Thanks for a great, detailed, and well-reasoned response.

I don’t think we’re actually that far apart. If you will, I think the main difference is related to this:

But a bankruptcy doesn’t have to mean, “lock the doors and sell off the furniture.” I believe Realogy’s lenders would be best served in taking over the company and parting out their divisions as functioning business units rather than to leave the company in the hands of Apollo.

I never thought Realogy would go into a Ch. 7 bankruptcy. My issue is that even in a Ch. 11 (a “Reorganization”), I’m not sure I see a whole lot of incentive for the creditors to push Realogy into bankruptcy.

Again, keep in mind that Realogy is currently servicing its debt. Once Realogy starts to miss payments, then all the pessimism in the world is justified. But while they’re making payments… why kill the golden goose?

Plus, I don’t know the internals of Realogy’s operations, but what’s the equivalent of the LandAmerica’s 1031 company? Is there one toxic division that — if it were cut out — would make Realogy a wonderful growth opportunity? I don’t see it.

Finally, for the creditors to take over the equity in bankruptcy… two things have to be true (IMHO). One, the creditors must believe that the equity will eventually recover the value in such a way as to compensate them for their debt-related losses. Two, the creditors must believe that they can do a better job of running Realogy than Apollo has. This is a bit difficult to believe since Apollo is not an operator; it doesn’t operate Realogy in any significant way. Realogy’s management does. So unless creditors are going to bring in all new management, who they believe are better than current management, not sure how equity takeover helps them.

-rsh

Thanks for a great, detailed, and well-reasoned response.

I don’t think we’re actually that far apart. If you will, I think the main difference is related to this:

But a bankruptcy doesn’t have to mean, “lock the doors and sell off the furniture.” I believe Realogy’s lenders would be best served in taking over the company and parting out their divisions as functioning business units rather than to leave the company in the hands of Apollo.

I never thought Realogy would go into a Ch. 7 bankruptcy. My issue is that even in a Ch. 11 (a “Reorganization”), I’m not sure I see a whole lot of incentive for the creditors to push Realogy into bankruptcy.

Again, keep in mind that Realogy is currently servicing its debt. Once Realogy starts to miss payments, then all the pessimism in the world is justified. But while they’re making payments… why kill the golden goose?

Plus, I don’t know the internals of Realogy’s operations, but what’s the equivalent of the LandAmerica’s 1031 company? Is there one toxic division that — if it were cut out — would make Realogy a wonderful growth opportunity? I don’t see it.

Finally, for the creditors to take over the equity in bankruptcy… two things have to be true (IMHO). One, the creditors must believe that the equity will eventually recover the value in such a way as to compensate them for their debt-related losses. Two, the creditors must believe that they can do a better job of running Realogy than Apollo has. This is a bit difficult to believe since Apollo is not an operator; it doesn’t operate Realogy in any significant way. Realogy’s management does. So unless creditors are going to bring in all new management, who they believe are better than current management, not sure how equity takeover helps them.

-rsh

I read your response to my comments a few days ago. I apologize I haven’t had the time to write up until now but maybe this will give you a reason to make another post!

Quick clarification, I am not “Still Skeptical” as you questioned (although he/she made some excellent points that I wish I had made). However I was the poster on the U.S. News blog that you commented on which is what brought me to your site in the first place.

I would also like to congratulate you on having educated followers to your blog and/or your excellent moderation of posts. It’s refreshing to read comments from posters that make solid points (for and against my arguments) without the emotional name calling and irrational love/hate statements you see in the comment sections on other discussions on this topic.

I will also add that I am a real estate agent but have never worked for a Realogy owned brand or NRT owned brokerage but do have friends at both. With that said, I don’t believe I have anything personal to gain or loose by Realogy’s success or failure. Bottom line, a complete failure of Realogy would just send their agents to other franchises not out of the industry- so nothing really changes at my level. Now if U.S. News is correct and Krispy Kreme were to fail, THAT would make an impact on my world! Seriously though, my fascination (and more to the point- fear) with this topic has more to do with the pending failure of dozens of these private equity companies, not just Realogy, that would otherwise be solid had they not been saddled with massive debt. The loss of Mervyn’s, Linens-n-Things, etc were all avoidable and it’s sad that companies like Apollo, Cerberus etc are able to still profit from all of this.

