Cushman & Wakefield's Margins Should Benefit From Brokerage Recovery

Equity Analyst

Suryansh Sharma

Cushman & Wakefield underwent a major business transformation after the combination of DTZ, Cassidy Turley, and Cushman & Wakefield in 2015. The combination of these three firms expanded its geographical presence, added incremental capabilities, and gave the company adequate scale to effectively compete with its larger rivals, CBRE and JLL, for lucrative global contracts from multinational clients. The company has benefited from the secular trends in the commercial real estate services industry and has grown strongly through organic growth opportunities, strategic infill acquisitions, and actively recruiting fee-earning teams. M&A is a strategic pillar in its quest to become a single-source provider for the full spectrum of real estate-related services on a global footprint, and the company has a record of successful integrations and broker onboarding. 

GAAP operating margin has been negatively affected by restructuring and integration-related charges and various efficiency-related projects over the past few years. However, we think that these investments were necessary and have resulted in enhancing scale and improving efficiency. In our opinion, these investments will contribute positively toward margin accretion in the upcoming years. We also expect nonrecurring changes to normalize, resulting in positive earnings and cash flow generation that can be reinvested in the business.

The leasing and capital market segments that make up about 40% of fee revenue provide full-service brokerage and have higher cyclicality in revenue. By contrast, the property and facility management segment, which makes up about 55% of fee revenue, represents the outsourcing business and provides a contractual stream of revenue. The valuation and other segment contributes 5% of fee revenue and provides solutions related to workplace strategy, digitization, valuation, and so on. The company should be able to post healthy growth rates as it continues to take share from its smaller competitors and benefits from rising capital flows into real estate, increasing corporate outsourcing, and growth in urbanization.

Business Strategy & Outlook

We believe that certain aspects of Cushman & Wakefield’s business have traces of intangible assets and switching costs, but various offsetting factors have prevented the company from earning a moat rating. The firm has not been able to earn returns on invested capital that are higher than its weighted average cost of capital in the last five years. Further, we think that the company still has gaps in its service capabilities when compared with its peers, such as CBRE and JLL, and it would be difficult for the company to challenge the dominant position of its larger rivals given industry dynamics. Other relatively comparable competitors like Colliers International can also match the breadth of service offerings and effectively compete with Cushman & Wakefield for client contracts. In addition to this, the company operates in a highly competitive industry that offers largely undifferentiated services and does not have the ability to charge premium prices for its offerings. The rapid technological progress and increased availability of commercial real estate data also pose long-term risks to the supposedly superior market intelligence and brokerage-related execution capabilities of the company. 

Intangible Assets

Cushman & Wakefield’s strong brand reputation, its broad execution capabilities, and the various structural elements inherent to the commercial real estate service industry will benefit the company over the next decade. However, we would like to see better competitive positioning, more evidence of an informational advantage, and better return generation ability before we reconsider our moat rating.

Cushman & Wakefield benefits from its long track record of effective service for clients, which has bolstered its brand reputation. In the real estate services industry, individual relationships, local market expertise, and perceptions are paramount to the dealmaking process. In addition, we think there is a symbiotic relationship between good producers and dominant platforms in the real estate brokerage industry. Since brokers are primarily compensated via commission that varies with productivity, it is likewise important for ambitious employees to work for firms with a strong reputation and a deep network in their desired market. This dynamic has created a virtuous cycle for the company, allowing it to simultaneously retain top talent. Having said this, we do not think that Cushman & Wakefield’s intangible assets allow it to charge premium prices for its service offerings.

A significant proportion of commercial real estate brokerage deals are won based on local market dynamics. Large brokerage firms with leading market shares in their respective markets execute a higher number of transactions compared with smaller brokerage firms. Therefore, the leading brokerage firms have better transaction data, local market expertise, and relevant connections that in turn helps them to better serve their clients and win more deals. This dynamic creates an information and market intelligence advantage for the company with a dominant market share and makes it very difficult for its competitors to disrupt its competitive positioning. Cushman & Wakefield's market share is substantially smaller than its larger rivals CBRE and Jones Lang LaSalle in most of the local markets where it operates. Cushman & Wakefield has an information advantage over smaller brokerage companies, however, the increased availability of commercial real estate data on platforms like CoStar will continue to challenge its market intelligence advantage. 

