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Gobbling up smaller firms

Bruce Mosler, left, and Colin Dyer

By Adam Piore

In New York City, the frozen credit markets and subprime fallout are beginning to take a toll on commercial activity.

Manhattan sales volume dropped by nearly 60 percent in the first half of 2008, compared to the same time last year. Meanwhile, as of the end of July, Manhattan leasing activity had fallen more than 10 percent compared to the same period last year.

But it is plummeting leasing transactions elsewhere that are driving down profits for the city's biggest commercial brokerage players. Investors got a look at the books of two of the biggest recently, and didn't like what they saw.

Both CB Richard Ellis, the largest commercial leasing firm in the world, and Jones Lang LaSalle, led by CEO Colin Dyer, which is now the second largest commercial brokerage in the world, were hammered in the markets after second-quarter profits failed to meet analysts' expectations.

Cushman & Wakefield, the third-largest commercial brokerage, has also seen revenues drop.

On July 29, CBRE saw its share price plummet 24 percent, to $14.03, the largest drop in its four-year history as a public company, after profit fell to 8 cents versus 59 cents in the year-ago quarter. Jones Lang LaSalle sank 15 percent, its hardest fall in three years, reflecting a decline in profits from $2.32 a year ago to 73 cents in the most recent quarter.

Still, even as the numbers tank, the firms continue to grow and gobble up smaller companies.

Back in February, CBRE's CEO Brett White explained the thinking when he told analysts, "we believe this current environment will significantly punish smaller, less diversified competitors, likely providing a ripe environment for further consolidation in the industry, an opportunity we will be pursuing with vigor."


'Bigger porch'

So far in 2008, CBRE, which is the biggest commercial brokerage in the city, has purchased 13 companies around the globe for $135 million, executives reported on a July 30 conference call.

For its part, Jones Lang LaSalle has completed 10 acquisitions so far this year. That includes a transformative megadeal, the $613 million purchase of the Texas-based real estate services firm the Staubach Company.

Cushman & Wakefield, meanwhile, has already bought five smaller firms in 2008 for "somewhere in the region of $100 million," said Bruce Mosler, the company's CEO.

All of those deals continue a trend that has been accelerating over the last five years: The larger players are expanding both geographically and in the range of services they offer.

Experts say companies are looking for ways to spread risk across different regions and services — the benefits of which have become clear as the United States market has skidded.

But there are disadvantages to such rapid growth.

Brandon Dobell, an analyst at William Blair and Company, said traditionally CBRE has had a variable cost structure, with much of its expenses coming in the form of commissions. Thus when revenues declined, so too did expenses — which "protects their operating profit margins." This time, he said, "that didn't happen."

Dobell added, "It's a much broader organization, so you've got more infrastructure across Europe and the U.S.; you've got research people, office space, travel expenses — that stuff is relatively fixed. That porch has become a little bit bigger."


Diversifying portfolios

CBRE's 2003 purchase of Insignia cemented its position as a local brokerage powerhouse in New York City, while its 2006 acquisition of Trammell Crow for $2.2 billion dramatically expanded its corporate services business.

Jones Lang LaSalle, meanwhile, already has a strong consulting business. Its recent acquisition of Staubach beefs up its brokerage operations, adding a stable of 70 North American offices, and a business that did 7,280 transactions totaling $28 billion last year.

Cushman & Wakefield dramatically increased the size of its structured finance business with its 2007 purchase of Sonnenblick Goldman, the New York City-based real estate investment bank that completed $7.5 billion in capital transactions in 2006.

Cushman's Mosler has made it publicly clear that he is open to a mega-sized acquisition along the lines of Jones Lang LaSalle's Staubach acquisition or CBRE's purchase of Trammel Crow — though he's taken pains to state he will be choosey.

"At the right moment in time, for the right acquisition, at the right multiple, Cushman has the ability to do a transformative deal," he told The Real Deal. "That might not be the route we go, but it's open to us. I'm in no rush."

Many of the recent acquisitions of the industry's top three firms expand their geographic reach.

CBRE's 2008 buys add to a roster that includes some 44 other "in-fill" acquisitions for an aggregate purchase price of $351 million since 2005, including companies in Canada, Chile, India, Italy, Japan, Spain and the U.K.

Jones Lang LaSalle's recent acquisitions include deals in India and France, among other places.

