Regus LON:RGU
June 05, 2015 - 7:15am EST by
Hal
2015 2016
Price: 249.00 EPS 0.10 0.14
Shares Out. (in M): 934 P/E 25 17
Market Cap (in $M): 2,359 P/FCF 0 12
Net Debt (in $M): 50 EBIT 144 187
TEV ($): 2,409 TEV/EBIT 17 13

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  • UK based
  • Real Estate
  • Cyclical
  • owner operator
  • Competitive Advantage
  • High Barriers to Entry, Moat
  • Rental & Leasing
  • Wework worth 10x as much?
 

Description

Regus
 
At first glance, Regus does not look like a stock which belongs in a value investor’s
portfolio:
 
1. It has a leveraged operating model, committing to long leases with landlords,
which it sells on to tenants on short-term leases making it highly cyclical and
exposed to economic down-turns.
 
2. Whilst it is by some margin the global market leader, its product really
competes at a local level. It is not immediately obvious what competitive
advantage its scale can really provide.
 
3. It has a troubled history: the US business went into Chapter 11 in 2003 and the
UK business was saved by selling a majority stake to Alchemy (under John
Moulton) in 2002.
 
4. It trades on a PE of 35x (2013 earnings).
 
This investment required a lot of effort to get comfortable that the business was
appropriate for our portfolio. Initially, our curiosity was piqued by two attributes of
Regus. Firstly, the founder, Mark Dixon, is still the CEO today an entrepreneur with over
30% ownership of the business; this is very much an “Owner Occupied” company.
Secondly, it intrigued us that a business which does not seem to have an intrinsic
competitive advantage can grow to such a dominant size in its industry. The other aspect
that caught our attention is that the economic model for the business has changed. Today
90% of Regus’ centres sign leases in Special Purpose Vehicles, with no recourse to the PLC.
The difference that this makes to the economics of the business is significant as we explain
in more detail below.
 
In terms of office estate, Regus is over 10x its nearest competitor, Servcorp an Australian
equivalent which offers a more upmarket (and expensive) product. With 2,250 centres,
we estimate it has 25-30% of a very fragmented market where the average number of
centres per provider is just 2.4. The selection of an office is primarily location, not brand
driven. It was therefore interesting to us that the market was so dominated by one player.
We struggled at first to understand what aspects of Regus’ model helped to provide it
with a “moat” which could lead to such a commanding position in the market.
 
After talking to a number of people in the industry, including competitors, agents and ex-
employees, we concluded that Regus’ competitive advantage was made up of many small
edges.
 
To drive higher average revenue per centre, Regus has some advantages over its
competitors:
 
1. It dominates internet search for popular search terms in its market, both paid
and organic. This is a genuine scale advantage for Regus which drives a higher
number of new leads per centre at a lower cost than its competitors.
 
 
2. It has relationships with global corporations such as Google, Tata and Toshiba.
Consequently, when it sets up a new centre in a new city, there is a reasonable
probability that the first tenants are drawn from this group.
 
 
3. It has strong relationships with the broker community who are important in
marketing Serviced Offices.
 
4. When a tenant takes space from Regus, he or she is able to access a national
and international network of offices as required.
 
These edges combine to make it more likely that Regus will fill a particular space to a
higher level of occupancy than a competitor. In addition to achieving a higher occupancy,
Regus is also able to drive more revenue per customer than its competitors. Only 60% of
Regus’ revenue comes from rent. The rest comes from an array of services, which Regus
has innovated; some of these services leverage IT infrastructure which a local single
centre provider (the bulk of Regus’ competition) cannot offer its customers.
 
Perhaps the most significant part of the Regus moat comes from its knowledge base. With
2,250 centres around the world, Regus has an unparalleled model for predicting the likely
success of each new centre it is considering and it exploits this advantage in a very
disciplined way. Every single new centre is approved by the CEO, Mark Dixon and CFO,
Dominique Yates. They know what deal they need to strike with any owner to get a return
on capital in excess of 20%. If the local market conditions for a particular new opening
are getting too hot, they walk away and look elsewhere.
 