Cushman & Wakefield’s brand reputation and execution capabilities allow it to attract major multinational clients in its outsourcing business. In fact, the company currently serves large multinational corporations such as Unilever, Citibank, Toyota, and Avaya. The implementation of some of the more operationally intense outsourcing contracts for properties like data centers, life sciences, and so on also depends on the company's knowledge, experience, and execution capabilities. The company has strategically been investing to develop new capabilities and has brought together several real estate services within a globally integrated platform that enables consistent execution on a global scale for corporate clients that want to outsource multiple services to the company. The various acquisitions and internal investments that the company has done over the past few years have effectively put it on a better footing to compete with CBRE and JLL for larger lucrative multinational contracts. In our opinion, the relative execution capabilities gap between Cushman & Wakefield and its competitors is not enough to justify a moat for the company. 

Industry Trends and Competitive Dynamics

Companies around the globe are increasingly realizing that they are better positioned to achieve their financial and operational goals by focusing on their core business competency and leaving real estate strategy and management to specialized service providers like Cushman & Wakefield. In addition to this, while multinationals outsourced various aspects of their real estate operations to different providers, they have been increasingly consolidating providers in recent years. In our opinion, the growth in corporate outsourcing is a secular trend in the industry and will benefit the company for many years to come. These dynamics are reflective of Cushman & Wakefield’s rapidly expanding suite of offerings that include property management, project development, advisory services, appraisal management, and investment management. Management has done a commendable job at expanding its service offerings, however, we believe that the company still has gaps in its service capabilities when compared with its larger rivals. We expect the company to reduce the service capability gaps in the upcoming years and enhance its scale in various service offerings across asset types, business lines, and geographic markets. We have seen that global full-service brokerage firms like Cushman & Wakefield have been successful in increasing their wallet share of the real estate-related spending of their clients.

The real estate services industry has been consolidating over the last two decades, however, it is still a fragmented industry. Industry sources estimate that the five largest global firms combined account for less than 20% of the global commercial real estate services industry by revenue. We think that smaller boutique firms are increasingly becoming less competitive in gaining business from multinational corporations and are ceding share to global behemoths like CBRE, JLL, and Cushman & Wakefield. Leading real estate service companies have broad scale and capabilities to win major client contracts, perform market research, and maintain globally integrated technology platforms that lead to improved service levels. In our opinion, there are only a few companies including CBRE, JLL, and Cushman & Wakefield that have the ability to provide a complete suite of services on a global footprint.

We project healthy growth rates for the company as it benefits from the combination of its continued ability to take share from smaller competitors and several tailwinds in the commercial real estate industry. Among these is the increasing institutionalization of real estate, which is driving investment dollars to the space. Institutional owners tend to use Cushman & Wakefield’s services more frequently and they also tend to turn over their properties more quickly than traditional owners. This dynamic has aided the capital markets business as well as the advisory business of the company. A related trend within the industry has been the globalization of commercial real estate, which has further led to consolidation in the form of M&A and changes in the market share of service providers. Whereas historically real estate service providers established local expertise and operated regionally, increased access to information via the internet and data from providers such as CoStar now benefits firms with a global reach. This is evidenced by the rapid pace of consolidation, with the company’s Cassidy Turley and DTZ acquisitions serving as salient examples. The company has also benefited from the corporate outsourcing trend in the property & facility management business segment as corporates have been increasingly outsourcing their real estate-related operations to companies like Cushman & Wakefield through multiyear, multiservice contracts that are managed by dedicated account teams. The company has been able to generate value for its corporate clients in the outsourcing business by providing convenience, streamlining real estate-related costs, demonstrating consistency across client’s portfolio, and enhancing the speed and agility of real estate operations. The confluence of these structural tailwinds aids the company, which is perhaps the third-largest globally integrated player in the real estate service industry after CBRE and JLL.

Switching Costs

We think that certain aspects of the property, facilities, and project management business benefit from switching costs, reflecting the difficulty involved in switching outsourcing providers. Firms such as Cushman & Wakefield increasingly bundle services to provide a consolidated suite of offerings. We believe that changing service providers in operationally intensive outsourcing contracts in sectors like life sciences and technology may entail business disruption risk; however, these types of contracts are a relatively small portion of the company’s outsourcing business. Beyond the sheer hassle of switching providers, clients do not have a lot of financial incentives in switching providers and only a limited number of companies can effectively compete for these larger contracts. Having said this, the explicit financial cost of switching a service provider is not very high in a large majority of contracts. This is especially true when clients of Cushman & Wakefield consider moving to its larger rivals, which have been creating processes to smoothen the transition period. This dynamic is reflected in the limited pricing power of the company in the outsourcing business. We agree that there is some degree of switching cost in the outsourcing business, but it does not translate into pricing power or economic profit for the company.

