy’s real assets are negligible, to say the least.  It owns no buildings that I know of (unlike other franchise models where the franchisor owns the franchise location and receives rent from the franchisee).  All of its company owned stores are lessees of other landlords.  Whether its servers, technology equipment, office equipment, and such are worth a lot is unknown, but one suspects that Realogy probably doesn’t own the equipment in its datacenters (it probably leases them from the hosting facility), and used furniture isn’t exactly going to make a huge dent in the billions owed.

In a Chapter 7 liquidation, you can’t hold on to any of the talent that makes Realogy the company it is.  People will get laid off, or walk out, but they’re not going to be sold at auction to repay creditors.

The best chance of getting repaid for a creditor is to let Realogy continue to operate, until things turn around.  That Realogy lost $200m or so in the past three years is relevant only to the shareholders of Realogy, namely Apollo Management, the private equity fund that bought Realogy in 2007 for $6.6B.  I’m sure their equity is hovering near zero at the moment.  But I’m equally sure that Realogy has been making all of its loan payments, including interest, for the past year and a half or so.

Realogy still owns NRT, which is still the #1 brokerage in the country by quite a margin, and did 323,000 sides in 2007.  Even if we assume that the NRT’s sides are down significantly, it will still be doing a couple of hundred thousand deals.  And that’s just NRT; all of the CB, C21, ERA, and Sotheby’s franchises (not to mention Coldwell Banker Commercial) will do deals.  They are perenially among the top brokerages in the country, some with billions in transaction volume.

The cashflow from all those operations are still quite significant.  Creditors want to keep that going for as long as possible.  Forcing Realogy into bankruptcy will likely cause significant disruptions of that continuing cashflow.  Certainly, forcing Realogy into liquidation will.

What could happen, of course, is that significant creditors end up replacing Apollo Management as the beneficial equity holders.  When Realogy debt is trading for pennies on the dollar, it’s impossible to think that Apollo’s equity is worth very much.  It may be that the banks and bondholders simply restructure the loan, extend the timeline, etc. but take over Apollo’s equity in Realogy in exchange.  That way, when the market turns around, those creditors will realize a fairly significant gain.  Chapter 11 bankruptcy is a popular way to make those kinds of deals happen, especially if Apollo ends up trying to resist the takeover by bondholders.

But however such boardroom intrigues play out, the real point is that a company that is generating very significant cashflow — even at a loss after all the expenses and such are taken care of — but has no real assets is not one that creditors want to exterminate.  To say Realogy is on the Endangered List is hyperventilating by a bit.  It is in financial difficulties, sure, and in the short-term there will be (and has been) layoffs, cost cutting, and so on.  It will, however, survive on the strength of its ability to generate revenues and operating cashflow.

-rsh

PS: While I worked at Realogy for years, I own no Realogy stock (unless one of my mutual funds bought it), have no inside relationships, etc.  This is just my opinion as an observer of the industry.

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21 Comments leave one →
  1. Aaron Thompson permalink
    February 9, 2009 4:08 pm

    I’m sure you’ve seen Realogy listed on today’s “15 companies that might not survive 2009”

    You got it first though!

  2. Aaron Thompson permalink
    February 9, 2009 4:11 pm

    sorry – I meant to include the link to the article referenced above…

    http://finance.yahoo.com/news/15-Companies-That-Might-Not-usnews-14279875.html

  3. February 9, 2009 5:42 pm

    @Aaraon –

    Thanks for the tip.

    I suppose Realogy may go bankrupt. Again, I’m not sure I really see the value of doing that if I’m holding Realogy debt. The company has no assets, apart from the brands themselves and the experience/knowledge of the people at Realogy who know how to sell/service affiliates.

    Again, I could see a pre-arranged Ch-11 bankruptcy for Realogy, but in that case, Apollo will take a hammer to the forehead and have its equity extinguished, and the bondholders take over. Does that mean Realogy fails to survive? Meh… Chapter 11 doesn’t strike me as a “death” of a company, especially one like Realogy.

    Maybe that’s the ideal scenario, I don’t know. It certainly would let Realogy out of some of their leases for the NRT operations…. Bondholders go write off huge losses, and hope that when the RE market turns around, their equity in Realogy turns into a home run.

    We’ll see what happens.

    -rsh

  4. Aaron Thompson permalink
    February 10, 2009 11:43 am

    I agree wholeheartedly with your level-headed analysis. However, one result of any BK filing, would likely send jitters through the real estate agents’ minds. Typically, an agent trying to convince YOU, to use them to buy or sell your next home (now more than ever, the single most significant transaction for almost every American)would feel just a bit hampered with the fact that the logo on their business card is the same that is splashed around the media associated with the word “bankruptcy”.

