Cushman & Wakefield CWK is the third-largest commercial real estate services company in the world, behind only CBRE CBRE and Jones Lang LaSalle JLL. It has seen its share price crater as the result of a confluence of concerns stemming from the weakness of the commercial real estate market amid the coronavirus pandemic. Although we expect Cushman & Wakefield to experience some near-term weakness, we think the shares are undervalued.
The company has overseen a boom in the commercial real estate services industry since the nadir of the real estate-driven global financial crisis of 2007. As the third-largest player in the space by market capitalization, Cushman & Wakefield has benefited disproportionately from various tailwinds that have underpinned its impressive run of growth. Key to this success has been the company’s industry-leading brand reputation and a platform that melds complementary business lines in areas such as property sales, leasing, project management, and outsourcing to serve its corporate and institutional clients.
Although Cushman & Wakefield nominally reports its segments on a regional basis, it also discloses the amount of revenue coming from each business line. Among these, the property, facilities, and project management business is the largest and also the most stable, providing contractual revenue from corporate customers. This business line, which contributes around 46% of companywide revenue, is where Cushman & Wakefield provides many of the services needed by corporations that occupy real estate. This is also where the company provides consultative services to help companies that are looking to reconfigure their office space.
The leasing business line is Cushman & Wakefield’s second largest, contributing around 30% of companywide revenue. In this business line, the company’s brokers help owners and occupiers of commercial real estate with the leasing process, primarily by executing lease agreements. The capital markets business line, which contributes around 16% of companywide revenue, is where brokers facilitate the sale and purchase of commercial real estate property.
The company’s valuation and other business line includes various services for corporate and institutional clients, including appraisals. Buoyed by trends such as urbanization, the institutionalization of real estate, and the growing tendency toward corporate outsourcing, Cushman & Wakefield should post healthy growth rates as it continues to take share from its smaller, more regional and weaker rivals.
Reputation and Scale Result in a Narrow Moat We believe Cushman & Wakefield has built a narrow-moat business, with the company benefiting from intangible assets and switching costs. These moat sources are supported by the company's strong brand reputation, its broad scale, and various structural elements inherent to the commercial real estate industry. Given the recent consolidation in the space, we expect smaller competitors will struggle to disrupt Cushman & Wakefield's market-leading position, which it shares with CBRE and JLL.
Cushman & Wakefield’s competitive position derives in large part from its lengthy record of effective service, which has allowed it to bolster its reputation. We think this history has made the company an especially trusted provider of commercial real estate services, supporting an intangible assets moat source. In the real estate services industry, individual relationships and perceptions are paramount to the deal-making process, which is why we think Cushman & Wakefield’s strong reputation supports a narrow moat rating.
While we do not contend that industry awards alone are reflective of intangible assets, we point to Cushman & Wakefield’s history of receiving prestigious awards as indicative of its excellent reputation. Evidence for this reputation is bolstered by the company’s ability to effectively manage talent. Given the importance of a talented workforce in the services-oriented commercial real estate industry, it is imperative for companies like Cushman & Wakefield to attract and retain top employees. Because brokers are primarily compensated via commission that varies with productivity, it is likewise important for ambitious employees to work for companies with a strong reputation and a deep network in their desired market. This dynamic has created a virtuous cycle for Cushman & Wakefield, allowing it to simultaneously retain top talent and poach employees from its competitors. We believe its impressive record on talent retention supports the claim that employees clearly recognize the value of tapping into the company’s deep network and enviable reputation in the industry.
Cushman & Wakefield’s reputation also allows it to attract major multinational clients in its property and facility management business. The company currently serves large multinational corporations such as Unilever, Citibank, Toyota, and Avaya. While multinationals will outsource various aspects of their real estate operations to different providers, they have been increasingly consolidating providers in recent years. This dynamic is reflective of Cushman & Wakefield’s expanding suite of offerings that include project development, advisory, and consulting.
Cushman & Wakefield’s rapid ascent derives from the combination of its continued ability to take share from competitors and several tailwinds in the commercial real estate industry. Among these is the increasing tendency of institutions to own and invest in real estate, which is driving investment dollars to the space. This dynamic has aided the capital markets business as well as the valuation advisory business.
A related trend in the industry has been the globalization of commercial real estate, driving consolidation in the form of M&A and changes in market share. Whereas historically real estate providers established local expertise and operated regionally, increased access to information via the Internet and data from providers such as CoStar now benefit companies with a global reach. This is evidenced by the rapid pace of consolidation, with the company’s Cassidy Turley and DTZ acquisitions serving as salient examples.
