|Shares Out. (in M):||12||P/E||0||0|
|Market Cap (in $M):||237||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
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Reis, Inc. (or “the Company”) operates an attractive subscription-based real estate database business characterized by predictable/recurring revenues that commands high margins and generates strong levels of free cash flow. Shares of Reis are currently trading ~20% below their recent 2015/2016 highs after its strong double digit growth trajectory in terms of revenues and EBITDA came to a halt during 2016. However, I believe that Reis’s operating results are at an inflection point following unfavorable comparisons over the past ~15 months (due to custom project work), outsized investment in its real estate database to bolster its products and services, duplicate rent expenses incurred during a portion of 2016 that are masking the Company’s underlying profitability, headcount expansion including a build out of the Company’s sales force, and a rare recent decline in the Company’s historically strong renewal rates. The vast majority of these items should be largely behind the Company (or show meaningful improvement) during the second half of 2017 enabling Reis to approach more normalized levels of profitability (mid 30s% consolidated EBITDA margins). Reis boasts an extremely strong balance sheet (arguably overcapitalized in light of the strong revenue/cash flow visibility inherent in the Company’s business model) with $21.5 million in cash (~$2 a share) and no long term debt. Although Reis pays a healthy dividend of $0.68 a share (3.3% yield), which was increased by 21% in early 2016, and has recently begun to repurchase shares again after a ~5 year hiatus, I believe that further optimization of the Company’s balance sheet could help unlock a meaningful amount of shareholder value in the near to intermediate term. Over the mid to long term, I view Reis as a likely acquisition candidate. Reis’s proprietary real estate database, which has been built over the past 37 years, would be virtually impossible to replicate and extremely appealing for a larger financial services entity. If Reis finds itself as the subject of an acquisition, I believe its shares would command a premium valuation.
Why Does This Opportunity Exist:
Between 2010 and early 2015, shares of Reis increased by more than 4 fold from ~$6 a share to $25 through. Shares were favorably impacted by the Company’s strong results with Reis Services (represents Reis’s main segment) revenue and EBITDA increasing at a 16% and 18% CAGR (for the 5 year period ending 2015), respectively and segment EBITDA margins increasing by about 400 basis points to 43.4% from 39.3%. However, shares have been under pressure over the past ~2 years, declining ~20% from 2015/2016 highs. The share price pressure reflects a number of items including:
Difficult Comparisons - The difficult comps reflect a large amount of custom/one time project work that boosted results beginning in 2015 through the first quarter of 2016. In 2016, Reis’s reported revenue declined by 6.6%, but results were adversely impacted by $4.5 million in custom data deliverables in 2015 compared with just $1.2 million in 2016 (all in the 1st quarter). Following the release of 1Q 2017 results in May 2017, CEO Lynford stated, “With our last difficult comparable reporting quarter behind us, we are confident that the resurgence in our financial performance will become apparent and reward all of Reis's stakeholders. We have made the critical investments necessary to generate sustained growth." In addition to the difficult comps, Reis also incurred approximately 5 months of duplicate rent expenses during 2016 due to the relocation of its NYC headquarters and build out of its White Plains location.
Elevated Expenses and Investments - Reis has stepped up investment in the business in recent years and this has also had an adverse impact on its results. The elevated investment can be seen through the increase in headcount over the past two years including an ~33% increase in 2015 followed by an ~6% increase in 2016. Website and capitalized development expenses, which had been averaging about ~$4 million a year, increased to $5.8 million in 2015 and to $8.5 million in 2016 and will likely remain elevated in 2017 with Reis expecting to capitalize ~$9 million of its website development expenses for the full year. Headcount is likely to remain flat going forward and I would not be surprised if 2017 represents the high water mark in terms of website development expenses.
