CBRE Group Inc - Class A (CBRE) — Q3 2019 Earnings Call Transcript

Thank you. And welcome to CBRE's third quarter 2019 earnings conference call. Earlier today, we issued a press release announcing our financial results, and it is posted on the Investor Relations page of our website, cbre.com along with a presentation slide deck that you can use to follow along with our prepared remarks as well as an excel file that contains additional supplemental materials. Our agenda for this morning's call will be as follows: First, I’ll provide an overview of our financial results for the quarter; next, Bob Sulentic, our President and CEO, and Leah Stearns, our CFO will discuss our third quarter results in more detail; after these comments, we will open up the call for your questions. Before I begin, I'll remind you that this presentation contains forward-looking statements that involve a number of risks and uncertainties. Examples of these statements include our expectations regarding CBRE's future growth momentum, operations, market share, business outlook, capital deployment, acquisition, integration, and financial performance including our 2019 outlook and any other statements regarding matters that are not historical fact. We urge you to consider these factors and remind you that we undertake no obligation to update the information contained on this call to reflect subsequent events or circumstances. You should be aware that these statements should be considered estimates only and certain factors may affect us in the future that could cause actual results to differ materially from those expressed in these forward-looking statements. For a full discussion of the risks and other factors that may impact these forward-looking statements, please refer to this morning's earnings press release and our most recent annual and quarterly reports filed on Form 10-K and Form 10-Quarter, respectively. We have provided reconciliations of adjusted EPS, adjusted EBITDA, and fee revenue and certain other non-GAAP financial measures included in our remarks to the most directly comparable GAAP measures, together with explanations of these measures in the appendix of the presentation slide deck. Now, please turn to slide four of our presentation, which highlights our financial results for the third quarter of 2019. Third quarter adjusted earnings per share was flat at $0.79. Strong top and bottom-line growth within our two services segments, Advisory Services and Global Workplace Solutions was offset by a decline in adjusted EBITDA in our Real Estate Investments segment. The $85 million of adjusted EBITDA realized in Real Estate Investments in last year's third quarter represented an all-time record for the segment. On a combined basis, our two services segments generated fee revenue growth and adjusted EBITDA growth of over 11% and 16%, respectively. In addition, the combined adjusted EBITDA margin for our Advisory and Global Workplace Solutions segments expanded approximately 70 basis points. Finally, our consolidated results also reflect negative foreign exchange translation impacts of 2% and 1% to fee revenue and adjusted EBITDA growth, respectively. Now, for an update on our business fundamentals, I will turn the call over to Bob.

Thank you, Brad, and good morning, everyone. As you’ve seen, we reported another strong quarter in our services business, driven by double-digit revenue growth in global occupier outsourcing, U.S. advisory property sales, and commercial mortgage origination. We continue to benefit from strong organic growth in operating leverage in our combined services businesses. Additionally, in early October, we completed the acquisition of Telford Homes, expanding our development capabilities into the UK, where the multifamily rental market is poised for long-term secular growth. We were able to acquire Telford at an attractive valuation, reflecting market concerns due to Brexit, without materially altering our capital structure or engaging in a lengthy integration process. We believe the very successful Telford team will be able to accomplish more on CBRE's platform than they could on their own. Strategic M&A is core to our strategy, and Telford represents the type of acquisition you should expect from CBRE. Sourcing, underwriting, and integrating acquisitions is a competitive advantage for our Company. Both our M&A and our senior business leadership teams are deeply experienced at targeting, underwriting closing and integrating acquisition opportunities. Since 2014, we have deployed nearly $2.6 billion for acquisitions that have bolstered our growth, our ability to serve our clients and our strategic position in the marketplace. Leah will discuss our approach to M&A and capital allocation after she reviews the quarter in more detail. Leah?