Let me next say you are absolutely correct with your comments on franchises being locked into long term contracts and thus being unable to make snap decisions to leave Realogy for another franchise quite as easy as a real estate agent with independent contractor status can leave for another broker. I also agree that agents aren’t going to leave a franchise just because Century 21 stopped TV ads or other little things like that. Believe it or not, I originally elaborated on those point in my posting but removed them as the post was getting rather lengthy.

Anyway, although I could elaborate on my original post and your response to it, I don’t want to beat the same points to death as there’s been plenty of excellent discussion on them already. However it has occurred to me that the one area you and I disagree on which hasn’t been addressed yet. At the core basis of your argument you feel a bankruptcy means a liquidation of an otherwise solid company and there would be little value to a lender to do that. I disagree.

Where you and I do agree is that there are some very valuable pieces of Realogy. Over the past couple of years Cartus, for example, has been able to shed itself of the unprofitable contracts they signed when the market was extremely hot and is now capitalizing on the weakened economy by growing their market share at the expense of lesser rivals. The franchise division’s resurrection of the Better Homes and Garden franchise was also a brilliant maneuver to bring to market a franchise name that already has market recognition from years past at a time when brokerages and agents are grasping for new ways to differentiate themselves. Even NRT has individual brokerage operations that are performing well, and when I look at the office’s they’ve closed locally by “merging” them with other offices I would generally have to give NRT management a “thumbs up” for the decisions I’ve seen them make.

But a bankruptcy doesn’t have to mean, “lock the doors and sell off the furniture.” I believe Realogy’s lenders would be best served in taking over the company and parting out their divisions as functioning business units rather than to leave the company in the hands of Apollo. A perfect example to draw parallels to was December bankruptcy of LandAmerica. LandAm was a Fortune 500 title company that despite the economy was doing better in the title business than many of their title competitors. However they had one division (a 1031 business) that had become extremely toxic and was dragging the entire organization down with its huge losses. Ultimately, however, bankruptcy allowed the viable title operations, which was the core of the company, to be parted off to Fidelity before the bad debt of that 1031 division forced their closings.

Now, for those that lost money and jobs when LandAm took bankruptcy, don’t think I’m implying that there wasn’t pain in this process. Shareholder equity of a company that had been trading above $100/share as late as 2007 was wiped out. There was some minor disruption to customers (and agents) and there were people who lost their jobs. But bottom line, the solid, sellable, title divisions of LandAm are still mostly open for business with only a few changes.

But back to Realogy going into bankruptcy. My opinion is that the sooner the lenders take over Realogy the more value Realogy’s assets are going to be to the lenders- and I also believe Carl Icahn knows that which is why he sued to stop their reorganization of debt last year.

Every company has fat it can cut when a market shifts. My guess is, the majority of that $350 million in cuts Realogy has made so far probably hasn’t really impacted their services yet. But as I pointed out in my posts, the $350 million in cuts they made in early 2008 still wasn’t enough to avoid taking on more debt. As things now stand Realogy’s management is being forced to make more cuts and eventually they will be drastic enough that they will begin to do real damage if they haven’t already. At the same time, the negative press that now surrounds the company as a result of it’s massive debt is probably more damaging to the company than the actual debt itself. As you said, agents won’t leave because services were cut. However they WILL leave when the local TV station runs a story on the company’s pending failure- and my experiences have been that when that happens the brokerages usually implode pretty quickly with a manger or two going to a competitor and the agents leaving en masse to follow them- and we’re just beginning to see signs of that happening (read yesterday that 35 NRT/Corcoran agents in Florida- basically one of their offices- just left for a competitor and I’ve heard rumors of that happening in my market as well).

