Regus: Misunderstood and undervalued

Tuesday, Mar 03 2015 by
3

Regus is a global provider of serviced offices which announced full results today. Revenues were up 9.3% to £1.6bn and operating profit was up 15% to £104m on a 24% increase in the network of offices to 2.2k locations. A further £207m of net capital was invested in growth with a lower average cost of investment due to mix and new office formats.

So why is this interesting? Lets start with a little bit of history.

Regus was founded in 1989 by Mark Dixon. Businessmen, Dixon reasoned, needed a remote location for meetings, somewhere cheap and easy but outside their usual place of work. By the late 1990s, Regus had, along with much else at this time, morphed into a tech company. Remote working was the future and Regus could provide the space, the growth potential was unlimited.

Unfortunately, this didn't happen and Mark Dixon lost over a billion pounds, on paper, in less than a year. Regus was forced to sell off part of the UK arm of the company and put the U.S. business into bankruptcy but survived to live another day.

Today, the business has returned to its former glory. Unfortunately, Dixon hasn't quite left the 1990s behind, this is a property company with an R&D budget. I have no idea how this budget is allocated but there is all the usual tech nonsense like self-driving office cars...or something. I don't think investors should be put off though, Dixon is clearly a dreamer and probably wouldn't have been able to recover from the early 2000s otherwise. His ~30% stake means he continues to be financially dependent on the future of Regus,

Now into the meat of it...this is a business with a £2.1bn market cap but only ~£80m of PBT, why on earth should investors be interested?

Yes, the headline numbers are hard to understand but if we look at how the company is allocating capital, we can see that this business is probably significantly undervalued.

So what Regus does, in simple terms, is spend a lot of money today and builds up capacity over three years until the investment starts to pay off. The difficulty for investors is that over the past three years, Regus has spent almost £600m developing new sites. Before 2012, the cumulative net growth investment in the business was £700m so this new investment is a huge amount.

The effect of this on the financials is that it looks like Regus isn't making much money. Of course, this is correct in one sense but if we look back at the half year results we can see that the mature centres (those more than three years old) generated £72m in after tax profit. Yes, this is after tax and just half a year. In 2013, the mature centres generated £156m in FCF, this is before management took out £20m of costs in the first half of 2014.

Interestingly, management stopped reporting out mature centres beyond the gross profit figure after the half year. However, based on the information above, it seems likely that the mature business alone generated £200m of free cash flow, roughly 10% of the current market cap.

What this means is that the market is placing almost no value, maybe a negative value on £600m of recent investment. Given that the £700m of investment before 2012 generated a 20.9% after-tax cash return, this is difficult to understand. In addition, Regus actually managed to bring overheads down whilst the top-line grew 9% suggesting some substantial operating leverage could come through on this future growth.

What could go wrong here? Well, the serviced office market is clearly a play on global economic growth. If the economy stops growing then the company is in real trouble. I don't think the company could go out of business, interest costs are only £17m on £105m of operating profit, but it would get very nasty given the strong weighting of investment towards immature centres.

The other possibility is that recent investments just won't be as profitable, perhaps the company has run out of room to grow and is now investing in marginal markets. This is a possibility, although one that is hard to verify from the outside. However, I would say: what price are we getting for this risk? These new investments don't really have a value anyway, according to the market.

Summary

This is an unusual situation at an unusual company. I don't think most investors are really aware of Regus, when they look at the financials their eyes glaze over as the first glance looks terrible. The annual reports tend to be worse with pictures of all the weird R&D stuff the company is doing.

On closer examination though we have a business investing very heavily, these investments are attributed with no value, and these investments have historically made 20%+ after tax returns. I think this investment could go wrong but we are getting a very good price for this risk.


Filed Under: Property, Stock Picks,

Disclaimer:  

No position is held by the author in any stock mentioned.

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IWG Plc is a Jersey-based workspace company. The Company operates under the Regus, Regus Express, Spaces, Signature, Kora and Open Office brands and provides a global network of places to work for all kinds of businesses from home-based workers to corporations. The Company focuses on both single location and integrated national networks and also provides sales and management services. The Company is present around the globe. more »

LSE Price
205.5p
Change
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Mkt Cap (£m)
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P/E (fwd)
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3.3



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