Thanks, Bob. Turning to slide five. Our Advisory Services segment generated 8% fee revenue growth during the quarter. Strong operating leverage drove margin expansion of about 140 basis points and 17% growth in adjusted EBITDA. Over half the margin expansion resulted from commercial mortgage origination gains; the remainder is attributable to well-disciplined operating expense management against healthy revenue growth. We saw double-digit adjusted EBITDA growth in local currency from both our Americas and non-Americas regions. Our North Asia division saw the strongest adjusted EBITDA growth of any geographical region in the quarter as outstanding capital markets activity in Japan more than offset soft market conditions in Hong Kong and China. These two markets make up our Greater China region and represent less than approximately 1% of CBRE’s total adjusted EBITDA. Global capital markets, which includes both property sales and commercial mortgage origination, set the pace for revenue growth, accelerating to 11%, up significantly from 1% in the first half of the year. This acceleration was led by our commercial mortgage origination revenue growth of nearly 24%, which was fueled by an increasing number of larger transactions and market share gains with private entities including life insurers, conduits, and credit funds. Property sales revenue growth was led by the United States, which increased by 19% on meaningful market share gains. This was primarily driven by a sizable number of larger transactions and notable strength in the Northeast region of the United States. Outside the Americas, property sales declined 6%, which includes the negative FX impact of 3%, and continued weakness in residential sales in the Pacific region and parts of Asia, excluding Asia Pacific residential, property sales growth outside the Americas was flat in local currency. Capital markets activity, particularly in the Americas, continues to be bolstered by the ample supply of capital focused on investing in commercial real estate, strong occupancy rates and measured supply growth. Advisory leasing revenue rose 4% or 5% in local currency terms, a healthy increase against 17% growth in the prior year’s quarter. U.S. leasing revenue grew by 4% and was driven by clients in technology, financial services and manufacturing sectors, which accounted for nearly 60% of U.S. leasing revenue. We also saw a notable acceleration in account-based deals in the quarter. Inclusive of activity now recorded in our Global Workplace Solutions segment, Americas leasing revenue rose 7% for the quarter. Leasing with coworking companies drove less than 4% of our trailing 12-month leasing revenue in the U.S., and less than 3% of U.S. leasing revenue in the third quarter. These figures include both negotiating leases for coworking companies as tenant representatives and placing occupiers in coworking space. The demand for coworking remains a relatively small component of the overall U.S. market, with no single operator representing more than 0.5% of the total. While flexible office space solutions will continue to grow, this sector is not large enough to swing overall commercial real estate market fundamentals in any meaningful way. Turning to our Global Workplace Solutions segment on slide six. We produced 15% adjusted EBITDA growth with strength across our three lines of business, facilities management, project management, and transactions. Importantly, our customer base also continues to be composed of large, high-quality companies with approximately 85% of our GWS revenues generated from investment grade rated clients. Fee revenue growth of 21% reflects continued strong momentum for occupier outsourcing services, boosted by landing large new enterprise client engagements and expanding existing relationships. In addition, fee revenue growth outpaced total revenue growth due to a greater rate of fixed price contracts. Slightly negative operating leverage reflected a couple of challenging accounts in Europe, which we expect to remediate next year, and a handful of choppier expense items and non-cash accounting adjustments, which totaled $12 million in the quarter. Our business has a distinct competitive advantage in securing large integrated global accounts. One recent example is Novartis, which has appointed us to provide facilities, project management and transaction and Advisory Services on a worldwide basis. The 70 million square foot portfolio represents one of our largest ever new contracts for our Global Workplace Solutions team. Our pipeline for the outsourcing business remains robust, and we're seeing more clients contracting for a bigger bundle of services. On a year-to-date basis, nearly 40% of the adjusted EBITDA associated with new contracts was derived from customers purchasing the full suite of services offered by our outsourcing business, which is up significantly, both sequentially and from the prior year period. Turning to slide seven, our Real Estate Investments segment. Adjusted EBITDA fell by over $70 million compared with the prior year period, primarily due to the timing of development transactions. Beyond development, strong growth in our investment management business offset by incremental investments in our new flexible office space business, Hana. Development adjusted EBITDA was slightly below our expectations for the third quarter as a couple of smaller deals are now expected to transact in 2020. We also now expect one larger $20 million adjusted EBITDA deal, previously anticipated in the fourth quarter to transact in 2020. Our development business’s financial performance has natural variability from quarter to quarter. The market overall remains very healthy and our combined in-process and pipeline portfolio reached a record level, rising $1.3 billion sequentially. Investor enthusiasm for development projects remains high and cap rates for our Class A projects remain tight. While our timing expectations have shifted for a few specific developments, our pricing expectations have not changed. Performance in our investment management business continued to improve, contributing just over $20 million of adjusted EBITDA during the quarter. Assets under management would have reached a new record level, but for a $1.7 billion headwind from foreign currency translation. Capital raising also remains elevated with more than $12 billion raised over the past 12 months. Finally, our new coworking concept Hana opened its first location in Dallas in the quarter with units planned in Southern California and London by early next year. We believe demand for flexible workspace is here to stay and landlords and occupiers are increasingly gravitating to high-quality operators with strong financial sponsorships. Our pipeline for future Hana locations focuses on major CBDs and includes a variety of structures, including management, partnership agreements, as well as leases. Turning to slide eight. We are very focused on pursuing a disciplined approach to allocating capital at CBRE. Over the last five years, we have strengthened our balance sheet, which is evidenced by our reduction in net leverage, and our more than $3 billion of liquidity. The capital structure provides us a solid foundation to execute our capital allocation strategy. Our priorities for capital allocation are focused on investing in growth, through tech enablement CapEx, accretive M&A and returning excess capital to shareholders. Year-to-date, we've deployed approximately $770 million of capital, including our recent Telford acquisition and share repurchases in October. We have also invested over $142 million on capital expenditures net of concessions, with well over half of this deployed for technology-focused investments that enable our professionals to bring higher levels of service to our clients with greater efficiency. In addition, as of today, CBRE has repurchased over $145 million of shares in 2019, including our recently initiated 10b5-1 program, which executed the repurchase of 100 million shares at an average price of $51.64 since the beginning of the third quarter. Given our current and forecasted levels of leverage as well as our significant financial capacity, you can expect us to utilize share repurchases in a more programmatic manner to both maintain flexibility around capital allocation and to provide a more consistent approach to returning capital to shareholders. Finally, with respect to our expectations for our full-year 2019 outlook. Due to the delayed timing of development deals, we now expect adjusted EBITDA in our Real Estate Investment segment at or slightly below the low end of the $200 million to $220 million range we set in March, inclusive of a modest benefit from Telford in the fourth quarter. Nonetheless, we are maintaining our guidance range at $3.70 to $3.80 for full-year adjusted EPS, as we expect strength in our services businesses to offset the impact of these delayed development deals. This implies 14% growth at the midpoint of our guidance range for 2019. Turning to slide nine, I'll turn the call back to Bob for his brief closing remarks.

