You in MY house now!
In the comments section of my post on Alex Perriello’s confidence in denying a bankruptcy for Realogy, a commenter by name of “Still Don’t Agree” raises several very interesting points. And because SDA wasn’t a raving lunatic, but apparently a very smart, very logical, and a calm & measured commentator, I thought it worth using his comment as the springboard to challenge some of the conventional wisdom circulating out there.
[And just in case some non-regulars don't realize, I used to work at Realogy, but never in the corporate executive suites, and haven't since November of 2007. I have no special access to anyone, no inside info (although I would love to get some *hint, hint*), blah blah blah. These are just my opinions as an industry observer.]
So SDA raises three points worth countering: Unprofitability, Cut in Services –> Loss of Revenues, and the Apollo Factor.
Unprofitability
First, the whole unprofitability issue. SDA writes:
But bottom line, Realogy has little to no cash reserves, is running out of credit and their revenue isn’t covering interest payments AFTER making $350 million in operational cuts.
Sure it’s a profitable company without that debt hanging over their heads, and kudos to their managers for that, but that debt IS there and it isn’t going to just go away- so looking at revenue before the interest is quite frankly irrelevant. Spin it anyway you or Realogy wants, THEY ARE OPERATING IN THE RED.
To survive, they either have to make more cuts that don’t hurt revenue, increase revenue, find a lender to extend them more credit until the market gets better or get their lenders to restructure debt and/or wave interest payments.
Now, to be fair, SDA makes a great point here.
It is an indisputable fact that Realogy is losing money; it is in fact operating $50M in the red. In SDA’s view, the reason why they’re in the red is irrelevant, since Realogy doesn’t have cash reserves, and lenders don’t care.
In my view, it’s highly relevant why a company is in the red if I’m a lender. If a company is in the red because their core operations suck ass, then my likelihood of seeing my money back decreases, and I’m going to freak out. But if their core operations are profitable, and they’re throwing off cash in desperate economic times, and they are making interest payments… and because of said interest payments to me, they’re in the red, well, then I’ll be cautious and watchful but happy to cash their checks.
Why would I want to mess with someone making payments and bring lawyers and bankruptcy judges and special masters and such into the picture? Because I like the idea of going a couple of years before a distribution is made in which I’ll get a few pennies on the dollar on my unsecured debt? And that only after I’ve spent a couple of million bucks paying my own creditor counsel? Yeah, okay.
Now, let’s examine this “Realogy has no cash reserves” statement. During to the Q3, 2008 Earnings Call, which is the latest available, Tony Hull the CFO said this:
Turning to the balance sheet on page 7 of the 10-Q, we ended the third quarter
with a $280 million balance on our revolving credit facility along with a reported cash balance of $269 million. This total includes $226 million of available cash from a draw-down on our revolver. We elected to hold cash because of current market uncertainty.
So they’re holding $269M in cash, and $280M on the revolver of which $226M is available?
Since Realogy’s net loss after interest and depreciation was $50M in Q3, this would imply that Realogy can limp along under Q3 circumstances (the latest quarter for which we have data) for some ten quarters, or two-and-a-half years? Geez — call the lawyers and get to the courthouse! They’re going down!
So in brief, to survive, Realogy doesn’t have to make any cuts, doesn’t have to get any more loans (assuming that the revolver is appropriately papered by sophisticated lawyers and relatively ironclad), until Q3 of 2011.
Could business get worse and shorten that timeline? Sure. It could also get better. But the “Realogy ain’t got no cash” argument rings hollow to me. Then again, what do I know? I’m not a Wall Street analyst….
Cut in Services –> Loss of Affiliates
The second point that SDA brings up — and others have brought this up as well — is that the $350M in cuts at Realogy, and the expectation of further cuts down the line, will lead to affiliates and agents leaving Realogy family:
After $350 million in operational cuts I question how they could make further cuts that wouldn’t impact revenue. The company’s customers aren’t people buying homes, rather it’s the agents and franchise brokers they service. At some point in time if services are cut too drastically, franchises will leave and agents, who are independent contractors, will find other brokers to work for.
With the market and economy as they are and all the negative media starting to swell around their company I doubt they can drastically increase revenue. That would mean recruiting successful agents away from other companies at a time when ever competitor is waving that US News report in front of the agents they already do have.
Okay, let’s take this at face value for now and agree, for the sake of discussion, that SDA is absolutely correct that the budget cuts lead to service cuts.
For those service cuts to lead to mass exodus of productive affiliates, Realogy has to be providing some set of franchisee/agent services that these cuts is impacting.
For the vast majority (and I mean well over 90%+) of franchisees, the reason they became franchisees in the first place was not because of some ill-defined service Realogy provides but simply because of the (perceived) power of the brands like Coldwell Banker and Century 21.