On the cost-side, the relationship between Regus and the property owner is increasingly
one of partnership. Regus can be trusted to fill a floor of a new or refurbished building,
bringing that early energy which is helpful to fill the rest of the building. It is trusted to fit
the centres out to a high quality level. Often this fit-out is part or even fully funded by
the property owner in return for a higher share in the revenue. Regus’ scale advantage
gives it an edge because Landlords trust Regus as a partner. In this way, there is a small
but material network effect. Landlords themselves rarely have an interest in running a
serviced office as they generally have neither the operational nor marketing skills to make
a success of this.
 
Also with respect to costs, Regus has a small number of advantages which together add
up to a potential to earn superior returns:
 
1. Serviced offices require a service oriented management team. A single centre
will need to have a reasonably expensive dedicated manager; Regus is able to
buy in the same expertise but spread the cost across multiple centres.
 
2. Regus is able to use its scale to purchase efficiently in areas such as centre fit-
out, telecoms, IT, office furniture.
 
A good illustration of Regus’ cost advantage occurred when Regus acquired MWB in 2013.
Regus was able to take out costs equivalent to over 10% of MWB’s revenue; essentially
MWB was operating a UK business half the size of Regus but with the same overhead.
 
The valuation for Regus is interesting because the true value of the business is hidden by
the fact the new centres take 2-4 years to get to full profitability as they fill up. In a period
of faster expansion, the profitability of the existing “mature centres” is concealed by the
early year losses of the new centres. It is not difficult to identify this because the
company is reasonably explicit about the true cashflow of the centres which have been
open for more than two years. We made some reasonably conservative judgements on
occupancy rates going forward, even assuming that the new centres opened in the last
two years only ever achieve 78% occupancy (a level it’s mature centres only briefly fell to
during the credit crunch) and found that we were able to invest in Regus on a single figure
multiple of the cash the business will throw off from its current estate, i.e. the business is
investable without further growth. But Regus is growing quickly: it continues to find high
return on capital growth opportunities throughout the world. The business is able to
redeploy its cashflow with a 20-25% return on capital.
 
We wrestled for a long-time with the cyclicality of the business. Profits fell by 75% in the
period from 2008 to 2010 and in the UK and EMEA, profits were virtually wiped out. We
learned that by 2008, the SPV structure had only been rolled out in the US, where profit
declined by around 50% and recovered quite quickly thereafter. The US experienced
some extreme rental price movements during the credit crunch, but Regus was able to
manage its relationships with the property owners to ensure that it did not take the full
hit of these market conditions Regus was unable to do this in the UK where most of the
leaseholds were still recourse to the Group. The SPV structure is now in place across 90%
of its portfolio of centres. A 50% profit drop at the bottom of the cycle implies we are
investing at a high teens multiple of the cyclical low point this is comfortable,
particularly for a business which we believe will be able to continue to grow with a 20%+
return on capital.
 
It is worth touching briefly on Regus’ history to explain why we think the issues the
company faced in 2000-2003 are unlikely to happen again. Mark Dixon’s initial foray into
serviced offices took little risk. He would take excess space from landlords with no
commitment and sell it on short leases with a services overlay. It was popular with both
tenants and the landlord. By 2000, the business had matured and in order to feed the
voracious appetite of venture funded Dot Com start-ups, the company had built out its
portfolio with multi-year lease obligations. When the bubble burst, Regus found that its
tenant base was largely made up of unprofitable companies many of which went bust.
 
Its tenant base today is much broader based. Many large companies use Regus to provide
additional capacity or to manage business continuity risk. Its smaller clients come from a
wide range of industries and the fuller service proposition and flexibility of its product
make it attractive for many companies who do not wish to commit to a traditional office
lease with all of its conditions. Mark Dixon has taken on board the lessons of that period
of the company’s history by in effect taking the business back to its roots and through the
SPV structure with the owners, creating a model which is much closer to the partnership
model he started with. This provides the most significant protection against a repeat of
the 2000-2003 crisis.
 
Although at first glance Regus did not appear to be a company that matches our criteria
for inclusion in the portfolio, the work we did showed that under the surface it is in fact a
business that should be able to survive periods of extreme market stress, has a moat
against competitive forces achieved through a combination of several factors and a price
significantly below a conservative estimate of the sum of the discounted cash flows it
should be able to generate in the future.
 