Thank you, Leah. As we enter the final months of 2019, we are looking ahead to 2020 with cautious optimism. Commercial real estate and macroeconomic fundamentals remain favorable, particularly in the Americas, our largest region. Our diversified business and geographic mix position CBRE to continue thriving, despite ongoing trade and geopolitical uncertainties. We also believe that our industry-leading service offering, scale and ongoing platform investments give us distinct competitive advantages. Our people are energized and their engagement levels have never been higher. With that, operator, we'll open the lines for questions.

Thank you, and good morning. Now that Telford is closed, can you spend a minute giving us a few details around how you thought about the EBITDA multiple, if you will, that you paid, where we should see that coming into the financials, and like how you see that business playing out?

Sure. Anthony, it's Leah. From an evaluation standpoint, we assessed Telford based on cash flow and believe we paid around 10 times its cash flow. Given how we recognize revenue under GAAP, you might see that revenue aligning closely with our current development business. We expect that about 50% of the cash will translate into GAAP revenue, at least in the first year of our ownership of Telford. There will be a slight increase in the fourth quarter, but we will provide more guidance on our expectations for Telford in February.

Okay. And then, in terms of the guidance, your fourth quarter leasing comp looks like it's actually a tougher one than the third quarter. How should we think about how bad that works out for the rest of this year?

We have provided guidance for EPS, indicating low-teens double-digit growth in the fourth quarter. While we won't go into specifics about leasing expectations, we anticipate that the challenging comparison from Q3 will carry over into Q4.

