Colliers International Group Inc. Q2 FY2023 Earnings Call

Welcome to the Colliers International Second Quarter Investors Conference Call. Today's call is being recorded. Legal counsel requires us to advise that the discussion scheduled to take place today may contain forward-looking statements that involve known and unknown risks and uncertainties. Actual results may be materially different from any future results, performance or achievements contemplated in the forward-looking statements. Additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statements is contained in the company's annual information form as filed with the Canadian Securities Administrators and in the company's annual report form 40-F as filed with the US Securities and Exchange Commission. As a reminder, today's call is being recorded. Today is August 2, 2023. And at this time, for opening remarks and introductions, I would like to turn the call over to the Global Chairman and Chief Executive Officer, Mr. Jay Hennick. Please go ahead, sir.

Thank you, operator. Good morning, and thanks to everyone for joining us for this second quarter conference call. I'm Jay Hennick, Chairman and Chief Executive Officer of the company. With me today is Chris McLernon, Chief Executive Officer of our Real Estate Services business, and Christian Mayer, our Chief Financial Officer. As always, this call is being webcast and is available on the Investor Relations section of our website, along with the presentation slide deck. During the second quarter, Colliers experienced strong growth in recurring revenues, which contributed 65% of our adjusted EBITDA. Having such a large percentage of recurring revenue highlights our balanced and resilient business model, enabling us to withstand market fluctuations and truly sets us apart from the others. Once again, investment management and outsourcing and advisory experienced robust growth during the quarter, while capital markets, and to a lesser extent, leasing, declined versus the prior year, a record quarter. As everyone knows, lower investment volumes have been caused by rising interest rates, challenging debt availability, and continued price discovery, which we expect will quickly rebound once conditions stabilize. Since the rest of our business has been performing well, we're maintaining our financial outlook for the year, as Christian will elaborate on. Our company is basically comprised of two parts. Colliers, one of the top global leaders in commercial real estate, makes up about 70% of our adjusted EBITDA and is led by CEO, Chris McLernon. Chris will provide some highlights in a few minutes. The second segment is Investment Management, our fastest-growing business. Since 2016, Colliers has built a highly differentiated private investment platform with an impressive $100 million of assets under management. Importantly, 85% of our AUM is comprised of perpetual or other long-duration investment vehicles, giving us predictable revenue streams over the long term. As importantly, 70% of these assets are in defensive strategies like seniors and student housing, healthcare, and infrastructure, classes that are highly sought after with strong tailwinds for the future. During the second quarter, IM continued to scale with revenues up 58%, including the benefit of acquisitions. We continue to invest in our platform, adding investment professionals and new products, as well as strengthening our distribution capabilities. While fundraising remains a challenge for the entire industry, the interest in our investment vehicles has never been greater. We expect our fundraising will accelerate as we move towards the end of the year. And now let me ask Chris McLernon to discuss some highlights from our real estate services business. Once he's completed, Christian will provide his usual financial report, and then we'll open things up to questions.

Thank you, Jay, and good morning. Our vision at Colliers is to accelerate the success of our clients and our people while creating value for our shareholders. Today, Colliers is stronger than ever. It is our unique enterprising culture that sets us apart from our competitors, as we continue to attract and retain the best talent in the industry while taking share from our competitors. Although transactional services of capital markets and leasing declined versus the prior year due to the challenging market conditions, our Outsourcing & Advisory services showed strong growth, continuing the momentum from the first quarter. Globally, capital markets investment volumes have hit the lowest level seen in a decade due to the rapid rise and continued uncertainty around interest rates, combined with tightening debt markets, which is affecting price discovery between buyers and sellers. We are confident that our transaction business will rebound strongly once market conditions improve. In the meantime, to counter the decline in transactional revenue, we have been proactive in optimizing our costs throughout the business. We have done this before, and our enterprising culture, with leadership at all levels, allows us to make hard decisions quickly and in the best interest of our clients, people, and shareholders. Finally, during the quarter, we continued to make progress toward our Enterprise 2025 plan, growing our outsourcing and advisory business internally and strengthening our service offering by completing three strategic investments in the US, Australia, and New Zealand. Now let me pass things over to Christian.