Competition Among Larger Firms

Cushman & Wakefield is the third-largest real estate service provider globally and its larger competitors CBRE and JLL have a dominant position in most markets in which they compete. The larger competitors of the company have more scale, a broader range of services, and a longer track record of successful execution, resulting in higher margins within similar business segments. We think that it would be difficult for the company to challenge the dominant position of its larger rivals given the industry dynamics. Other relatively comparable competitors like Colliers International can also match the breadth of service offerings and effectively compete with Cushman & Wakefield for large client contracts in certain geographic regions. The service offerings of the company remain highly competitive, and we believe that the company does not have the ability to charge premium prices for its services when compared with its rivals. In addition to this, it is extremely difficult for Cushman & Wakefield to differentiate most of its services from the services provided by competitors of comparable size. This dynamic makes it difficult to maintain pricing power for most of its services which are largely undifferentiated. 

We also have reasons to believe that the competition for acquiring smaller brokerage firms and unique service capabilities has been quite fierce among the larger firms. The fierce competition for M&A increases acquisition valuations and reduces the return on invested capital. In our opinion, most of the infill acquisitions done by Cushman & Wakefield over the last five years have been fully priced. In addition to this, further consolidation among its smaller rivals also represents a significant risk to the company, since it would make the competitive landscape more difficult for it to operate in.

Risk of Technological Disruption

In the long run, advances in technology, data, and artificial intelligence have a very real potential to disrupt the traditional real estate brokerage model where brokers act as intermediaries in commercial real estate transactions. We now have technology-enabled solutions and standardized property databases that can seriously challenge the value added by a broker. In our opinion, increased data collection and data availability from companies like CoStar have the potential to shift the balance of power in favor of clients. The more clients know about the unique characteristics of a property, recent valuation of comparable properties through transaction data, and likely potential buyers, the less value a broker provides to its clients. Online commercial real estate marketplaces, like LoopNet and TenX, are already providing easy access to property listings, valuation-related data, property contact information, and so on. Currently, the online marketplaces are more like listing services, and they monetize their platforms by providing services to brokers and other commercial real estate professionals. However, in the long run, these platforms have the potential to challenge the traditional brokerage model.

Having said this, we think that large commercial real estate deals that require granular analysis and local market expertise retain characteristics suitable to the current brokerage model. Cushman & Wakefield has been strategically focused on investing capital in technologies to improve efficiency and globally standardize the processes and systems used in the company. It has also partnered and invested with other companies to cope with emerging property technology, deliver data-driven insights, and enhance the client experience. However, in our opinion, the company is behind its larger competitors when it comes to investing in potentially disruptive property technology.

Conclusion

Cushman & Wakefield’s returns on invested capital (adjusted for goodwill) have been below its cost of capital partly due to the nonrecurring expenditures associated with restructuring, integration, and efficiency-related initiatives. We expect its ROIC to materially improve over the next decade as the firm benefits from increased scale and reduced nonrecurring expenses. However, we are not completely confident in the company’s ability to consistently earn returns that exceed the cost of capital. In addition to this, we have not been able to find enough evidence of qualitative sources of competitive advantage to justify a narrow moat rating for the company.

None

Economic Moat

Cushman & Wakefield plc

Cushman & Wakefield Plc engages in the provision of commercial real estate services It operates through the following geographical segments: Americas; Europe, Middle East and Africa (EMEA); and Asia Pacific (APAC). The Americas segment consists of operations located in the United States, Canada and key markets in Latin America. The EMEA segment includes operations in the UK, France, Netherlands and other markets in Europe and the Middle East. The APAC segment comprises of operations in Australia, Singapore, China and other markets in the Asia Pacific region. The company was founded in 1917 is headquartered in London, the United Kingdom.

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Cushman & Wakefield Plc engages in the provision of commercial real estate services. It operates through the following geographical segments: Americas, Europe, Middle East and Africa (EMEA), and Asia Pacific (APAC). The Americas segment consists of operations located in the United States, Canada and key markets in Latin America. The EMEA segment includes operations in the UK, France, Netherlands and other markets in Europe and the Middle East. The APAC segment comprises of operations in Australia, Singapore, China and other markets in the Asia Pacific region. The company was founded in 1917 is headquartered in London, the United Kingdom.

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