Okay. And then, my last question is on GWS. You mentioned a couple of accounts in Europe acting as a drag on margins there. Can you describe what scenarios actually caused that sort of a drag? It just seems like a recurring fee kind of business. So, like, what happens actually that creates that variability?

Sure. So, when we underwrite transactions in GWS, we have expectations of a glide path in terms of reduction in cost. And we account for that in how we think about pricing within those agreements. In some cases, in Europe, in a few cases and they’re isolated, we've actually gone in and we're bringing in new talent to run those accounts, given the fact that we haven't been able to achieve the cost savings that we have expected. And so, we expect to remediate that in the fourth quarter and well into 2020 as well.

So, when you refer to cost savings that you anticipate for the client, does it mean that if you don't achieve those savings, you will receive less income?

Exactly.

Great. Okay. Thank you.

Thank you.

On the share buyback front, previously, you guys have bought back stock at the high-30s and at least appeared unwilling to buy in the 40s. And now, you're buying in the low-50s. I'm curious whether this is a function of viewing the stock as sitting at a discount, or if it's a lack of opportunity in the marketplace from an acquisitions perspective?

Hi, Jason. I would say, it's actually neither of those two. It's really about thinking about capital allocation in a broader context. Given where we are with respect to our leverage, the fact that we are migrating down to the very low end of our overall leverage range, I think it's prudent for us to approach it in a more programmatic fashion. We still have a nice bucket of the authorization that we can use in an opportunistic manner to that extent that we do see dislocation in the market. We do believe that we're buying shares back at an attractive value. But it's more about offsetting the equity dilution, for example, from our stock compensation program. And we'll use that remaining authorization for opportunistic periods of time, where we do see the shares under pressure. But, I think you'll see us be more programmatic, at least at a minimum level within the buyback in the future.

And then, switching over to the commercial mortgage origination side, originations were up significantly and you mentioned it was fueled in part by larger transactions with private entities. Was this at all driven by new initiatives at the GSEs and FHFA? And if so, should we expect this business to be less of an agency business moving forward?

I’d say, there's two pieces to that. One, we did see credit really from all sources. So, it was banks, life companies, debt funds and the GSEs. So, I would say it was a balanced mix. We clearly have been watching reform on the GSE side. And so, part of our growth this year has been to further diversify that business, not necessarily away from the GSEs, but to add additional quality contract and client accounts to that. So, from our perspective, it wasn't specifically because the GSEs were down, it was just a concerted effort across our commercial mortgage origination teams to go out and further diversify that client base.

Got it. And then, I guess, just my last one, while we're on the topic, as it pertains to the housing reform plan. I guess, our read was all else being equal, the proposals for specifically residential reform would probably reflect positively on CBRE's business, but just curious what your thoughts are on the reform plan that's out there right now?

I agree with that. I mean, we've certainly been monitoring this process since the beginning of the year. Multifamily is really where we play with the GSEs. And so, that is a very profitable pursuit for them. We'd expect that to continue to be in place, post any future reform measures. But, we certainly do believe that there has been positive movement with respect to the published caps. And so, we're pleased with how that's come out year-to-date. And again, we are also looking at expanding the work that we do with private operators. So, we think that that's also positive.

I just wanted to double back on Telford and then the U.S. development business in general. It seems the U.S. development business is getting a boost from opportunity zones throughout the course of this year. And I'm wondering if you think that is the case, and does that continue into 2020? And then, how does the pipeline look for UK multifamily? I think, Telford's pipeline in process at the end of Q1 was about $1.7 billion.

Josh, we are not being impacted in a major way by opportunity zones. I think they’ll continue to be out there, there’ll continue to be an opportunity. There’s a lot of political pressure around those of different kinds. But that has not had a major impact on our business; we don't think it will, going forward. Our development business is in very good shape in terms of the pipelines we have, in terms of the exit cap rates we expect, rental rates, etc. Telford, early signs are that their ability to secure new opportunities is going to be at least as good as we thought it was when we underwrote that acquisition. Our teams over there are now just getting going with Telford, and there is a lot to be learned on that business, but we're quite encouraged about it.