Now, yesterday Realogy reported their Q4 numbers. Although there are people who probably see positives in the story and other who see negatives, I see a report that says, “nothing has changed.” Because they tapped out a line of credit earlier in the year, they have the cash on hand to avoid being out of compliance with credit agreements. But Apollo’s announcement that they MAY lend them $150 million really means nothing in my opinion. It’s just lip service to get the media off Realogy’s back. If Apollo wanted to protect this investment they would have written them a check and put it in Realogy’s bank account already so Realogy wouldn’t be forced to continue to scale back services to a point it harms their revenue.

When you read the fine print, Apollo’s promise to help is “based upon management’s current financial outlook”. To paraphrase another posting I saw on this topic, “if a few million bucks will keep Realogy in compliance with their senior debt, then yes Apollo will do something to protect their assets. But if things change for the worse and Realogy needs operating cash to make payroll or even interest payments then Apollo isn’t going to spend a dime to keep this company in business.” To back this up, read this fine article on how Apollo makes their profits and why they don’t really care if Realogy fails. http://www.portfolio.com/views/columns/wall-street/2009/02/11/Analysis-of-Private-Equity-Business

I read your response to my comments a few days ago. I apologize I haven’t had the time to write up until now but maybe this will give you a reason to make another post!

Quick clarification, I am not “Still Skeptical” as you questioned (although he/she made some excellent points that I wish I had made). However I was the poster on the U.S. News blog that you commented on which is what brought me to your site in the first place.

I would also like to congratulate you on having educated followers to your blog and/or your excellent moderation of posts. It’s refreshing to read comments from posters that make solid points (for and against my arguments) without the emotional name calling and irrational love/hate statements you see in the comment sections on other discussions on this topic.

I will also add that I am a real estate agent but have never worked for a Realogy owned brand or NRT owned brokerage but do have friends at both. With that said, I don’t believe I have anything personal to gain or loose by Realogy’s success or failure. Bottom line, a complete failure of Realogy would just send their agents to other franchises not out of the industry- so nothing really changes at my level. Now if U.S. News is correct and Krispy Kreme were to fail, THAT would make an impact on my world! Seriously though, my fascination (and more to the point- fear) with this topic has more to do with the pending failure of dozens of these private equity companies, not just Realogy, that would otherwise be solid had they not been saddled with massive debt. The loss of Mervyn’s, Linens-n-Things, etc were all avoidable and it’s sad that companies like Apollo, Cerberus etc are able to still profit from all of this.

Let me next say you are absolutely correct with your comments on franchises being locked into long term contracts and thus being unable to make snap decisions to leave Realogy for another franchise quite as easy as a real estate agent with independent contractor status can leave for another broker. I also agree that agents aren’t going to leave a franchise just because Century 21 stopped TV ads or other little things like that. Believe it or not, I originally elaborated on those point in my posting but removed them as the post was getting rather lengthy.

Anyway, although I could elaborate on my original post and your response to it, I don’t want to beat the same points to death as there’s been plenty of excellent discussion on them already. However it has occurred to me that the one area you and I disagree on which hasn’t been addressed yet. At the core basis of your argument you feel a bankruptcy means a liquidation of an otherwise solid company and there would be little value to a lender to do that. I disagree.

Where you and I do agree is that there are some very valuable pieces of Realogy. Over the past couple of years Cartus, for example, has been able to shed itself of the unprofitable contracts they signed when the market was extremely hot and is now capitalizing on the weakened economy by growing their market share at the expense of lesser rivals. The franchise division’s resurrection of the Better Homes and Garden franchise was also a brilliant maneuver to bring to market a franchise name that already has market recognition from years past at a time when brokerages and agents are grasping for new ways to differentiate themselves. Even NRT has individual brokerage operations that are performing well, and when I look at the office’s they’ve closed locally by “merging” them with other offices I would generally have to give NRT management a “thumbs up” for the decisions I’ve seen them make.

