[CBG – CBRE Group] Expensive on Normalized Earnings

CBG is a fine company but to claim that it is reasonably cycle-resilient post-GWS acquisition is an exaggeration.  Deriving 70% of fee revenue from contractual and purportedly recurring sources will not meaningfully cushion profits in the event of a commercial real estate swoon.

From its roots as a regional commercial real estate broker founded in the aftermath of the 1906 San Francisco earthquake, the company expanded its presence first within the West during the ’40s and then more broadly throughout the US during the ’60s and ’70s.  In 1989, the company was bought by employees and private investors and spent the ’90s expanding its capabilities via acquisitions – encompassing investment management, mortgage banking, property and corporate facilities management, and capital markets – to meet the needs of increasingly sophisticated occupier and investor clients who required integrated real estate services across various geographies.  CB Commercial (as it was known at the time) IPO’ed in 1996, pushed into Europe and APAC in 1998 through its acquisitions of REI Ltd. (which prompted a re-bannering as CB Richard Ellis (CBRE)) and Hillier Parker May & Rowden, and was taken private in 2001 by Blum Capital Partners and Freeman Spogli & Co. before returning to the public markets in 2004.  Today, CBG is the largest commercial real estate services firm in the world.

The company’s various segments are framed a number of different ways across presentations and SEC filings, but here is the most relevant display…

Fee revenue, because it deducts client reimbursed costs (consisting of employees dedicated to client facilities and subcontracted work performed for clients) is the relevant top-line metric.  The above exhibit shows that over 40% of CGB’s fee revenue is recognized under contractual agreements, which revenue, relative to transaction-derived fees, is less vulnerable to swings in the commercial real estate activity.  This is a big mix shift from a decade ago, when contractual fee revenue constituted just ~20% of the total.  Leasing revenue, while not technically contractual, is lumped into the green ellipse above because of its recurring characteristics (owners want their buildings filled year-in/year-out; in a typical year, ~17%-20% of leases roll-over), so really, ~3/4 of CBG’s revenue is supposedly sticky and/or recurring.

Occupier Outsourcing is mostly the Global Workplace Solutions business that CBG acquired from Johnson Controls in September 2015 for $1.5bn cash ($1.3bn after backing off the NPV of tax benefits), around 8x EBITDA including run-rate synergies of $35mn (10 years ago, the company’s occupier outsourcing revenue was just $500mn vs. $6bn today).  GWS manages facilities – data centers, labs, retail space, manufacturing plants – for major corporations (Fortune 500) and health care providers under.  Under a typical 3-5 year facilities management contract, CBG will take over the total cost of operating a building, including HVAC, technical engineering and building automation systems, repairs, maintenance, grounds, catering, etc., getting paid management and incentive fees (if certain performance thresholds are met) on top of being reimbursed for subcontracted and client-dedicated labor.