And then, one to touch on GWS. I was hoping you could unpack the growth in the quarter, certainly stronger than we expected, which is good to see. And maybe break down the contribution of growth from new versus existing clients and whether you have a strong hold on certain industries that's helping wins? And maybe lastly, are you reaching any type of employment capacity that could sort of hamper growth in the future? Thanks.

Sure. I'll address that. From the GWS perspective, we experienced significant growth in our facilities management and the transaction and advisory aspects of that segment. We're seeing an increase in accounts signing up for the full suite of services, including facilities management, project management, and transactions. This growth was bolstered by the Novartis signing in the third quarter. Regarding other areas for growth, we had strong performance geographically across the U.S., EMEA, and APAC. Additionally, from a margin standpoint, the Americas are showing impressive results. We have a strong positioning in data center services, which sets CBRE apart. We are also expanding our capabilities tailored for sectors such as healthcare and pharmaceuticals, as evidenced by our pursuit with Novartis. Overall, CBRE's approach in the GWS segment offers distinct advantages, enabling us to deliver exceptional results for our high-quality clients, including large enterprise and investment-grade customers.

And no employment capacity constraints to speak of there?

I think that they're not necessarily. I mean, certainly, we continue to watch the growth of that segment. We've had tremendous growth. And I think that certainly bringing on Novartis was another very large win for us. I don't see that employment or the labor availability necessarily as being a limitation because most of that is really rebadging of employees; it's not necessarily us going out and finding folks to cover that.

Good morning. This is Ryan Tomasello filling in for Jade today. I appreciate your remarks on coworking. You mentioned that coworking accounted for about 3% of your leasing in the third quarter. Could you provide a comparison to what that figure was in the same period last year? Additionally, do you see the potential pullback from WeWork as a challenge for your leasing business, or do you think it might offer opportunities, particularly with the space that WeWork is relinquishing and for the Hana business? Lastly, could you share your updated views on the capital you plan to invest in Hana?

Sure. I'll start with the first piece, and then Bob will discuss the broader strategic opportunity. In the third quarter, the impact from coworking was about 3%. We also noted that the trailing 12-month contribution to growth was around 4%. There was a slight deceleration in leasing contributions for the quarter, but we do not see this as a long-term trend. We believe coworking is a trend driven by market needs, and we expect continued demand not just for future coworking locations but also for sales, which constitutes about half of that figure. This indicates there is still a significant need in the market for coworking activity. Now, Bob, can you share your thoughts on the strategy?

Yes. Ryan, I would say that what happened with WeWork has had a tactical impact on our Hana strategy, but it has not changed our overall strategy. In the short term, we're seeing more inquiries from Hana occupiers and landlords who are now considering us that perhaps weren't before. However, in the long term, as Leah mentioned, we still view the coworking or flexible space market opportunity as we did before; it currently represents about 2% of the global multi-tenant space. We believe it could grow to as much as 10%. Our confidence in this direction comes from the insights we've gained from our global occupiers. They anticipate that a portion of their future occupancy will be in this type of space, which we find promising. Our strategy for Hana is to gradually expand our footprint with a more capital-intensive approach, meaning increased investment and more leases, and eventually likely transition to a model where we manage coworking spaces owned by landlords. We believe that over time, landlords will seek to incorporate coworking spaces into their buildings because they understand that their tenants will want them. They probably wish to have control over these spaces to manage tenancy effectively, as they perceive themselves to bear much of the downside. Thus, they want to capture the upside, and we are aligning Hana to adapt to this direction if the market shifts that way. In the short term, our results with Hana have not been significantly influenced compared to our prior expectations.

That's very helpful. Thanks. And then, just on the broader leasing environment, setting aside that Q4 will clearly be a tougher comp, like you mentioned, just hoping to get your broader thoughts on the outlook for that business. What are you seeing in terms of demand for space overall? Do you expect that demand will continue to be driven by some of these industries you've called out, like technology, financial services, and I guess still coworking considering that's a trend that you believe in? Just curious overall what you're hearing from occupiers in the leasing environment.