The confluence of these forces aids Cushman & Wakefield, easily the third-largest player in commercial real estate services. Multinational corporations that operate globally are increasingly turning to companies such as Cushman & Wakefield as a one-stop shop for their real estate needs. As a result, the company is a preferred option among larger clients, especially as these types of companies increasingly look to outsource their real estate operations. This dynamic, which has driven impressive growth in corporate outsourcing, represents an excellent opportunity for Cushman & Wakefield.
We think the outsourcing business benefits from switching costs, reflective of the difficulty involved in switching providers. Companies such as Cushman & Wakefield increasingly bundle services to provide a consolidated suite of offerings. This benefits Cushman & Wakefield, in that it can leverage certain parts of its business such as research and consulting, and it benefits clients, who receive a more customized and tailored experience.
Beyond the sheer hassle involved in switching providers, only competitors CBRE and Jones Lang LaSalle have the scale to effectively compete for these larger contracts. As the trend of outsourcing continues and the level of complexity of services provided increases, it will only become more difficult to switch service providers. We think the existence of switching costs is supported by the high retention rate the company has historically experienced among its client base.
Returns on invested capital (adjusting for goodwill, prior impairments, and past real estate ownership) for Cushman & Wakefield should comfortably exceed its cost of capital over the next decade, a period that will invariably have both cyclical high and low points for the commercial real estate industry. In the stronger parts of the cycle, the company’s brokerage employees share in the upside, essentially capping margin expansion potential and ROIC growth for the company. However, in weakened environments, its professionals share in the pain as the company is able to significantly cut costs, helping preserve reasonable profits, cash flow, and ROIC.
We are confident that Cushman & Wakefield will be able to outearn its cost of capital over the next decade, particularly because its product mix has become more contractual and less cyclical as compared with the previous downturn, due to an aggressive expansion into corporate outsourcing. Ultimately, we view the company’s outsourcing offering as significantly less cyclical than the other business lines. Since this business has seen significant growth lately, we think Cushman & Wakefield is poised to better withstand future downturns.
Cyclicality and Financial Situation Among Risks Although we think Cushman & Wakefield is set to experience impressive financial performance well into the future, investors should be cognizant of several risks. The most significant of these is the inherent cyclicality of the commercial real estate industry. In particular, the company's capital markets and leasing businesses tend to magnify existing volatility in the overall marketplace because of their transactional nature. This is especially concerning in an environment where the spread of the coronavirus has injected considerable uncertainty and is threatening to freeze investment volume altogether.
We also think the effect of technology on commercial real estate represents a risk to Cushman & Wakefield. The space has been relatively insulated from technological disruption thus far, and we still believe that strong relationships and local expertise will remain valued assets in the real estate industry. Nevertheless, the risk posed by technological intermediation, whereby the services provided by brokers are increasingly offered online, is significant. However, technology represents an opportunity for the company that correctly integrates it into its services, thus increasing the value of its platform and embedding more switching costs.
Since Cushman & Wakefield relies heavily on its brand, we would also view any developments that damage its reputation as being injurious to the company. Finally, consolidation among key competitors represents a significant risk to Cushman & Wakefield, since it would make the competitive landscape more difficult for it to operate in.
Cushman & Wakefield’s financial health is questionable. At the end of 2019, the company had a net debt/EBITDA ratio of about 5.4 and EBIT/interest expense ratio at 4.1. Although these figures have shown some improvement over the past few years, the company’s debt load is certainly more worrisome than that of CBRE and JLL, which have been prudent in carrying low leverage levels. Commercial real estate is highly cyclical and suffers from significant volatility during downturns, meriting a more cautious approach. Cushman & Wakefield’s higher leverage is the result of an aggressive acquisition strategy that has helped cement the company’s position as a global provider able to compete effectively with CBRE and JLL.
In response to the coronavirus crisis, Cushman & Wakefield announced it would issue $650 million in senior notes, bringing further attention to its borderline precarious financial situation. Although we do not view the company’s high level of debt as an immediate liquidity concern, a prolonged crisis could call its underlying financial stability into question. While we expect the company to benefit from various tailwinds, we think it is more advisable for management to err on the side of caution rather than take on too much debt, given the cyclical nature of the commercial real estate industry.