    While you or I don’t associate that word nesessarily as “The End”, most folks do. Just as the CEO of GM recently told Congress, people will not buy a car from an automaker that has filed for bankruptcy. We must remember that it’s the perception that matters here. If I were a Real Estate Agent, I certainly would not want to be affiliated with a company in BK.

    Also, any filing would also most likely send Realogy’s franchisees running for the door looking for an escape clause as well.

    So, while it may not make the most sense for the bondholders, and while it may be a good strategic restructuring idea, the perception on Main St. would be devastating.

    Methinks anyways. But we shall see.

  5. February 10, 2009 1:26 pm

    Good points, Aaron, about perception of a bankruptcy filing.

    But I do think Realogy (and other services companies) are a rather different animal. GM is right that people won’t buy a car from a bankrupt carmaker, but that’s in large part due to the fact that consumers rely on the manufacturer for ongoing support. If I buy a Chevy, and two years out, it needs a new carburetor, I need to know that I can find the parts, and the dealers, and the technicians to fix my car. Financial institutions are in a similar quandary: if I’m going to deposit my money with you, I want to know that I can get it back when I want.

    Realtors, however, are a one-and-done entity that provides no ongoing value to the consumer past the transaction. Sure, they would like to become more of an ongoing source of value, but they are not there yet. I buy a house from a seller, use a broker to help, and then I’m on my own. Whether the broker is or is not bankrupt has very little impact on me or my transaction.

    Would franchisees flee? Perhaps. But there are some rather significant switching costs involved — just redoing all of the signage and business cards can run into tens or hundreds of thousands of dollars. Unless the parent company of the national brand of which I am just a part going bankrupt means my consumers in my local market stop wanting to do business with me, I doubt I’d take the trouble.

    In a weird way, if Realogy were to go bankrupt, and consumers did start saying things like, “You know, I really like you, and think you’re a great realtor, but since Century 21 is bankrupt, I don’t feel comfortable having you show me that home”… it would be the greatest proof that these brands do matter to the consumer.

    The fear/problem today is that no one would care that the parent company of the national overbrand went bankrupt. 🙂

    -rsh

    • February 25, 2009 11:41 pm

      A number of C-21 offices closed in Atlanta because the Franchise owners had financial problems. Real Estate is a relationship based business and most Buyers and Sellers choose an agent first not the Brand. As pointed out the assets of the Company are its agents. additionally, their listings. The individual agents will be the first to jump ship and without them there is NO business. Franchise owners may stay in longer because of an investment and as pointed out they are the owners of the Real property and assets.

      I would have moved my business already. There is enough drama for Sellers to deal with now. I would not want to add any additional.

  6. February 11, 2009 3:10 pm

    By the way, as the trackback link says, some additional info on Realogy and bankruptcy:

    http://notorious-rob.com/2009/02/11/realogy-sure-sounds-confident/

    Short summary: They don’t sound like they need it.

    -rsh

  7. February 26, 2009 9:39 am

    “Realogy says Apollo has its back” See complete story for details: http://twurl.nl/id5x6k.

  8. Franklin Hanks permalink
    April 23, 2009 10:09 am

    If they file, its the sales associates at the NRT offices that will be hurt the most. A trustee will own their listings and any transactions that they have in contract or escrow become property of the trustee as well. Tens of thousand of agents will looose all of their income and potential income to the trustee. Franchisees will be damaged by the it as well. The press will be all over it and no consumer in the right mind will list with a Realogy franchisee. Everybody looses. ( except the competition)

    • April 24, 2009 11:36 am

      It’s been ages since I’ve reviewed the relevant parts of the Bankruptcy Code, but I really doubt that the trustee will own an NRT agent’s listings, transactions in contract, or escrow.

      Escrow doesn’t belong to the NRT; it belongs to the buyer until closing, when the funds are released to the seller. It’s a strictly custodial account. I see no ownership interest by the NRT or the agent there.

      Transactions in contract, or listings on market — it’s entirely unclear to me that these can even be considered assets.

      Plus, I’m pretty sure all NRT agents are 1099 independent contractors, which means that any money owed them from a transaction is governed by terms of their contract. I don’t know whether real estate agents would be considered employees or vendors for purposes of determining priority of payments, but I’m pretty sure either way, they’d rank above shareholders.

      It will be disruptive, for sure, but I don’t think the doomsday scenario is quite what will happen.

      -rsh

Trackbacks

  1. Realogy Sure Sounds Confident « The Notorious R.O.B.

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