Leasing is strong. It's only not strong when you compare it to what happened last year. So, when you look at our combined GWS business and our agency business in the U.S., 7% growth this year on top of almost 20% growth a year ago. That's a healthy leasing market. But, the growth we said a year ago when we were talking about that kind of growth and we were asked will it sustain? Well, we never thought we were going to be able to sustain 20% growth. But, it's a healthy leasing market. A lot of it is being driven by tech companies, but it's very balanced. It's being driven by distribution space users, financial services companies, manufacturing companies, etc. We expect leasing to be strong in the fourth quarter. We don't expect it to grow the way it did a year ago. And we expect next year the economy to be a little slower than it is this year, but some decent growth, and we expect our leasing business to continue to be solid.

And then, just one last one, if I could. Just on 2020 guidance, I believe last year for 2019, you gave guidance at your Investor Day, and please correct me if I'm remembering that incorrectly. Just wondering if you can say when you plan to give guidance for 2020 this year.

Yes. We'll address that in February when we release year-end.

Great. Thanks for taking the questions.

Thank you.

Good morning. Bob, can you explain how Hana is different from the other products available?

Hana is tailored more for enterprise users compared to other options in the market, focusing on teams rather than individual memberships. This emphasis makes it more suitable for institutional needs, with better infrastructure and enhanced data security. It offers similar amenities like food and beverages. Importantly, we are actively collaborating with many of the major global clients, providing various flexible space solutions within their premises. We understand their requirements, particularly their desire to incorporate flexible space within their property portfolios. Historically, occupiers have chosen to own some spaces, lease others traditionally, and engage minimally in coworking. However, that perspective has shifted. Now, they view coworking as a significant component of their occupancy strategies moving forward, and we have aligned our Hana concept accordingly.

And what went through your mind with regards to selecting these initial markets, Dallas, and I think you mentioned Southern California and London. Why those markets and not others?

Well, everything we've done in the coworking sector with Hana has been guided by our direct collaboration with our clients on both the occupier and investor sides. After assessing the opportunities available through these two groups, we chose to focus on those markets. By the end of next year, we expect to have Hana operational in several other markets as well. There are some that we are very close to launching, but we are not yet ready to disclose those.

Got you. You may have mentioned this previously, and I apologize, but the Telford transaction, was that a big off or was it a relationship that drove the discussions to acquire them?

It was neither. We had conducted extensive strategic work regarding our Real Estate Investment business, similar to what we did several years ago, which led Bill Concannon and our GWS team to focus on Norland. We had specific goals for our Real Estate Investment business, one being to expand our development opportunities and position ourselves for initiatives outside the U.S. Our leadership team at Trammell Crow Company identified those types of businesses. After searching for suitable companies and due to favorable pricing movements from Brexit, they focused on Telford, established a strong relationship with their team, and we found their team to be outstanding. We also believed they were aligned with significant market trends, which culminated in the acquisition of Telford.

I have a question regarding the outlook. You've reaffirmed it, but it appears that Real Estate Investments might be underperforming compared to what you anticipated when you last communicated with us in the second quarter. Additionally, there were some extra expenses and disruptions in Europe related to GWS. Is this the correct perspective on how things evolved from the second quarter to the third quarter, or is there something else we should know?

No. I would say that's fair. I would just say a lot of the Real Estate Investments change is driven by timing. It's just not market changes that we're seeing around the development portfolio that we have in place. For example, one industrial project that we have, it's fully leased, but the triggering event for the recognition isn't until the tenants move in, and that won't happen until next year. And then, we have a multifamily project that is scheduled to close and the buyer had a 30-day option extension, they exercised that. But, we fully expect that will close in Q4. So, these aren't fundamental drivers of change in terms of how we view cap rates or these assets transacting with respect to their cap rates. So, I feel good about the Real Estate Investments business. And I'd say, leasing and certainly the benefit from Telford and our capital markets business and GWS altogether will make up for that shift really in timing for those development projects.

Thanks, everyone. And we look forward to talking to you in about three months when we review our year-end results.