But a bankruptcy doesn’t have to mean, “lock the doors and sell off the furniture.” I believe Realogy’s lenders would be best served in taking over the company and parting out their divisions as functioning business units rather than to leave the company in the hands of Apollo. A perfect example to draw parallels to was December bankruptcy of LandAmerica. LandAm was a Fortune 500 title company that despite the economy was doing better in the title business than many of their title competitors. However they had one division (a 1031 business) that had become extremely toxic and was dragging the entire organization down with its huge losses. Ultimately, however, bankruptcy allowed the viable title operations, which was the core of the company, to be parted off to Fidelity before the bad debt of that 1031 division forced their closings.

Now, for those that lost money and jobs when LandAm took bankruptcy, don’t think I’m implying that there wasn’t pain in this process. Shareholder equity of a company that had been trading above $100/share as late as 2007 was wiped out. There was some minor disruption to customers (and agents) and there were people who lost their jobs. But bottom line, the solid, sellable, title divisions of LandAm are still mostly open for business with only a few changes.

But back to Realogy going into bankruptcy. My opinion is that the sooner the lenders take over Realogy the more value Realogy’s assets are going to be to the lenders- and I also believe Carl Icahn knows that which is why he sued to stop their reorganization of debt last year.

Every company has fat it can cut when a market shifts. My guess is, the majority of that $350 million in cuts Realogy has made so far probably hasn’t really impacted their services yet. But as I pointed out in my posts, the $350 million in cuts they made in early 2008 still wasn’t enough to avoid taking on more debt. As things now stand Realogy’s management is being forced to make more cuts and eventually they will be drastic enough that they will begin to do real damage if they haven’t already. At the same time, the negative press that now surrounds the company as a result of it’s massive debt is probably more damaging to the company than the actual debt itself. As you said, agents won’t leave because services were cut. However they WILL leave when the local TV station runs a story on the company’s pending failure- and my experiences have been that when that happens the brokerages usually implode pretty quickly with a manger or two going to a competitor and the agents leaving en masse to follow them- and we’re just beginning to see signs of that happening (read yesterday that 35 NRT/Corcoran agents in Florida- basically one of their offices- just left for a competitor and I’ve heard rumors of that happening in my market as well).

Now, yesterday Realogy reported their Q4 numbers. Although there are people who probably see positives in the story and other who see negatives, I see a report that says, “nothing has changed.” Because they tapped out a line of credit earlier in the year, they have the cash on hand to avoid being out of compliance with credit agreements. But Apollo’s announcement that they MAY lend them $150 million really means nothing in my opinion. It’s just lip service to get the media off Realogy’s back. If Apollo wanted to protect this investment they would have written them a check and put it in Realogy’s bank account already so Realogy wouldn’t be forced to continue to scale back services to a point it harms their revenue.

When you read the fine print, Apollo’s promise to help is “based upon management’s current financial outlook”. To paraphrase another posting I saw on this topic, “if a few million bucks will keep Realogy in compliance with their senior debt, then yes Apollo will do something to protect their assets. But if things change for the worse and Realogy needs operating cash to make payroll or even interest payments then Apollo isn’t going to spend a dime to keep this company in business.” To back this up, read this fine article on how Apollo makes their profits and why they don’t really care if Realogy fails. http://www.portfolio.com/views/columns/wall-street/2009/02/11/Analysis-of-Private-Equity-Business

Thanks! And thanks for your comments/points — they’re rock solid. I only have a few points.

First, yes, if Realogy violates the covenants, then bondholders can force them into bankrutpcy. But that don’t mean they will or that to do so is rational. I can try to see if I’m bulletproof; don’t mean I will.

Second, the big point you raise is about agent splits. I think your point is that Realogy’s core business may be weaker (than whom?) because they rely heavily on inexperienced agents who are on House-Favorable splits.