I’ve sat in on some of the “VIP meetings” where corporate staff try to sell a franchise to an affiliate. I’ve even made presentations at those. And you know what? Despite all the goodies we dangle in front of them (“10% off at Staples!” and “Discounts on your cellphone plan!” and so on), at the end of the day, the decision to sign up is based on the principal broker’s feeling that the brand will bring them business they wouldn’t otherwise get.
The argument that service cuts will inevitably lead to loss of affiliates is somewhat like saying that folks aren’t going to buy Gulfstream G650′s because of the price of fuel. It’s completely ancillary to the core decision. Keep in mind that affiliates sign a ten-year agreement during which they fork over 6% of all commission income in exchange for use of the brand. They’re going to jet because the Realogy field rep only comes once a quarter instead of once a month? Come on now.
Further, to claim that even if the affiliate broker won’t leave, the agents will is to not understand agents very well. And it is to be ignorant of the real revolution going on at the heart of real estate today. If even a single agent really leaves his Coldwell Banker branded brokerage to go to some other franchise brand over the “cut in services”, I’ll print this blogpost out and eat it. In fact, that the agent cares not at all about the services provided by the Realogy brand is the real problem here.
You can verify for yourself if you’d like — go grab your local Century 21 agent and ask her what services she’s afraid of losing when Realogy cuts another $20m in costs. If her answer is anything other than “Nothing”, please come back and tell us.
Now, let’s actually examine that assertion for a moment. Again, from that same earnings call transcript, here’s Richard Smith, Chairman of Realogy:
As to NRT management’s ability to attract and retain top-producing agents, as in prior periods, NRT retained approximately 92% of GCI from its top two quartiles of sales associates in the third quarter. The top two quartiles generate approximately 88% of NRT’s revenue.
Consider that the NRT is Realogy’s company owned stores (if you will). If the budget cuts have a service impact, the NRT agents are the ones who will be most directly impacted. Affiliates have their own budget, their own issues, but the NRT is directly tied to Realogy’s financial problems.
If cuts in services lead to mass defections, then the NRT should have been losing droves of these top producing agents. They have not. I have no idea whether 92% retention is good or bad for brokerages, but it certainly doesn’t smell like panic to me.
And one final piece of counter-evidence from the wider agent world. This is from a Keller Williams agent in Boise ID speculating on the coming bankruptcy for Coldwell Banker and ERA (this is the “competitor waving that US News article” thing):
It seems a high debt load and low cash reserves may be signaling a likely default in a troubled market. Why am I surprised? Well mostly because the of number brokerages Coldwell Banker has been buying up in the Boise area. I’ll be watching this one closely in the weeks and months to come.
Here’s a hint: when someone is buying up competing brokerages, that someone ain’t hurting that bad.
The Apollo Factor
The final point that SDA raises is that lenders might want to push things to force Apollo to cough up some dough:
That means Realogy’s survival basically hangs on the charity of lenders who, at some point in time in the near future, will more than likely have to wave interest payments in order to allow the company to make payroll. Problem is, Carl Icahn, their largest lender, isn’t exactly known for his charity and other lenders have their back so far against the wall right now that you can’t be sure they will always do the logical thing.
More important, if you’re a lender in this situation, it’s pretty hard to forfeit the interest you are owed when equity holder Apollo has mighty deep pockets.
Okay. Maybe this makes sense to someone on Wall Street, but as a former bankruptcy guy, I just don’t get it.
Unless Apollo signed a guarantee of some sort on Realogy’s debt that puts them on the hook in the event of a default or bankruptcy, that Apollo has deep pockets is completely irrelevant to bankruptcy. Because Apollo presumably is the equity interest here. With such a high debt load, in the event of even a Chapter 11, Apollo’s interest is likely to be extinguished completely. That sucks for Apollo, but it isn’t as if Apollo is going to then be liable to the creditors.
An equity holder’s liability is limited to the amount of equity in the company. That’s the whole premise of limited liability.
So all that a lender would achieve here is taking over Realogy’s equity from Apollo in some sort of satisfaction for the debt. Think of it as a giant foreclosure. But to do that, we’re talking about years — and I mean years — of litigation in bankruptcy court with Realogy, with Apollo, with other creditors, with the Trustee possibly, with vendors, with unions, with landlords and so on and so forth. And during these years of litigation, no one gets paid a damn thing.
If you’re a lender — even a nasty one like Icahn — and you’re actually making a vulture play to take over Realogy via the credit path, you’d be far far better off just offering Apollo a private deal to swap equity for debt. Everyone keeps getting paid, Icahn takes over Realogy, and Apollo goes away, and no one is much affected.
Anyhow, I have no earthly idea why I keep writing on this topic, but I do confess a weird sort of fun in it. 
But then, I’m not a Wall Street guy, and those guys are financial experts who wouldn’t ever make a mistake on debt valuation or things like that now… would they?
-rsh
PS: Final parting thought. Why is this robust defense of Realogy happening on my widdle WordPress blog and not on the Realogy corporate blog? By people who know what the hell they’re talking about? Mark (Panus) — call me, I can help you with a social media strategy.
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