Here’s why a Compass-Pacific Union deal makes sense

On the night of Aug. 5, Pacific Union CEO Mark McLaughlin fired off an email to his top deputies. What followed were “highly confidential” instructions for conducting due diligence on a potential tie-up with Compass.

“Lots to do — short window of time,” he wrote.

On Tuesday, word of the bombshell deal leaked — catching both companies off guard and stunning those who have heard McLaughlin throw shade at Compass in the past.

Despite McLaughlin’s prior criticism, the deal’s potential upside for both two companies proved impossible to resist in the cutthroat brokerage business, where firms are now being squeezed by discount models, competition for agents and pressure to pay higher splits.

“Mark and I have been looking at solutions over the last year on how we make sure that if disruption happens, we are the ones doing the disrupting,” Pacific Union president Patrick Barber told agents in a voicemail Tuesday.

For Compass, whose stated goal is to dominate the U.S. residential market, buying Pacific Union would be a coup. The firm, partly owned by title insurance giant Fidelity National Financial, is one of the largest on the West Coast with 1,700 agents and $14 billion in sales last year.

“They are now the dominant company in the city of San Francisco,” said Steve Murray, founder of Real Trends, a Colorado-based research and consulting firm. Murray, who does valuation work for residential brokerages, estimated the purchase price could be between $100 million and $200 million. No figure has been released.

In messages to agents just after the news broke, San Francisco-based Pacific Union and Compass stressed that the deal was far from done. “This is a little premature,” Barber said in the voicemail to agents. “We have not inked a deal, and Mark and Fidelity National Financial are working diligently on this.”

But in an email to agents, Compass CEO Robert Reffkin described “very productive discussions to bring Pacific Union into the Compass family.”

He said he would be in San Francisco and Los Angeles on Thursday and Friday and for several weeks. “We recognize the size of this combination would be greater than anything we have done in the past,” he wrote. “While there is going to be a lot of excitement and interest associated with this potential partnership, I recognize there could also be some skepticism and unknowns.”

Compass, which was founded in New York in 2012, has been gobbling up firms over the past few months in a bid to control 20 percent market share in 20 major U.S. cities. But not all markets are created equal, and the Bay Area is a marquee region.

“They’ve purposely gone big in San Francisco because they want to dominate there, where the VC money is,” said one New York brokerage chief. “So they have a lot of visibility.”

In an interview with The Real Deal earlier this month, Reffkin confirmed the company is not done raising money. To date, Compass has raised $775 million from investors, including $450 million from SoftBank. Reffkin declined to comment on rumors that the Japanese conglomerate plans to double down on its bet on Compass.

Compass is also on the verge of rolling out several new business lines — including title, mortgage and escrow. Even if Fidelity is not part of the new partnership, a California-based title company is on the table as part of the current deal.

Meanwhile, in an email to employees, McLaughlin confirmed the proposed partnership would include the Mark Company, a San Francisco-based development firm. It would also include Chartwell Escrow, a title and escrow company in Sherman Oaks, Calif.

Despite the upbeat tone of his email, McLaughlin has been a vocal critic of Compass, and last month he shot down its claim of being the top firm in the Bay Area. “Most of the Paragon team joined us about 90 days ago,” he was quoted as saying last month, when Compass announced its acquisition of that San Francisco based rival.

In Barber’s voicemail, however, he indicated that Pacific Union ultimately could not compete with Compass’ technology, which McLaughlin previewed during a visit to New York. “Most of these tools we have tried to do ourselves,” he said.

Compass is reportedly buying 66 percent of Pacific Union, which is the exact amount Fidelity owns. It remains unclear whether that entire amount is Fidelity’s stake, though several sources speculated Fidelity is pushing for the deal.

For the past few years, the title insurance giant — with $7.7 billion in 2017 revenue — had been quietly building its brokerage business. In 2014, it increased its stake in Pacific Union to 66 percent. It is also the sole owner of J. Rockliff Realtors in San Francisco, and in 2016, Fidelity paid $229 million to acquire Commissions Inc., a web-based marketing, CRM and lead management tool for top-producing agents.

Despite those bets, brokerage was never one of Fidelity’s core businesses.

During the second quarter, the company generated $2.1 billion in revenue, including $161 million from its real estate and technology business. That compares to $1.7 billion in first-quarter revenue, including $103 million from real estate and technology.

And as residential brokerage continues to get squeezed — with fewer sales, competition for agents and pressure to pay higher agent splits — it’s likely Fidelity opted to take the business in a different direction.

Bose George, an analyst who covers Fidelity for the investment bank Keefe, Brutette & Woods, speculated the company would remain focused on technology for agents. “They can get better returns as opposed to being in the space and competing with realtors,” he said.

And a big part of that competition was one particularly aggressive upstart.

“This year has shown that the business has been challenged, just from the competitive environment for agents, especially in the big markets,” George added. “A lot of it points back to Compass.”