Declining Renewal Rates - Reis’s renewal rates have historically been in the high 80s to low 90s(%) range, but its 2016 renewal rate declined to 82% on a TTM basis at year end 2016. The quarterly renewal rate bottomed during 2Q 2016 at 74%, but rebounded to 84% in each of 3Q 2016 and 4Q 2016 and increased further to 91% in 1Q 2017 driving three consecutive quarters of improving renewal rates on a TTM basis through 1Q 2017. One of the factors that negatively impacted Reis’s renewal rates was the success of the Company’s IP enforcement initiatives (cracking down on password sharing, etc.) in recent years that resulted in a large number of cancellations of contracts during 2016 that were signed in 2014 and 2015 as part of its IP compliance efforts.
Potential Insider Share Sale Overhang - In April 2015, with Reis shares trading near their all-time highs, Reis filed a form S-3 that registered the vast majority of the shares held by the Company’s founders including CEO Lynford and EVP Garfield for sale. Although these executives have sold only a nominal amount of their shares subsequent to the filing, the move was curious and raised more than a few eyebrows.
Background of the Company - No Good Deed Goes Unpunished:
Reis was founded in 1980 by current CEO Lloyd Lynford and Executive Vice President Jonathan Garfield. In 1998, Wellsford Real Properties, a publicly traded real estate development company operated by Lloyd Lynford’s brother Jeffrey Lynford, acquired preferred securities in Reis which were convertible into an approximately 23% share of the Company’s common stock.
During the spring of 2005 and after reviewing the Company’s operations, financial condition, projects and growth strategies, Reis’s management decided to consider strategic alternatives, including a possible sale of the Company—primarily in order to increase its access to capital. This exploratory process resulted in 14 initial offers and final bids were submitted by three potential buyers in February 2006. Reis entered into exclusive negotiations with the most attractive bidder, which had offered Reis approximately $93 million in cash. The offer represented a healthy 13.4x TTM EBITDA. However disagreements with the potential buyer quickly emerged and negotiations broke down soon afterwards.
Around the same time, Wellsford was also exploring strategic alternatives. In May 2005, Wellsford determined that the best way to maximize shareholder value was to adopt a plan of liquidation. The plan, approved by its shareholders in November 2005, entailed the orderly completion of all construction projects, disposal of their remaining development properties, collection of all outstanding receivables owed to the company by customers, the sale of Wellsford’s remaining assets (including its 23% ownership stake in Reis), the discharge of all outstanding liabilities to third parties and finally, the distribution of all remaining cash to shareholders.
As Reis’s negotiations with a potential purchaser were starting to break down, Wellsford entered the picture as a potential partner. On October 11, 2006, a merger agreement was executed between Wellsford and Reis where Wellsford would acquire the remaining 77% of Reis that it did not already own for $75.2 million, paid roughly half in cash and half in stock. The deal valued Reis at approximately 10.5x adjusted TTM EBITDA. Factoring in Wellsford’s share of Reis, the offer represented only a slight premium to the previous high bid. However, the inclusion of a partial share-based payment offered a more favorable tax structure and also enabled the then private Reis shareholders to participate in potential upside for the continuing entity. The combination also unlocked additional value from Wellsford’s substantial net operating loss carryforwards (NOLs). Furthermore, Lloyd Lynford also got to bail out big brother Jeffrey! Accordingly, Wellsford terminated its plan of liquidation, but continued to wind down the real estate development business and changed its name to Reis. The transaction was effectively a backdoor IPO for private Reis and allowed private Reis shareholders (excluding Wellsford’s existing stake) to maintain approximately 40% equity interest in the new Reis. Most of the Reis management team remained intact after the merger, with the notable exceptions being Jeffrey Lynford’s assumption of the Chairman’s role and Mark Cantaluppi (Wellsford’s CFO) taking over as CFO.
In March 2012, Reis disclosed that it had received an adverse jury award that found it, and former officers including Jeffrey Lynford (note: Jeffrey left Reis’s board in June 2011), and the construction manager/contractor of a former Wellsford condominium project (Gold Peak), liable for over $18 million associated with construction defects. Reis moved quickly to settle the matter and put the overhang behind it. In June 2012, Reis agreed to pay $17 million as part of a settlement though it would ultimately recover $5.7 million from multiple parties including insurance carriers, trial attorneys, an insurance broker, and other responsible parties for the Gold Peak project.