Frankly, that is a much larger topic for which I simply don’t have any data. I haven’t seen any information that suggests the “majority” of any affiliate (nevermind Realogy units) income comes from these high-margin agents. If anything, anecdotal evidence might suggest that the low-margin agents are the ones who bring in the revenues through volume. Broker/owners constantly talk about the 20/80 rule in real estate where 20% of the agents bring in 80% of the revenues.

Unless we know some of the nitty-gritty details of GCI, transaction count, cost to support (aka, “desk costs”), profitability, and so on — then be able to get the same data for all of the competitors (like Re/Max and Prudential and KW and so on) it would be rank speculation to suggest that somehow Realogy brands are uniquely in trouble.

As to the too-many-brands problem… I happen to agree with you. Realogy is like a family, with really competitive siblings. Back when I was working at Realogy, I suggested (sort of half-jokingly) that every single corporate staff at the brand level should rotate every two years to ensure that no one gets too attached to any one brand at the expense of the company.

They may end up restructuring in some way as they come out of this crisis — we’ll see.

As for Apollo — I just don’t see the relevance one way or the other. I don’t think they’ll ‘rescue’ Realogy anymore than I think creditors will get more $$ out of Apollo. My point is more that creditors wouldn’t/shouldn’t put Realogy into bankruptcy — unlike Linens ‘n’ Things which presumably had at least some inventory that could be auctioned off — Realogy has no real hard assets.

You know what I think is going on, is that Wall St. and “financial reporters” (who don’t know squat, as it turns out) look at homebuilders like Kara Homes going bankrupt and think, “Hey, real estate is in trouble; I bet Realogy goes down too.” Except that homebuilders have enormous assets in land, development rights, unsold properties, and the like. And 9 times out of 10, a creditor is more likely to get $$ back in bankruptcy. Not so with a services company like these guys.

-rsh

Thanks! And thanks for your comments/points — they’re rock solid. I only have a few points.

First, yes, if Realogy violates the covenants, then bondholders can force them into bankrutpcy. But that don’t mean they will or that to do so is rational. I can try to see if I’m bulletproof; don’t mean I will.

Second, the big point you raise is about agent splits. I think your point is that Realogy’s core business may be weaker (than whom?) because they rely heavily on inexperienced agents who are on House-Favorable splits.

Frankly, that is a much larger topic for which I simply don’t have any data. I haven’t seen any information that suggests the “majority” of any affiliate (nevermind Realogy units) income comes from these high-margin agents. If anything, anecdotal evidence might suggest that the low-margin agents are the ones who bring in the revenues through volume. Broker/owners constantly talk about the 20/80 rule in real estate where 20% of the agents bring in 80% of the revenues.

Unless we know some of the nitty-gritty details of GCI, transaction count, cost to support (aka, “desk costs”), profitability, and so on — then be able to get the same data for all of the competitors (like Re/Max and Prudential and KW and so on) it would be rank speculation to suggest that somehow Realogy brands are uniquely in trouble.

As to the too-many-brands problem… I happen to agree with you. Realogy is like a family, with really competitive siblings. Back when I was working at Realogy, I suggested (sort of half-jokingly) that every single corporate staff at the brand level should rotate every two years to ensure that no one gets too attached to any one brand at the expense of the company.

They may end up restructuring in some way as they come out of this crisis — we’ll see.

As for Apollo — I just don’t see the relevance one way or the other. I don’t think they’ll ‘rescue’ Realogy anymore than I think creditors will get more $$ out of Apollo. My point is more that creditors wouldn’t/shouldn’t put Realogy into bankruptcy — unlike Linens ‘n’ Things which presumably had at least some inventory that could be auctioned off — Realogy has no real hard assets.

You know what I think is going on, is that Wall St. and “financial reporters” (who don’t know squat, as it turns out) look at homebuilders like Kara Homes going bankrupt and think, “Hey, real estate is in trouble; I bet Realogy goes down too.” Except that homebuilders have enormous assets in land, development rights, unsold properties, and the like. And 9 times out of 10, a creditor is more likely to get $$ back in bankruptcy. Not so with a services company like these guys.

-rsh