Description

Summary  

• Everyone appears to be freaked about commercial real estate (CRE), but what is bad for asset-heavy levered CRE owners in a volatile market facing a massive $2+ trillion debt maturity wall through 2025 is actually good for asset-light CRE brokers and intermediaries like Newmark

• More importantly, Newmark has an excellent top tier multifamily business highlighted by its underappreciated high margin GSE servicing business, a crown jewel asset that produces a long term, growing, call protected, recurring stream of free cash flow; I estimate NMRK’s multifamily business alone is worth well more than NMRK’s entire current enterprise value of $2B, yet it only represents ~1/3 of normalized EBITDA

• NMRK has a much less volatile earnings stream than the market perceives, a clean balance sheet (~1.3x leverage), a 70% variable cost structure (commission based), is taking out $50M of fixed costs, and generates material FCF conversion every year (averages 74% of EBITDA); the company’s strong management team owns a ton of stock and are currently on full offense, they have bought back ~23% of the company’s shares on gross basis since the end of 2020 and are aggressively hiring/buying teams/talent to position the company for the coming upcycle, guiding EBITDA to more than double to >$900M over the next several years

• In the meantime, despite the CRE/macro backdrop, I believe the company has guided to solid EBITDA and cash flow this year; this is characterized as NMRK’s trough earnings power as with CRE transaction volumes generally at a standstill, 2023 guided earnings are consequently largely driven by the servicing, multifamily, core leasing and other more recurring business lines; view the stock is very attractive, trading at 4.7x EBITDA and a 22% free cash flow yield on trough numbers that are on the verge of material inflection

History/Business

• Top 5 commercial CRE services firm in the U.S.; this is a fundamentally good sector, with the big guys getting bigger and taking share for last decade in part by offering a broad suite of services and cross-selling; CRE can be cyclical but over time has tailwinds with lot of dry powder, increasing institutional ownership and volumes driven by natural churn in leases, asset sales, financings/refinancings, etc.; NMRK and its peers have a good mix of recurring/quasi-recurring (loan servicing, asset/property management, valuation/advisory, parts of leasing) and transactional (asset sales, mortgage financing, etc.) businesses

• I believe NMRK’s execution has been impressive with consistent peer-leading organic growth and accretive team/producer/bolt-on acquisitions with ample white space to grow the core business in the US and internationally; since the IPO, EBITDA doubled, the company has de-levered and bought back a large % of the company, yet the stock is down; company was managed very well through COVID, proving the resilience of the recurring portions of the business and the variable cost structure of the operating model; NMRK also has a competitively advantaged corporate structure that creates material tax savings and a differentiated ability to attract and retain talent

• Everyone appears to be freaked about commercial real estate (CRE), partly for good reason, with respect to higher rates, the challenges in the office sector and regional bank exposure; however, CRE is not going away and the other major subsectors (multifamily, industrial, hotel, strip retail, self-storage, data centers, etc.) are fundamentally situated much better from both an operating and supply/demand perspective

• NMRK and the CRE brokers are well positioned for both the return of regular way transaction volumes in the fundamentally stronger subsectors when rates stabilize, as well as to take advantage of the coming distress in more challenged sectors; furthermore, there is a >$2 trillion maturity wall of CRE debt coming due over the next ~3yrs that will have to be refinanced/paid down/addressed as well as $400B of private institutional global equity dry powder earmarked for CRE investment; we are at the front end of these meaningful tailwinds as all of these transactions require the services of CRE intermediaries and NMRK will get its fair share; importantly and notably, NMRK was chosen by the FDIC to sell the $60B loan book of Signature Bank, the largest CRE loan sale in history

• Company has excellent disclosure and highly informative slide decks on the IR site for additional reading and analysis

Newmark’s Multifamily Franchise

• Multifamily GSE origination and servicing business:

  • Fannie, Freddie and Ginnie (GSEs) are the largest providers of financing to the multifamily market and are acyclical lenders that are in the market every year with both government mandated levels of financing they must provide to the market as well as additional discretionary financing each can provide up to their government mandated caps (which generally increase every year); the GSEs rely on a limited number of service providers to source, originate and underwrite these loans on their behalf, granting a limited number of licenses to do so and NMRK is a top tier player

  • I believe this is an excellent, asset light, low risk business; while the accounting is complex, the business is not as NMRK is paid fees both (i) upfront to originate and warehouse multifamily loans and (ii) on a recurring basis to service these loans over their term; very importantly, these loans are structured differently than single family mortgages in that they generally are not prepayable/callable, thus providing a long term recurring fee stream

  • The size of the servicing asset and resultant cash flow grows every year as more loans are made; at the end of 2022, the servicing portfolio was comprised of $71B of loans with weighted average life of 7.1yrs; the servicing business alone drove $216M of high-margin, recurring, and predictable revenue in 2022; based on disclosure from comparable company Walker Dunlop (WD), estimate this is a >70% EBITDA margin business, suggesting NMRK’s servicing business alone produces ~$150M of recurring/growing EBITDA (not including the origination fees payable on the closing of each loan which is reported as brokerage, not servicing revenue)

  • The NPV of this stream coming off just the current book is valued on the balance sheet as a $550M MSR (Mortgage Servicing Right), but I believe this is well conservative given the abovementioned estimated size of the underlying cash flow stream; furthermore, these are tradable financial assets and the largest competitor, Walker & Dunlop (WD), estimates the fair value of its comparable servicing asset at 44% higher than book – this suggests NMRK’s current MSR alone is worth closer to ~$800M 