 
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

The maturing of new office openings will make the the free cash flow generating ability of the office portfolio as a whole more transparent.

    sort by    

    Description

    Regus
     
    At first glance, Regus does not look like a stock which belongs in a value investor’s
    portfolio:
     
    1. It has a leveraged operating model, committing to long leases with landlords,
    which it sells on to tenants on short-term leases making it highly cyclical and
    exposed to economic down-turns.
     
    2. Whilst it is by some margin the global market leader, its product really
    competes at a local level. It is not immediately obvious what competitive
    advantage its scale can really provide.
     
    3. It has a troubled history: the US business went into Chapter 11 in 2003 and the
    UK business was saved by selling a majority stake to Alchemy (under John
    Moulton) in 2002.
     
    4. It trades on a PE of 35x (2013 earnings).
     
    This investment required a lot of effort to get comfortable that the business was
    appropriate for our portfolio. Initially, our curiosity was piqued by two attributes of
    Regus. Firstly, the founder, Mark Dixon, is still the CEO today an entrepreneur with over
    30% ownership of the business; this is very much an “Owner Occupied” company.
    Secondly, it intrigued us that a business which does not seem to have an intrinsic
    competitive advantage can grow to such a dominant size in its industry. The other aspect
    that caught our attention is that the economic model for the business has changed. Today
    90% of Regus’ centres sign leases in Special Purpose Vehicles, with no recourse to the PLC.
    The difference that this makes to the economics of the business is significant as we explain
    in more detail below.
     
    In terms of office estate, Regus is over 10x its nearest competitor, Servcorp an Australian
    equivalent which offers a more upmarket (and expensive) product. With 2,250 centres,
    we estimate it has 25-30% of a very fragmented market where the average number of
    centres per provider is just 2.4. The selection of an office is primarily location, not brand
    driven. It was therefore interesting to us that the market was so dominated by one player.
    We struggled at first to understand what aspects of Regus’ model helped to provide it
    with a “moat” which could lead to such a commanding position in the market.
     
    After talking to a number of people in the industry, including competitors, agents and ex-
    employees, we concluded that Regus’ competitive advantage was made up of many small
    edges.
     
    To drive higher average revenue per centre, Regus has some advantages over its
    competitors:
     
    1. It dominates internet search for popular search terms in its market, both paid
    and organic. This is a genuine scale advantage for Regus which drives a higher
    number of new leads per centre at a lower cost than its competitors.
     
     
    2. It has relationships with global corporations such as Google, Tata and Toshiba.
    Consequently, when it sets up a new centre in a new city, there is a reasonable
    probability that the first tenants are drawn from this group.
     
     
    3. It has strong relationships with the broker community who are important in
    marketing Serviced Offices.
     
    4. When a tenant takes space from Regus, he or she is able to access a national
    and international network of offices as required.
     
    These edges combine to make it more likely that Regus will fill a particular space to a
    higher level of occupancy than a competitor. In addition to achieving a higher occupancy,
    Regus is also able to drive more revenue per customer than its competitors. Only 60% of
    Regus’ revenue comes from rent. The rest comes from an array of services, which Regus
    has innovated; some of these services leverage IT infrastructure which a local single
    centre provider (the bulk of Regus’ competition) cannot offer its customers.
     
    Perhaps the most significant part of the Regus moat comes from its knowledge base. With
    2,250 centres around the world, Regus has an unparalleled model for predicting the likely
    success of each new centre it is considering and it exploits this advantage in a very
    disciplined way. Every single new centre is approved by the CEO, Mark Dixon and CFO,
    Dominique Yates. They know what deal they need to strike with any owner to get a return
    on capital in excess of 20%. If the local market conditions for a particular new opening
    are getting too hot, they walk away and look elsewhere.
     
    On the cost-side, the relationship between Regus and the property owner is increasingly
    one of partnership. Regus can be trusted to fill a floor of a new or refurbished building,
    bringing that early energy which is helpful to fill the rest of the building. It is trusted to fit
    the centres out to a high quality level. Often this fit-out is part or even fully funded by
    the property owner in return for a higher share in the revenue. Regus’ scale advantage
    gives it an edge because Landlords trust Regus as a partner. In this way, there is a small
    but material network effect. Landlords themselves rarely have an interest in running a
    serviced office as they generally have neither the operational nor marketing skills to make
    a success of this.
     
