September 2007

Now that's wicked!

AUGUST was indeed a wicked month, as I suggested in my last column.

It was not so wicked for the UK housing market, but certainly for the world’s financial markets.

I don’t want to dwell on the details — the City pages and the financial websites have provided more than enough coverage.

But I would like to mention a report in the Sunday Telegraph business section of August 19 which suggested that the two major private equity estate agency buyouts earlier this summer, of Foxtons by BC Partners and of Countrywide by Apollo Management LLP, have suffered from the financial market turmoil.

According to the report, BC’s backers, Bank of America and Japanese Bank Mizuho, have encountered problems selling off some tranches of the debt raised to buy Foxtons and have had to cut the price to 98.5p in the pound, perhaps even less, according to some rumours.

A source close to BC Partners told me: “It’s a credit market issue and Foxtons is performing well as a business.”

With the Apollo takeover of Countrywide, Credit Suisse, the bank leading the underwriting, managed to sell off the debt before the financial crisis. But rumour has it that this debt has traded at below face when it is sold on again.

The name of the game for private equity groups was raise debt to buy companies. The banks which lent the money were able to sell off the debt in tranches, rather like insurance companies spreading their risk among re-insurers, but as the market dried up, this has become very difficult.

So we cannot expect any more major private equity deals involving estate agency firms until the markets settle down.

LSL - results amid the market panic

BY sheer coincidence, Lending Solutions (LSL), the parrent company of Your Move and Reeds Rains, announced its half year profit figures amid the panic in the financial markets.

The results were a mix of good news and bad news. They showed underlying profit of £15.6 million for the half year to June 30, compared with £13.3 million in the same period of 2006. This represents an 18 per cent uplift.

Group revenue was up 13 per cent to £102.8 million, while the overall profit margin was 15.2 per cent against 14.5 per cent.

Pre-tax profits were £14.7 million and Earnings Per Share 10.1p. Shareholders receive a maiden dividend of 3p per share.

Estate agency and financial services made £6.4 million, a 42 per cent uplift on the first half of 2006.

Now for the not so good news. Compared with the first half of 2006, exchanges in the estate agency business Your Move were down four per cent.

Depending on interest rate trends, LSL expects a further fall of up to 15 per cent in housing market volumes for the second half of this year and single figure house price inflation.

Chief executive Simon Embley said: “If interest rates reach six per cent and stay at this level for any length of time, we could see a 15 per cent fall in transaction volume and house price falls of about one per cent in the weakest areas. But the market might not be as weak as this. However, our view is that there is downward pressure on transaction volume.

“In recent years, the peak annual level of transactions was about 1.5 million, while the lowest annual level was about 1.1 million.

“In my view the difference between these figures represents ‘aspirational moves’, people moving because they feel better off and want to trade up. The number of these ‘aspirational moves’ is falling. Note that for all its profitability, last year saw about 1.3 million transactions against a long term average of 1.33 million.” That suggests one reason why the estate agency business was so profitable last year was the rise in prices which swelled commission volume.

The other not so good news relates to LSL borrowing, which increased this summer to finance the £30 million deal done with C & G to handle the lender’s surveying. It’s rather like a rail franchise paying to run a service.

As at June 30, 2007 net debt was £56.3 million against an average borrowing level of £37.5 million during the first half of this year and interest payments of £1.2 million (£3.3 million in 2006).

Against that, net assets as of June 30 2007 totalled £35 million, up £9.1 million compared with a year earlier.

Mr Embley says net debt will peak as the benefits of their purchase of Cheltenham & Gloucester’s surveying business shows through and points out that cash flow during the first half of this year increased to £10 million. He says the deals which increase LSL’s surveying business will decrease the group’s exposure to the housing cycle.

Indeed profits from surveying during the first half of 2007 were £11.7 million, against £9.8 million a year earlier and nearly double the profits from estate agency and financial services.

Analysts at Numis and ABN Amro recommend LSL as a buy, though they warn of short term fluctuations. They forecast full year pre-tax profits of about £37 million and earnings per share of about 25p, rising to £48 million/32p in 2008. They are not too concerned about the level of LSL’s borrowings and expect profits from surveying will increase to comfortably service the debt.

Phillip Lindsay, analyst at ABN Amro, said: “Once LSL has proved resilient through the housing market cycle, it will merit a re-rating. Countrywide profits were volatile in the past because of estate agency. LSL’s business model derives a much larger proportion of its revenue from surveying. LSL manages survey volumes for major mortgage providers. A feature of this model is that some is in house, some contracted out. So if the surveying business volume dips, the amount contracted out to panel surveyors can be cut.”

But he warns: “We think volumes of contracts exchanged will be 15 per cent lower during the second half of this year than they were a year earlier. Estate agency profits could well fall by 20 per cent to 25 per cent. The reason why borrowings have increased is the £30 million paid up front for the C and G surveying business. But we reckon LSL is cash generative and by 2009 will be debt free.”

LSL continues expansion, having bought two more estate agencies this year and it is looking for partners in the property management business according to Mr Embley.

Despite the stock market bloodbath and a fall in the LSL share price to about 236p, it is still above the 212p flotation price of late November 2006.

I mentioned in my last column that Barclays Private Equity had cut their stake to 18 per cent and sold at 260p. I hope I did not confuse readers when I mentioned 360p in one paragraph instead of 260p.

LSL was BPE’s first venture into the estate agency business and it has certainly proved successful.

BPE not only recouped a good chunk of its original LSL investment when it sold some of its stake at 260p per share, but its remaining stake in LSL promises to be a nice little earner in the future.

Savills caught up in turmoil of the market

THE recent turmoil in the financial markets has also impacted on estate agency-related stocks.

Since “Black Thursday and Friday”, August 9 and 10, Savills shares have traded around their year’s low, in the 450p to 500p range. That compares with the year’s high of 700p.

To complicate the situation, Savills announced the acquisition of a US Bank, Granite Partners, amid the market turmoil caused partly by the US sub-prime sector.

Granite is not a sub-prime lender but a commercial property lender, with a good track record.

The price of $54 million does not exactly raid Savills’ piggy bank, while the final price of $85 million depends on performance.

But I suspect some shareholders and analysts took fright when they saw the deal, and this might have exaggerated the fall in Savills’ share price.

But there remains the link between the fortunes of the financial markets and the upper market residential property market.

There is also a link between economic growth and commercial property market trends. With the financial market uncertainty suggesting a down trend in both sectors of the property market, I expect the Savills share price will remain subdued for the time being. The shares are now on price-earnings ratio of about eight and yield about five per cent, at which level I believe they are attractive to income seekers.

Indeed analysts point out only 15 to 20 per cent of Savills’ profits is earned from the residential sector.

Analysts at ABN Amro still expect some growth in profit and earnings per share this year.

Another bull point is that Savills have appointed as finance director Mark Deasley, formerly with the European operations of Aviva, one of the leading insurance groups and former owners of the Your Move estate agency chain.

n The next Rightmove results were due after we had gone to press for this issue. I will review them next month and in the meantime post a brief article on our website.