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Mike Goodman

December 2008 / January 2009

LSL hold up well as recession bites...

FIRSTLY, something of an apology. A year ago I reported that some speakers at the influential European Mortgage Federation annual conference in Brussels suggested that the “credit crunch” would be easing by summer 2008. It didn’t — in fact , it worsened.

That said, will the Chancellor’s pre-Budget measures help the housing market? The consensus is “no”.

As Ross Bowen, managing director of Connells Surveys and Valuations puts it: “The Chancellor has clumsily sidestepped the housing market.”

There are a few crumbs for small businesses, which might be useful to some estate agency firms.

But my view is that the £12.4 billion cost of the VAT cut could have been targeted at the building industry, by way of a special low rate of VAT on home improvements, more cuts in Stamp Duty, and more funding for social housing to mop up unsold new homes and re-activate abandoned housing projects.

Meanwhile, we are halfway through the global recession and the global economy might pick up as quickly as it slowed down, according to David Harro, the investment chief of Harris Associates.

That is the US fund which holds a 20 per cent stake in LSL Property Services plc, owners of Your Move and Reeds Rains.

Mr Harro, who experienced the 1990s recession, doubts this recession will be as deep as feared, partly because of the underyling strength of India and China and partly because it was caused by an over-borrowed financial system rather than other factors.

Harris Associates is therefore looking to invest further in UK companies with low valuations.

If Mr Herro’s prognosis proves correct, and that’s a big if, then this time next year the global economic outlook will be less gloomy.

Gordon Brown and Alistair Darling must be praying for such a scenario, considering how much public debt is piling up.

In the meantime, Harris Associates is sitting on a paper loss of at least 30 per cent on its 20 per cent stake in LSL, which was mostly acquired when the share price was over 70p.

The share price hit a new low of 30p last month but has since recovered to nearer 40p.

One reason was the news that Simon Embley, the group chief executive, bought 1.26 million shares at 31.6p after the group issued a trading statement on November 12. That brings his holding to 8.94 per cent.

Including Embley’s stake, the management holds about 30 per cent, Harris Associates 20 per cent, Barclays Private Equity 15 per cent and Sheffield Asset Management LLC, another US fund, holds 15 per cent.

That leaves only 20 to 25 per cent of the shares for smaller outside shareholders, so any purchases or sales result in sharp movements in the share price.

When a chief executive increases his stake in a company during a rough trading period it’s a sign of confidence in the company’s future.

Sometimes this proves misplaced.For example, when the Humbert management upped their stake in the group it went into administration several months later.

Barring further calamities in the financial and housing markets, this is hardly likely with LSL Holdings.

The group has finance in place until about 2011 and judging by last month’s trading statement, conditions are about as bad as they could be in the housing market, yet LSL’s own trading position is holding up.

The statement does not mention the profit and loss position but compares turnover for the first ten months of this year with the same period of 2007, a year which started well before the Northen Rock crisis kicked in.

Overall, turnover was down 22.4 per cent, but surveying showed a 6.4 per cent fall and estate agency and financial services a 33.3 per cent fall.

I expect LSL’s full year profits to crash from the bumper £36 million last year but I don’t expect an overall loss.

Indeed, analysts expect full-year trading profits, before interest etc, of about £16 million.

Mr Embley says his recent share purchase was partly a vote of confidence in LSL’s future but was also a move to restore the management’s original stake in LSL which was reduced when the group was floated.

He said: “ I owned 10 per cent of the company when it floated and am now re-building my stake.”

Mr Embley was one of the first estate agency chiefs to realise that business would plunge following the Northern Rock crisis, and began cutting staff and branches from autumn 2007.

But he was still surprised at the extent of the collapse and is not budgeting for a recovery in 2009.

He added: “I think I got the trend right and we took action early to cut costs. This year I do not expect more than 600,000 transactions in the UK, and next year could see a further fall to 550,000.

“The only way to run the business is to be cautious. You can always increase resources again if business picks up.

“The estate agency business is performing slightly better than forecast, and overall I do not see any nasty surprises in our second half results.”

LSL have cut about 45 offices from the 320 or so it ran this time last year, with Your Move down 25 offices, representing 12 per cent of its former total, and Reeds Rains also down 25 offices. But these represent 15 per cent of the total network. Mr Embley does not expect any more closures on this scale.

He expects prices could fall a further 15 per cent, so they will bottom out at about 30 per cent off their peak. But he believes affordability is improving and if the availability of mortgages recovers, turnover could finally improve.

Countrywide losses ‘containable’

COUNTRYWIDE’S chief executive Grenville Turner has reacted sharply to rating agency Standard and Poor’s downgrading of the securities issued by Castle HoldCo 4, the holding company set up by US investment fund Apollo LLP for last year’s buyout.

He said: “The report from Standard and Poor’s seems to assume we just sit and watch as market conditions deteriorate.” He admits Countrywide is making trading losses but they are containable.

The Standard and Poor’s report, published last month, downgraded the long-term corporate credit rating of Castle Holdco 4 debt from B to CCC and downgraded its other debt issues.

The S&P analysts expressed concern over the company’s ability to maintain adequate liquidity and to earn enough to service its interest payments.

They added: “The downgrading reflects the worsening liquidity position of Castle HoldCo 4 during the first three quarters of 2008 and our expectation is that this position will progressively worsen during the next 12 months.”

According to the analysts, Castle HoldCo 4 revenues for the nine months to September 30 this year were £327 million, about 33 per cent less than for the same period of 2007, while operating losses, excluding exceptional items, totalled £29 million.

There was a net decrease in cash balances of £64 million. As at September 30 2008, there were net cash balances of £94.8 million, although the group had drawn on its committed borrowing facilities.

Mr Turner admits Countrywide posted a £3.7 million loss during the third quarter and made losses during previous quarters but he reckons the group has over £100 million in the bank.

He added: “The Standard and Poor’s report was intended for institutional investors and has been quoted out of context.

“We dispute the conclusions as it assumes we just sit back and watch the business pile up losses. We expect a tough market next year, perhaps only 550,000 to 600,000 transactions.

“But our market share is increasing, as competitors go out of business. We’ve also taken cost cutting steps such as closing about 10 per cent of our branches.”

Perhaps the market might improve during 2009, then Countrywide might make trading profits again. If that’s the case, even Standard and Poor’s analysts say they might revise Castle HoldCo 4’s credit ratings.

“In the event that transaction volumes improve and cash outflows were reversed, a revision of the outlook to stable could be considered,” said a spokesman.

Another scenario is that Apollo LLP injects more capital into the business and cuts the debt.

It might be a likely one, once it appears the UK housing market has stabilised, and further failures and slimming downs among some of its competitorsfurther increase Countrywide’s market share.

In any event, former shareholders of Countrywide plc must feel fortunate they exited at over 600p per share in Spring 2007.

If Countrywide was still publicly quoted today, I expect its shares would be back to the level of the dark days of the 1990s.

But once the housing revival got underway, they staged a strong recovery. Hopefully, history will repeat itself.