Reis maintains a proprietary real estate database with detailed information on commercial properties throughout the U.S. The database currently consists of 9 main property types (office, retail, self storage, etc.) and is used by a variety of industry constituents including investors, lenders and brokers. The Company’s flagship product is Reis SE and is geared toward mid and large sized businesses while ReisReports is aimed at small businesses and individuals. Subscriptions to Reis SE range from $1,000 to over $1 million per year and average about $40k while monthly subscriptions to ReisReports are in the low hundreds of dollars.
The Company’s client base is broadly diversified and consists of a mix of capital providers (83% of total) and service providers (17%). Reis’ capital provider clients include debt investors (56% of the total) such as banks and insurance companies and equity investors (27%) with developers, REITs and investment managers among the clients. Meanwhile, service providers include appraisers and brokers among other. The Company’s largest client accounts for just 6.3% of total revenues.
Reis has made a concerted effort in recent years to sign up its clients to multi-year (two, three and even four years) contracts. At December 31, 2016, 38% of its clients were in multi-year contracts, up from 33% at year-end 2015. The average length of a multi-year contract contract signed in each of the past 3 years was 2.2 years. Although multi-year contracts tend to smooth out the revenue recognized over the life of the contract, they have several benefits including improving renewal rates, enhancing revenue visibility, and increasing the odds that Reis’s data and analytics become an integral component of an organization’s work flow (think of it as a goal to become the Bloomberg for commercial real estate).
An interesting aspect of the Company’s business model is that it basically gets paid by large information service providers (such as FactSet and Capital IQ) to market its services. Through data redistribution agreements with these firms, consumers of third party services have access to limited views of Reis’s market data, but over time these consumers may end up signing up with Reis for its full suite of services providing a valuable source of new leads.
Reis continues to invest in its business to bolster its proprietary database capabilities including increasing both the depth and breadth of its coverage by introducing new property types and expanding coverage of existing property types into additional geographies. In 2016, the Company began offering coverage of the affordable housing industry, which has been one of the most successful new property types that Reis has introduced over the past ~5 years. Another recent new product enhancement is Reis’s “every comp, everywhere” campaign to expand its sales comparables database that is expected to provide it with a meaningful advantage over its competition.
Operating Results at an Inflection Point:
Due to the factors mentioned above, Reis posted disappointing results in 2016 with revenue declining by 6.6% and consolidated EBITDA falling by 35% to $11.5 million (20.1% margin) from $17.7 million (34.8% margin). However, I believe that the Company’s results are at an inflection point and should begin to experience meaningful improvement during the back half of 2017. Management currently expects to exit 2017 at a double digit growth rate for revenue and consolidated EBITDA (based on quarterly run rate) with consolidated EBITDA margins approaching ~34% (run rate). There are a number of items that should favorably impact future growth including strong recent new customer growth, improving renewal rates, recent new products and product enhancements. In addition, Reis continues to believe that there will be an ongoing opportunity to capitalize on its compliance initiatives aimed at cracking down on unauthorized access to its products and services. The Company’s aggregate revenue under contract (defined as deferred revenue plus amounts under non-cancellable contracts where the Company does not have the right to bill at period end) declined during the first three quarters of 2016 (on a Y/Y basis), but has increased by over 6% in each of the past two quarters.
Overcapitalized Balance Sheet:
Given Reis’ business model characterized by strong revenue and cash flow visibility, I believe the Company’s balance sheet is extremely overcapitalized with $21.5 million in cash (~$2 a share) and no long-term debt as of March 31, 2017. Although recent results have been a little uneven, the strong and resilient business model is something that is not lost on management. During the Company’s 1Q 2016 earnings call, CEO Lynford stated, “The cornerstone of Reis’s financial model continue to be predictable in recurring revenue, high margins, cash generation and growth.” Accordingly, I believe that Reis could easily handle a modest (at a minimum!) financial leverage. With Reis’s results at an inflection point following its recent outsized investments, I believe that optimization of the Company’s current lazy balance sheet could be on the horizon. It is encouraging to see Reis begin repurchasing shares after not completing any buybacks since 2011 when it exhausted a prior $5 million share repurchase authorization. In August 2016, Reis initiated a new $5 million share repurchase authorization and has repurchased approximately $2.6 million of shares at an average cost of ~19.80 a share over the past two quarters. CEO Lynford recently stated that the Company will “remain opportunistic” buyers of its shares. In my view, this development not only bodes well for future balance sheet optimization, but also likely reflects management’s confidence in the trajectory of Reis’s future results.
