June 2007

Long-term returns the crucial takeover objective

AS I reflect on the recent sales of the 1,000-plus offices estate agency giant Countrywide and London-based Foxtons, with some 20 UK branches, I can see a parallel with the way financial institutions scrambled for estate agencies in the mid to late 1980s, when I started writing about this sector.

There are, however, some major differences. Then, banks and life insurance companies saw estate agencies as a distribution channel for mortgages and endowment policies, amid a booming and expanding property market.

This time round, institutional investors are also buying big into the estate agency sector. But their reasons are very different. They are not looking for retail outlets for financial products, but profitable businesses that can deliver long-term returns.

Last time round most of the institutional buyers ‘retired hurt’ — and often suffering heavy losses.

The dramatic housing market slump of the early 1990s did for them. But there was also a lack of understanding of the estate agency business — that it needs to generate successful home sale volumes, not just financial service commission income, that local names count and that, above all, estate agencies need motivated and talented management and staff.

Of the institutional players of the 80s, Hambros Bank got it right, as it provided the finance for Hambro Countrywide, and let Harry Hill and his colleagues get on with building up the business.

The Skipton Building Society takes a similar ‘arms-length approach’ to Connells. By contrast, the Prudential stamped its brand on the firms it bought, had grandiose ideas about IT systems, and lost hundreds of millions in the process.

Will the new equity capital owners of Countrywide and Foxtons take the “let them get on with it” approach, or carry out “re-structurings”, or introduce “smart” new ways of doing business which may or may not work?

A key challenge, especially for the new owners of Countrywide is to make group earnings less cyclical. The old Hambro Countrywide management tried to do this by launching a life assurance company which was eventually de-merged as Chesnara. I’m not sure whether Apollo will take this approach. But let’s wait and see.

Incidentally, Foxton’s founder, Jon Hunt is estimated to have realised £370 million with the £400 million sale to BC Partners of the London-based estate agency, He’s keeping the US business. The calculation of his stake is based on his ownership of 97 per cent of its shares.

Countrywide’s directors have not enjoyed such lavish wealth. According to director shareholding information, finance director Mike Nower owned about 520,000 shares and chief executive Harry Hill 350,000.

At 620p per share, that means a few million for the two of them and even then some of these shares had to be bought through the exercise of share options.

Countrywide, through various share option schemes, shared its value with other directors, managers and staff, so I am sure plenty have enjoyed nice little nest eggs thanks to the Apollo deal. Good luck to them.

...and more acquisitions look to be on the cards

CITY analysts believe more equity capital takeovers of estate agencies are in the pipeline. The 3i Group is an obvious potential bidder after being thwarted in its approaches to Countrywide and Foxtons. Likewise, TA Associates, another FTSE 100 listed group, was said to be the under bidder to BC Partners in the Foxtons sale. And I don’t see any lack of bid targets, even if they are smaller chains. I wonder how many family-run or privately owned estate agency chains would refuse a generous offer? I remember how many firms sold out to major institutions in the 1980s, and how their partners retired gratefully into tax exile. I think we might see a re run.

Now the dust has settled on the Countrywide takeover, here’s some more reflections. In racing terms, I understand the 3i Group remained a serious bidder almost to the final hurdle. But Polygon Capital holding 30 per cent threw its weight behind Apollo. A key reason is that Apollo was prepared to allow Polygon and other major shareholders to keep a stake in Countrywide through the unquoted stub equity shares. That’s why the stub equity element was increased at the last minute.

As I reported on our website, the final offer allowed Countrywide shareholders to keep a bigger stake in the group, up to 55 per cent instead of 45 per cent previously. The other elements of the offer remained unchanged, at 530p cash per share and 0.16487 per Rightmove share held by Countrywide. The 3i Group was believed to have offered more, but in cash, and that’s not what Polygon wanted. Add to that rumours that Apollo itself might float on the US stock market, and I can see the logic of Polygon hanging on to a piece of the action.

Rightmove booming

YOU might think that Countrywide’s stake being put on the market might have depressed the share price of stock market-listed portal Rightmove.

Furthermore, the one year moratorium on directors and major shareholders disposing of their holdings has elapsed leading to other disposals. Miles Shipside, Rightmove’s commercial director, sold 300,000 shares, half his holding, at 560p per share.

But the Rightmove share price is buoyant — and the main reason is performance.

The next results are due in late August/early September and City analysts have upgraded their forecasts.

The current concensus is that full year profits will be £27 million to £30 million for 2007 with Earnings Per Share of 14p to 17p. For 2008, the forecasts range from £34 million to £38 million with EPS from 19p to 21p. More details are posted on the Rightmove website in the shareholder section. The current share price puts Rightmove on a price/earnings ratio of about 30 based on 2008 earnings. Compare this with the 10 to 12 times earnings valuation of Countrywide.

HBOS also sold some of its stake and, more recently, Connells sold 6.3 million shares, which reduced its holding from 20 to 16 per cent. Note that this is just above the 15 per cent needed to maintain a Connell representative on the Rightmove board. So Connells chief Stephen Shipperley remains as a Rightmove non-executive director and he told me: “It was good to take some profit on our holding. However, we are still very positive about Rightmove as a business.”

Obviously, the City likes Rightmove as a successful ‘dot com’ stock. Analysts are also noting that US investment house ReachCapital built up a 3.48 per cent stake when Countrywide placed its holding. But there is another reason for the share price rising, and it’s a consequence of the major shareholders diluting their stakes. It makes it easier for Rightmove to buy back its shares in the future. Indeed it gained the powers to do this last month.

Robin Savage, analyst at KBC Peel Hunt, said: “I don’t think a share buyback is on the agenda this year, but the recent changes in ownership provide greater scope for Rightmove to buy back shares.”

If Rightmove shares were still concentrated among the original owners, they would be even more concentrated with a share buyback and one of the major shareholders might be forced to bid under City takeover rules, I understand.

The advantage of a share buyback is that it concentrates earnings among fewer shares. It’s been done with some top FTSE 100 companies to boost shareholder returns and it’s a sign that a company is making more profits than it can use to invest in the business. In other words, its a sign of success. So if I was an estate agency founder shareholder, I’d hold on.

Incidentally, Mr Shipside told me he sold his shares to buy a new home. “It’s a sign I don’t believe the market will collapse,” he added.

He might further add that even if it did, he won’t be suffering negative equity or worrying about mortgage repayments. Which is why, perhaps, cash buyers are such a key element in the market.