Foxtons Group — M&A contribution and potential overlooked

In the last three years, Foxtons has executed six acquisitions, which collectively brought c 7,000 tenancies into the group, expanding the tenancy book by more than a third. We believe the market is missing the potential value created here. When analysing the largest deal, the £15.0m purchase of D&G in March 2021, it can be demonstrated that the retained lettings business was bought on an EBIT multiple of just 2.9x. Subsequently, Foxtons bought Gordon & Co and Stones Residential, which we believe could offer similar synergies. With a fragmented lettings market and a strong balance sheet, we believe it is likely that Foxtons will continue to make value-enhancing acquisitions.

At its capital markets day in June 2021, Foxtons highlighted its willingness to expand the business via acquisition. It had, in fact, already executed four deals in the preceding 18 months, adding 4,500 tenancies to its book at that point, and has subsequently added a further 2,500 tenancies this year with the purchases of Gordon & Co and Stones Residential. These 7,000 new tenancies added via acquisition imply that the lettings book has grown by more than a third to 27,500 tenancies in just over two years.

The six deals completed to date had a total consideration of £30.1m and a total revenue of £24.4m, implying that on average Foxtons paid c 1.2x revenue for the portfolio. However, this multiple hides the real value that can be created by these acquisitions. It we look more closely at the D&G purchase, Foxtons paid £15.0m for a business with total sales of £16.5m and an EBITDA of £0.6m, which at first glance looks very expensive.

However, this completely ignores the rationale for the deal. Foxtons has a lettings management system that is scalable, almost into infinity, which means that it could take on the D&G lettings book with only limited additional costs. It also allowed Foxtons to sell the D&G Sales business, with its branch network, back to the original owners for a nominal price of £2. This in effect took c £4m of costs out of the business, which Foxtons was then able to capture. We also believe in the period since the deal that D&G Lettings has grown. We base this assumption on the comment from Foxtons that D&G Lettings generated revenue in H1 of c £5.7m, and an operating profit of £2.6m.

Plugging all of these numbers into the table below, and annualising the D&G H1 profit, we estimate that Foxtons bought D&G on a forward EBIT multiple of just 2.9x. We forecast that Foxtons will generate a revised operating profit of £11.3m in FY22, which implies that this one deal alone accounts for c 45% of group profits. We also know that the two deals executed this year also contain a modest number of branches, so a similar uplift may be possible either here, and/or on future deals. We believe these facts may have been missed by the market.

We have previously discussed that Foxtons targets c 40% operating profit margins post synergies and the last three deals appear to achieve this hurdle. We think there will be more deals to come.

The lettings market is highly fragmented, with Foxtons being the largest player in Greater London with a market share of c 8%. The chart below gives some indication of the opportunity available to Foxtons. The fragmentation, the increasing complexity of the market and succession issues with owners are some of the reasons that there appears to be a steady flow of lettings books becoming available on the market.

On 2 March, Foxtons announced that it expected to invest £8m in 2022. It subsequently announced the purchase of Gordon & Co for £8.4m and added Stones Residential, which had a consideration of £2.2m. Given Foxtons’ track record on acquisitions (detailed in Exhibit 1) and its strong balance sheet (which ended the first half, after paying for the deals achieved to date, with net cash of £11.7m), it seems likely that other value-enhancing deals could be forthcoming in H2 and/or 2023 and beyond.

H122 revenue increased 2.7% to £65.1m and adjusted operating profit rose 13% to £6.2m as the business benefited from operational gearing. PBT (pre exceptionals) rose 18.7% to £5.2m and the basic, diluted and adjusted EPS came in at 1.1p, from which the company declared an interim dividend of 0.2p. Foxtons ended the period with net cash of £11.6m, having spent £8.5m on M&A, £0.9m on share buybacks and a similar figure on dividends in the period. Revenue growth was a blend of an improvement in Lettings, and year-on-year declines in both Sales and Financial Services due to very tough, Stamp Duty Land Tax affected comparables in 2021.

Costs in H122 increased £0.9m driven by an increase in employers’ National Insurance contributions, utility costs and business rates. These cost increases were totally offset by other costs taken out of the business, including the simplification of the management structure and the removal of the COO from the board. In total, the company expects these measures to reduce costs by c £3m in FY23. Overall, the company has made good strategic progress and continues to return cash to shareholders via dividends and the £3m share buyback, which should be completed by the end of the year.

In Lettings, revenue grew 19.8%, or £6.5m, to £39.4m which was driven by a 32% increase in overall revenue per transaction, to £4,330, due to a better rental environment as well as the inclusion of D&G volumes that attract a higher fee. Volumes dipped 9.1% to 9,110, reflecting a tight market. £4.0m of the growth was organic, reflecting the increase in prices offset by the lower volumes. £2m was growth and annualisation of the D&G acquisition in May 2021, and £0.5m was generated from the two deals completed in May 2022. In total, D&G Lettings contributed £5.7m in revenue and £2.6m of operating profit. The drop-through was impressive as the Lettings contribution rose £6.8m to £28.9m, and operating profit increased from £1.5m to £7.3m, implying a contribution drop-through rate of c 85%. Following the acquisition of Gordon & Co and Stones Residential in May, the letting portfolio has grown to c 27,500 tenancies.

In Sales, revenue fell 17% to £20.8m reflecting a strong comparable in 2021 rather than a weak market in itself. This can be seen clearly in Exhibit 6 where the volume of sales fell from an artificially inflated number of 1,895 in H121, to a more ‘normalised’ level of 1,525 in H122. To put this into context, the H122 volumes were c 28% ahead of H119. The average revenue per transaction increased 1% to £13,627 as Foxtons took some market share, especially in the mid-price level properties where the average price of property sold increased c 5% to £586k. The trends in both volumes and revenue per unit are positive, which has had a strong influence on the divisional revenue, which has risen from £15.4m in H119 to £20.8m in H122.

The under-offer commission pipeline stood at £19m at the end of June, which was significantly better than the position both last year and at the same point in 2019. Industry-wide capacity constraints in conveyancing and surveying are adding to the time scale to progress sales from the offer stage to exchange.

In Financial Services, volumes fell from 2,795 in H121, to 2,334 in H122, reflecting the lower levels of sales activity year-on-year. That said, volumes were c 11% higher than H119 boosted by efforts to take market share in financial services. Again, revenue fell, to £4.8m, reflecting the pull forward of purchase mortgages into H121 rather than underlying market weakness, and revenue per transaction rose 11% to £2,057. The drive to bring in more negotiators and advisers into Sales and Financial Services respectively is going well, with some contribution expected in H2.

Following the acquisitions in May and the robust interim results, we have made no material changes to our underlying trading assumptions. However, we have adjusted our estimates to reflect the acquisitions of Gordon & Co and Stones Residential completed in May, and have now reflected the full impact of the ongoing £3m share buyback, which the company expects to be completed this year. In total, this raises EPS in both years by c 10% and, because the dividend payout is set in our model at 35% of EPS, the dividend rises by a similar proportion.

The other material change here is in the forecast net cash, which falls by c £10m in both periods reflecting the £8.5m cost of the acquisitions and the share buyback, previously left out of the model, of c £2m.

We retain our 128p per share valuation despite the increase in estimates, at least in part reflecting the more questionable economic situation.