Management/Board Ownership Interest Aligned with Shareholders:
At present Reis’ insiders currently own 21.6% of its outstanding shares with the vast majority held by the Company’s two founders including CEO Lloyd Lynford (11.4%) and EVP Jonathan Garfield (8.2%), who both currently serve on the Company’s board. In my view, this outsized inside ownerships helps tightly align management/board interest with that of outside shareholders. Co-founders Lynford and Garfield are both in their early 60s and I would not be surprised to see them sell the business at some point down the road and management has previously expressed an interest in selling the business. In fact, the last bullet point of the Company’s investor presentations used to state, “Outstanding Monetization/Exit Opportunities: Attractive acquisition target for large information and media companies.”
Precedent Industry Transactions Provide Glimpse of Reis’ Value:
Transactions in the real estate database industry have commanded healthy multiples in recent years. These relevant precedent deals include CoStar’s acquisition of Apartments.com (2014; 21x EBITDA), CoStar’s purchase of LoopNet (2011; 27x EBITDA), Altus’ deal to acquire Argus Software (2011; 14x EBITDA), and CoStar’s deal for Property & Portfolio Research (2009; 24x EBITDA). If Reis was put up for sale, I believe it would command a healthy multiple. It should be noted that an acquisition of Reis in the near term may be unlikely due to the fact that it could compromise the Company’s NOLs.
On the surface, shares of Reis do not look particularly inexpensive on a EV/EBITDA basis since there is meaningful noise in recent results including outsized investment in the business and duplicate corporate rent costs that are currently suppressing Reis’ true run rate level of profitability. In addition, Reis has meaningful NOLs ($38.7 million federal NOLs as of December 2016) that are expected to shield the Company from federal taxes for the next ~4 years that renders the current EBITDA valuation metric as less meaningful. The fact that management highlights a “Reis Services” metric in its releases/filings seems odd (especially for a 1 segment business to be broken out this way) and is likely an indication that the ultimate end game for the Company is an acquisition by a strategic acquirer, which would likely be able to eliminate a meaningful amount of Reis’s corporate overhead.
Risks and Mitigants:
Commercial Real Estate Market Valuations - Commercial real estate prices are now above their pre-crisis highs and many industry observers are suggesting that valuations have reached peak levels. However, a declining market could introduce a new set of constituents (distressed investors) that would be interested in the Company’s products and services. Furthermore, Reis’s business model has proven resilient historically with an increasing amount of its business locked up under annual and multi-year contracts in recent years. During 2009, Reis Services’ EBITDA declined by just 7%, markedly outperforming the performance of its peers including CoStar (down 18%) and LoopNet (down 34%).
Unfavorable Corporate Governance - Reis is incorporated in Maryland and therefore has some strict anti-takeover provisions in its by-laws/governing documents including the ability to issue “blank check” stock that could help deter a takeover attempt. Maryland law and may result in decisions that are not optimal for shareholders.
Potential for Reduced Financial Institution Regulations - The prospect for reduced regulation of financial institutions could prove to be a headwind for the Company.
Competitive Landscape - Increased investment in the business suggests (or be in response to) a more competitive industry landscape. However, it is encouraging to note the improvement in renewal rates in the wake of recent investments and that the Company has experienced strong new customer additions.
Improved operating results following recent investments to bolster its database business and sales force
Lapping of unfavorable comps beginning in 2Q 2017 following a large amount of one time custom project work
Optimization of Reis’s currently overcapitalized/lazy balance sheet
Moderation of investment spending intended to bolster the Company’s products and services
Sale of the Company to a strategic acquirer
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