Cushman has expanded in Romania, Turkey, Brazil and Australia recently. The firm already has a growing profile in Europe — since 2006, it has been majority-owned by the Italian conglomerate IFIL.


Pressure to grow

Smaller firms are also feeling the pressure to grow.

Last month, the firms Colliers Turley Martin Tucker, Colliers Pinkard and Cassidy & Pinkard Colliers announced they would merge. After the deal is complete, Colliers ABR of New York City will join the company.

The merger will create one of the largest commercial firms in the world, giving them a management portfolio of 288 million square feet with a leasing portfolio of 210 million square feet. In 2007, the combined capital markets transaction volume of the companies was estimated at $5 billion.

A number of market factors are driving the consolidation trend. For one, diversification can maximize profits by allowing companies to expand fee income and to represent both sides of a transaction. For another, consolidation offers streamlined operations and economies of scale.

Diversification is also giving larger firms the edge when competing for the business of an increasingly globalized clientele. Many customers are looking for "one-stop shopping," while at the same time tapping firms with local expertise, experts say. By buying up regional and local firms, the big brokers can offer the best of both worlds.

"Clients gravitate to firms that help them across the board in an efficient way," said Cushman's Mosler. "I think that global players provide more resources than competitors.

"We have been very clear in saying we want to continue to grow our business in Europe and Asia."


Expansion exposure

New York remains a strong spot for CBRE. But the very size of CBRE's operations elsewhere have also exposed it to the brunt of the subprime fallout.

"Leasing and sales advisory work in downtown markets is tough, but it's nowhere as tough as suburban secondary markets where volume is down 90 percent — there's nothing going on," said William Blair analyst Dobell. "That's one of the major differences between CB and LaSalle."

In addition, CBRE's building management business carries fixed costs, and it has also grown significantly with the acquisition of Trammel Crow, which limits the amount of cost reductions available.

"A bigger business that's lower-margin and maybe not as variable — it really hurts," said Dobell. "Most investors I talked to were expecting the commentary on the market to be weak. But very few expected that much of an earnings miss, because they did not expect margins to fall as much as they did."

Still, diversification is proving its value as companies look overseas for profits to offset the damage in U.S. markets.

CBRE took the majority of its revenue declines in its Americas region — with revenue falling from $934 million in the second quarter of 2007 to $785.5 million in the second quarter of this year. Revenues from Europe, the Middle East and Africa declined from $330.8 million to $299.7 million. But in Asia Pacific, revenue grew to $155.7 million — up 28 percent from last year.

Dobell argued that Jones Lang LaSalle is better positioned to weather the storm. CBRE is much more weighted toward the U.S. than Jones "on a relative basis, and the U.S. is where things are the worst right now," he said.

Jones Lang LaSalle's revenue from the Americas region was $190 million, up 6 percent from the same period last year; it had revenue of $236 million, up 20 percent, in Europe. Asia Pacific was $142 million, down from $211 million in 2007, in part because the 2007 results included a significant one-time advisory fee earned in the Asia Pacific hotel business.


Eyes on Cushman

At press time, Cushman & Wakefield had not yet released its results — it is majority-owned by IFIL, which was slated to report on Aug. 30. But Cushman, too, is caught in the vise of the credit crisis and the plummeting commercial sales volumes that come with it, analysts said.

"I would think that Cushman would have the same problems as CBRE, if not worse," said Will Marks, managing director at JMP Securities. "If Cushman is less diversified in terms of international presence than CBRE, it's probably experiencing even more pain."

The latest financial information available for Cushman, released in May when IFIL reported its last results, showed a loss of 17.3 milion euros, or about $26 million, in the first quarter of the year.

The company's CEO Mosler acknowledged that year-over-year revenues are down, but downplayed the significance, noting that real estate is a cyclical business and most firms do much better during the second half of the year.

The loss also reflected one-time accounting changes related to the merger with IFIL, as well as the costs of acquisitions, Mosler said. He has been actively looking to expand the firm's overseas presence in recent years, and that is paying off, he noted. Three years ago, only about 20 percent of the company's revenue came from outside the United States. That had grown to 43 percent by the end of last year and should reach 45 percent at the end of 2008, Mosler said.

Cushman's five acquisitions this year were done with "little debt," added Mosler.

"I think you will continue to see consolidation with large providers," Mosler said. "We feel this is a time of opportunity for an underleveraged global brand."