Thank you, Chris, and good morning. Now that you've heard from Jay about investment management and from Chris on Real Estate Services, I will add some comments on our consolidated results, our balance sheet, and our financial outlook for the full year. Please note that all references to revenue growth made on this call are expressed in local currency and that the non-GAAP measures discussed here today are as defined in the materials accompanying this call. For our second quarter, revenues were $1.1 billion, down 4% relative to the prior year, which was a record second quarter for our business. Our capital markets and leasing service lines reported revenue declines of 38% and 7%, respectively, in line with market conditions and our expectations, continuing the challenging trend that started last summer. Our recurring investment management and outsourcing and advisory service lines each reported strong growth. On an overall basis, internal revenues declined 10%, attributable entirely to lower transaction volumes. Consolidated adjusted EBITDA for the second quarter was $147 million relative to $161 million in the prior year, with margins at 13.6% versus 14.3% in the prior year quarter. The margin reduction was attributable to the decline in capital markets volume, particularly in our EMEA region, where producer compensation is partially fixed. The overall margin impact was moderated by growth in our higher-margin Investment Management operations as well as aggressive cost control actions across the company. We have achieved cost savings of approximately 28% during the second quarter, and we expect a similar or greater level of savings in each of the third and fourth quarters. Turning to our balance sheet. Our financial leverage ratio, defined as net debt to pro forma adjusted EBITDA, was 2.4 times at June 30, reflecting capital deployed on acquisitions during the past 18 months, which are performing in line with our expectations as well as seasonal working capital usage. Absent any significant further acquisitions, we expect our leverage to decline to under 2.0 times by year-end. On June 1, we completed the early redemption of our 4% convertible notes, issuing 4.1 million new subordinate voting shares. The early redemption eliminates the interest expense related to those notes and increases the amount of permanent capital on our balance sheet. At present, 55% of our indebtedness is at attractive low fixed interest rates. Our weighted average interest rate for the second quarter was 4.6%, up 130 basis points over the prior year, far less than the 450 basis point jump in floating reference rates during the same period, demonstrating our active management of borrowing costs. With respect to our financial outlook for the full year 2023, we are maintaining our current outlook. We expect lower capital markets and leasing transaction volumes to persist for the remainder of the year, with the impact partly offset by cost control efforts across our company. We also expect continuing strong growth in our recurring service lines, Investment Management and Outsourcing & Advisory. Overall, we expect full year adjusted EBITDA to be up between 6% and 14% relative to 2022. We expect the majority of our second half growth to be focused in the fourth quarter due to easier prior year comparatives in our transactional business and expected incremental management fees from fundraising and investment management. Full year adjusted earnings per share is expected to be down slightly to up slightly on higher interest expense as well as the impact of a larger proportion of earnings coming from non-fully owned operations. That concludes my prepared remarks. I would now like to open the call for questions. Operator, can you please open the line?

Thank you, ladies and gentlemen. We will now begin the question-and-answer session. Your first question comes from Steve MacLeod with BMO Capital Markets. Please go ahead.

Great. Thank you. Good morning, everyone. Just a couple of questions...

Good morning, Steve.

Good morning. Just a couple of questions. One is around the investment management fundraising environment. You suggested that you expect a very strong back half for fundraising. And I'm just curious if you can give a little bit of color around what's driving that. As you pointed out, Jay, I think in your prepared remarks that fundraising is a challenge in the industry, but you're still expecting a strong accelerated back half.

It's still unclear. The slowdown we're experiencing, similar to the entire industry, is due to the uncertainty in capital markets and its impact on asset values in funds. Our Investment Management platform, developed over a long period, emphasizes defense strategies, infrastructure, and other highly sought-after investment classes. Consequently, our redemptions have been modest, unlike many funds focused on traditional real estate asset classes. Generally, investors are becoming more cautious. However, our pipelines are stronger than ever, with increased meetings and discussions with potential LPs. We're excited about this, even though it's taking longer for them to reach final decisions, a trend observed for the past two to three quarters. Eventually, they will need to make decisions, and we believe we will be positioned favorably given our asset classes.

Okay. That's great. That's good color. Thank you, Jay. And then just within Capital Markets and Leasing, obviously, you've talked about just the sort of weaker backdrop persisting for the back half of the year, which I think is an expectation that everyone has. Can you talk a little bit about just sort of your activity levels? Are you seeing a lot of kicking of the tires and just the transactions are not getting done? I mean, just as it relates to potentially pent-up demand?

Hi, Steve. It's Chris here. We're definitely holding more meetings in the second quarter and looking ahead to the third quarter, pitching more and introducing new mandates to the market, though at lower numbers and volumes. However, we anticipate activity will begin to materialize, likely by the fourth quarter. The market has slowed down significantly, as I mentioned earlier, reaching a 10-year low. For instance, Germany has seen a 68% decline year-over-year, and the US is down 65%. That said, we're noticing some promising meetings occurring, and investors seem interested in exploring the market.

That's great. Thanks, Chris. Appreciate that color. Thanks, guys.

Your next question comes from Stephen Sheldon with William Blair. Please go ahead.