  • As part of the service, NMRK warehouses the loans for the GSEs on its balance sheet pre-securitization for a short time (30-45 days); as these loans are 100% presold to and guaranteed by the GSEs, NMRK has no/minimal risk during warehousing; the loans are funded at a 100% advance rate and are non-recourse to parent company NMRK (this debt shows up incorrectly on Bloomberg as NMRK’s debt, overstating leverage); for Fannie Mae serviced loans only, there is a de minimus loss sharing risk in the event an underlying loan defaults; this risk is spread across thousands of loans with a weighted avg loan-to-value (LTV) of 62% as of 12/31/22 (and thus 38% equity cushion), and over the 24 years (started in 1999) the business has operated through multiple cycles (including the GFC and COVID) with historical realized per annum losses <2bps

• Multifamily is historically the best and most stable asset class in CRE and NMRK is a market leader; the abovementioned GSE business is only a subset of the company’s franchise which also includes a large loan brokerage business serving all other non-GSE sources of multifamily lending capital as well as a leading investment sales business wherein they represent the buyers and sellers of multifamily assets; the multifamily sector alone represented more than 50% of NMRK’s total investment sales volumes in 2022

Thesis/Opportunity

• Market sentiment towards CRE is max negative and the broker stocks have been taken down with the REITs and other CRE-related companies in concert; this happened during the GFC and again during COVID and the companies have come out bigger and stronger each time with the stocks posting outsized returns (during COVID, NMRK bottomed at <$3 and thereafter peaked at >$18)

• Estimate NMRK’s multifamily business alone is worth well more than the current entire enterprise value of $2B, but it only represents ~1/3 of normalized EBITDA, getting the rest of the company for free; triangulate to this value in several ways/with several data points: (i) based on the above mentioned NPV of the current servicing asset plus the franchise value of its future earnings power, (ii) the core of the multifamily business was bought for $875M in 2017 and the business today is multiples larger, (iii) disclosure from NMRK investor day points to a multifamily business that made ~$220M of EBITDA in 2021, estimate 2023 EBITDA is larger and the perfect pure play multifamily comp WD currently trades at 11x EBITDA

• For 2023, at the low-end guidance of $425M of EBITDA, the company expects to generate $300-$350M of cash flow ($1.25-$1.45 per share); characterize this to be a trough number as the large majority of this EBITDA and thus cash flow is comprised of high margin recurring/growing servicing income + other largely recurring management fees from valuation/appraisal/property management + a base level of lease renewals and below normal multifamily transaction activity

• Management at times has been viewed as controversial and the corporate structure is complex, but they have delivered fundamentally, created a lot of value and bought back substantial shares to their and the remaining shareholders benefit; if the market does not properly value the stock, can speculate at some point they buy in the rest of the company and go private

• Comps:  on 2023 numbers, WD trades at 11x EBITDA and 15.2x EPS; CBRE trades at 10.6x EBITDA and 16x EPS; JLL trades at 9.6x EBITDA and 12.1x EPS; CWK is over-levered and trades at 7.4x EBITDA and 8.1x EPS; CIGI trades at 10.4x EBITDA and 13.6x EPS

• Extremely compelling risk/reward; downside protection from clean balance sheet, huge FCF yield and potential takeout; NMRK trades at just 4.7x EBITDA and 5x EPS; just making numbers this year, at 6.5x EBITDA / 7.5x EPS the stock is worth >$10, just getting back to 2022 earnings ($600 EBITDA, $1.80 EPS) at similar multiples stock is worth >$14 and at $800-$900M EBITDA at again similar multiples, stock is >$21-$22; these price targets notably do not include the $4-5 per share the company will generate in FCF in the interim or the optionality of material multiple expansion from the applied 6.5x EBITDA closing the gap to its comps, with each 1x turn of EBITDA worth another $2.00-$3.50 per share

Important Disclaimer

The information contained herein (the “Information”) represents the views of the author as of the date submitted based on public information published or disseminated by the companies referenced below, including, but not limited to, through SEC filings, investor relations materials and public conference calls, or other third parties as of such date.  Securities of the companies discussed herein have been and are currently portfolio holdings of the author or clients of the author’s firm.  The Information does not constitute investment advice or a recommendation, and it is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or other asset or to participate in any trading or investment strategy.  Furthermore, not all relevant facts and information may have been considered in developing the Information and such Information is subject to change.  The author has no obligation (express or implied) to update any or all of the Information or to advise you of any changes to the Information; nor does the author make any express or implied warranties or representations as to the completeness or accuracy of the Information or accept responsibility for errors.  You should not rely on the Information, in whole or in part, without conducting your independent verification as to its accuracy.  The Information contains forward-looking statements, including observations about markets and industry and other trends as of the date hereof. Forward-looking statements may be identified by, among other things, the use of words such as "expects," "believes," “targets,” or "estimates," or the negatives of these terms, and similar expressions. Forward-looking statements reflect the views of the author as of such date with respect to possible future events. Actual results could differ materially from those in the forward-looking statements as a result of factors beyond the control of the author and you are cautioned not to place undue reliance on such statements.  The Information may not be reproduced or disseminated in any manner without the express written consent of the author.

Catalyst

Strong FCF on trough earnings, rates stabilize, transactions inflect