    Also with respect to costs, Regus has a small number of advantages which together add
    up to a potential to earn superior returns:
     
    1. Serviced offices require a service oriented management team. A single centre
    will need to have a reasonably expensive dedicated manager; Regus is able to
    buy in the same expertise but spread the cost across multiple centres.
     
    2. Regus is able to use its scale to purchase efficiently in areas such as centre fit-
    out, telecoms, IT, office furniture.
     
    A good illustration of Regus’ cost advantage occurred when Regus acquired MWB in 2013.
    Regus was able to take out costs equivalent to over 10% of MWB’s revenue; essentially
    MWB was operating a UK business half the size of Regus but with the same overhead.
     
    The valuation for Regus is interesting because the true value of the business is hidden by
    the fact the new centres take 2-4 years to get to full profitability as they fill up. In a period
    of faster expansion, the profitability of the existing “mature centres” is concealed by the
    early year losses of the new centres. It is not difficult to identify this because the
    company is reasonably explicit about the true cashflow of the centres which have been
    open for more than two years. We made some reasonably conservative judgements on
    occupancy rates going forward, even assuming that the new centres opened in the last
    two years only ever achieve 78% occupancy (a level it’s mature centres only briefly fell to
    during the credit crunch) and found that we were able to invest in Regus on a single figure
    multiple of the cash the business will throw off from its current estate, i.e. the business is
    investable without further growth. But Regus is growing quickly: it continues to find high
    return on capital growth opportunities throughout the world. The business is able to
    redeploy its cashflow with a 20-25% return on capital.
     
    We wrestled for a long-time with the cyclicality of the business. Profits fell by 75% in the
    period from 2008 to 2010 and in the UK and EMEA, profits were virtually wiped out. We
    learned that by 2008, the SPV structure had only been rolled out in the US, where profit
    declined by around 50% and recovered quite quickly thereafter. The US experienced
    some extreme rental price movements during the credit crunch, but Regus was able to
    manage its relationships with the property owners to ensure that it did not take the full
    hit of these market conditions Regus was unable to do this in the UK where most of the
    leaseholds were still recourse to the Group. The SPV structure is now in place across 90%
    of its portfolio of centres. A 50% profit drop at the bottom of the cycle implies we are
    investing at a high teens multiple of the cyclical low point this is comfortable,
    particularly for a business which we believe will be able to continue to grow with a 20%+
    return on capital.
     
    It is worth touching briefly on Regus’ history to explain why we think the issues the
    company faced in 2000-2003 are unlikely to happen again. Mark Dixon’s initial foray into
    serviced offices took little risk. He would take excess space from landlords with no
    commitment and sell it on short leases with a services overlay. It was popular with both
    tenants and the landlord. By 2000, the business had matured and in order to feed the
    voracious appetite of venture funded Dot Com start-ups, the company had built out its
    portfolio with multi-year lease obligations. When the bubble burst, Regus found that its
    tenant base was largely made up of unprofitable companies many of which went bust.
     
    Its tenant base today is much broader based. Many large companies use Regus to provide
    additional capacity or to manage business continuity risk. Its smaller clients come from a
    wide range of industries and the fuller service proposition and flexibility of its product
    make it attractive for many companies who do not wish to commit to a traditional office
    lease with all of its conditions. Mark Dixon has taken on board the lessons of that period
    of the company’s history by in effect taking the business back to its roots and through the
    SPV structure with the owners, creating a model which is much closer to the partnership
    model he started with. This provides the most significant protection against a repeat of
    the 2000-2003 crisis.
     
    Although at first glance Regus did not appear to be a company that matches our criteria
    for inclusion in the portfolio, the work we did showed that under the surface it is in fact a
    business that should be able to survive periods of extreme market stress, has a moat
    against competitive forces achieved through a combination of several factors and a price
    significantly below a conservative estimate of the sum of the discounted cash flows it
    should be able to generate in the future.
     
     
     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    The maturing of new office openings will make the the free cash flow generating ability of the office portfolio as a whole more transparent.

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