A Word (or Two) About Realogy
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”
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.
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.