Article on REIS
Reis (REIS) generates a high margin, recurring revenue stream that should continue to rise due to favorable industry growth prospects. The significant discount to the peer group and M&A multiples presents an asymmetric opportunity.
REIS provides commercial real estate market information and analytical tools used by lenders and real estate professionals in the buying, selling and financing decision making process. This information is also used by debt and equity investors to manage risks associated with individual mortgages, properties, portfolios and real estate backed securities.
REIS maintains a proprietary database containing detailed information on commercial properties (apartment, office, retail, warehouse/distribution, flex/R&D, self storage) in 275 metropolitan markets and over 6,800 market segments. In the last two years, REIS delivered more than one million market reports to real estate professionals through its flagship Reis SE product.
The persistent "microcap discount"
The absolute valuation is misleading in isolation as it does not account for the growing high margin, recurring revenue stream. The rapidly rising EBITDA provides significant upside potential even assuming no multiple expansion or even a modest decline.
Investors hesitant to enter at such a "high" valuation should remember that disruptive companies with attractive business models rarely trade at low valuations for this very reason. In this instance the best time to enter is on a pullback during the rising trend where risk can be minimized.
As the chart below shows, REIS trades below the multiple it would receive in a takeover. Its much larger peer CSGP would be a perfect acquirer as the combined company would dominate the market for commercial real estate information.
In April 2011, CSGP acquired LoopNet for more than twice the current REIS EBITDA multiple.
As the chart below shows, REIS is the only company with a "reasonable" multiple, especially given the triple digit multiples of the more residential-focused Z and TRLA. There are two main reasons for this valuation disconnect, which should not be expected to persist given the increasing institutional interest in the industry.
The first reason (and the one mostly responsible) is the small size of REIS compared to its peers (e.g. market cap of $177 million vs. $4.8 billion for CSGP). This disconnect exists in spite of superior fundamentals and reflects the extremely inefficient nature of the microcap market*.
The second reason is the fact that the residential real estate market generally receives more media and investor attention than the commercial real estate market.
Moreover, REIS was started in 1980 while both Z and TRLA were founded in 2005. REIS is being penalized for having a longer (and successful) operating history, which created a high level of trust among its institutional clients.
*This is the main reason I focus on this market as it has the most alpha and the best opportunity to add value through fundamental analysis.
The attractive (and disruptive) business model deserve a high valuation
Before REIS revolutionized the commercial real estate information market, real estate professionals and investors were forced to rely on closely-held, fragmented, and sometimes biased information. REIS digitally delivers standardized and transparent information, which significantly reduces research and information gathering costs. The small number of firms with the national coverage and capabilities creates a high barrier to entry and provides strong pricing power. Z and TRLA employ a similar model for the residential real estate market and enjoy much higher valuations.
REIS generates revenue primarily from subscriptions to its flagship, web-based Reis SE product. No subscriber accounted for more than 4.1% of deferred revenue as of 6/30/13. The relatively long contractual period (typically one year but can be as long as four) provides a large and growing recurring revenue stream.
This "higher quality" business model (subscription vs. ad based) deserves a higher valuation given the increased visibility and stronger customer relationships. Moreover, the fact that the contract pricing model is based on actual and projected report consumption (as opposed to being based on individual user licenses) significantly reduces the exposure to the effects of lower economic growth, which can result in fewer subscribers due to workforce reductions.
The inherently low costs associated with digitally delivering information provide high margins (see below) and operating leverage, which along with continued strong top line growth, should drive "startup like" growth in the near to medium term (e.g. 2014 earnings are projected to grow ~79%). Management mentioned the possibility of a buyback or dividend on the most recent conference call given this high and growing free cash flow.
This revenue visibility is maintained by the extremely high renewal rate of 91% for the trailing twelve months. Furthermore, REIS is less exposed to a downturn in the real estate market than many would think given that the renewal rate only fell to 83% in September 2009. The reason for the high renewal rates is that the information provided is so value-added and critical to the ongoing business of its customers, regardless of current industry conditions. Management noted broad-based strength in the commercial real estate market, including increased transaction activity, on the most recent conference call, which should provide another revenue tailwind.
In the mrq, revenue rose 13% (the 13th consecutive increase) driven by growth in Reis SE and its small business product ReisReports. Aggregate revenue under contract* rose ~27%.
EBITDA rose 16.1% (the 11th consecutive quarterly increase). Operating expenses rose at a slower rate than revenue, which drove a 110 basis point increase in the EBITDA margin to 41.9%.
*Includes deferred revenue and amounts under non-cancellable contracts for which REIS does not yet have the contractual right to bill.
Source: Company presentation
New products to drive even higher growth
The trusted brand name, high quality databases and growing subscriber base should continue to drive strong growth in existing markets as well as provide leverage to enter new markets. For example, the following areas represent significant growth opportunities:
Expansion into new markets including self-storage, apartment and senior housing/congregate care.
Expanding relationships with major business information vendors that license its data such as SNL Financial, FactSet, Capital IQ, Thomson Reuters and Bloomberg. This represents a low-cost way to increase revenue and strengthen the brand name.
ReisReports aimed at small businesses and "prosumers" is contributing a growing share of revenue and provides greater diversification.
Introduction of portfolio monitoring product Mobiuss Portfolio CRE (developed with Opera Solutions, a big data and predictive analytics company) that quantifies cash flows, collateral values and reports risks at the loan level from the bottom up. This information could have alerted banks, investors and regulators much earlier to the growing problems in the real estate market before the collapse five years ago*. Additional uses for this information include the rebounding CMBS market and stress tests required by regulators.
Introduction of a single market subscription option, which should result in an expanded potential customer base. Larger financial information providers such as Bloomberg do not allow this capability (e.g. you must pay for 100% of the subscription price even if you only use less than 5% of the functionality).
*The small number of investors that famously profited from the collapse were able to do so largely in part to their expensive (though minor in comparison to the profits earned) "boots on the ground" fundamental research. Subscribers to REIS products could receive similar information at a much lower cost.
Strong balance sheet
REIS has no debt (eliminated in 2012 with repayment of ~$5.7 million bank loan), cash of $8.1 million and access to a $10 million credit facility. The strong balance sheet along with the rising free cash flow provide the ability to internally fund expansion plans.
Significant tax assets
REIS has a net deferred tax asset of ~$9.1 million as of 6/30/13, which could be increased given the strong operating performance (in 4Q12 and 4Q11 REIS reduced the valuation allowance). Management said in the 2012 10-K that it "does not anticipate paying federal income taxes for the foreseeable future". Moreover, the nearest NOL expiration is not until 2017 (only ~$5.5 million of total NOLs of ~$68 million).
Competition. REIS competes primarily against CoStar Group, Real Capital Analytics and CBRE Econometric Advisors (a wholly-owned subsidiary of CB Richard Ellis) as well as local and regional data providers and in-house real estate research departments.
Exposure to real estate downturn. Although this risk is relatively small (and significantly smaller than that of other real estate companies such as homebuilders), REIS would be negatively affected by a sharp and protracted downturn in the real estate market.
The target price of $19.48 is based on a 15x EBITDA multiple, which is conservative given the reasons mentioned above.
The pullback to the rising 200 DMA provides a low risk/high reward entry point as well as an excellent place for a tight stop loss of no more than 5%. The time frame is one year.