Hey. Good morning, guys. Thanks for taking my questions. Great quarter overall in a tough environment. Did want to ask about the slowdown in Outsourcing and Advisory in the Americas. I think it's been growing kind of high single digits the past two quarters, down to 3% year-over-year this quarter. Anything specific driving that, such as tough comps or one-off items? And then how are you thinking about the growth outlook there over the next few quarters and into early 2024?

Just give me a sec here, Stephen, we're going to pull out the...

We’re unsure if we should be surprised by them.

Surprised by your question, but…

Okay. Maybe I'll ask another…

O&A is actually up in the Americas, Stephen, by about $10 million on a quarter-over-quarter basis. So I'm not sure.

Yeah, I asked year-over-year slowdown because it had been growing, I think, in my numbers at least 9% 4Q, 7%, 1Q down to 3% this quarter year-over-year. So I don't know if maybe valuation has slowed down given that there's some transactional…

I believe I understand your question now. Our interest in the Advisory business includes a valuation practice, which is a recurring service that provides ongoing property valuations annually to large financial institutions that hire us for this work. There is also some additional work done upfront when transactions take place and new loans are initiated; however, that part of the valuation business has clearly declined. This could be what you're observing, and it likely represents the main factor contributing to a reduction in volume.

Okay, I understand. That's what I thought. With 2025 approaching and your targets already set, I'm curious about when you plan to share your outlook for 2030. I know there are many immediate matters to address, but when might we expect to see some of those longer-term targets again?

It's interesting you brought up 2030. We are currently working on our plans for that year, which is much earlier than we typically would have started in the past. Usually, we begin formulating our five-year plan about three and a half to four years into our existing plan, but this time we've initiated it sooner. However, I don't anticipate that we will publicly share details before we complete our current five-year plan. We have been doing a lot of thinking about what our organization will look like in 2030, and it's quite exciting from our view as we envision various compelling avenues for sustaining our growth. For now, though, it feels like a long way off. My point is that we believe we can maintain our current growth rate for a significant time beyond the current five-year plan.

Got it. And maybe just one more. Chris, I think you kind of talked about seeing some good activity on the capital markets side, although deal volume is still down quite a bit year-over-year. It doesn't seem like it picked up yet. Some of your peers have reported green shoots in areas like or subsectors like multifamily, industrial, subsectors like that. Just curious what you're seeing out there if we looked by almost by subsector or different asset classes within commercial real estate. Is there more activity happening in certain subsectors than others?

Yeah, absolutely. The number one asset class that investors are looking at is that industrial logistics, it's been a five-year boom in the marketplace. Vacancy is quite low. So we're seeing rental appreciation. And so that continues to be a hot sector. Same with multifamily, with many cities around the world, you've got an over-demand situation where rental tenants are looking for properties, and so we're seeing rental increases in multifamily. So I think that's a good sector. There's the whole flight to quality in terms of office leasing. So the very best buildings, the trophy assets with the best amenities, best locations, and best tenants are still going to be an attractive investment. And then I would say the alternatives, student housing, data centers, etc. But the problem is that it's such a small pool of assets, but it's very much in demand. So those are the sectors that we're seeing that have interest with investors today.

I would also like to mention something related to what Chris said, which is our geographic diversification. Looking at our APAC numbers, they performed surprisingly better than the rest of the world, which is notable since conditions may be improving there a bit, while in the US, capital markets and leasing declined, whereas in APAC, they did not drop as significantly. We are still uncertain if these are early indicators, but to us, that represents a positive sign.

Absolutely. Jay, just to follow up on that. In Asia Pacific, we've got a first-class regional and local management teams. And we're seeing real good progress in our Japanese capital markets business going from strength to strength. We've also improved our operations in Korea and Singapore. So we saw a couple of large transactions this quarter in those two markets. And then a pillar of strength is still our Australian business, and we're seeing some, again, industrial and logistics sales and then the return to residential project marketing with the heavy immigration coming into Australia. So definitely some green shoots there.

Thank you, guys. Appreciate the color.

Your next question comes from Frederic Bastien with Raymond James. Please go ahead.

Thanks. It's nice to have Chris join us for the call and presumably for future ones. Also, thanks for your comments on the APAC region because that was one of the questions I had. I guess my biggest concern coming into the print were margins and they held up quite nicely, especially in the Americas. So it certainly showed you've been quite proactive with your cost structure. Question is around the outlook you provided for the back half. I think you mentioned in your prepared remarks, you expected more savings to be achieved. Wondering if you could provide additional color there? Thanks.

Yeah. Frederik, we've been active on managing our costs, and we've been positioning ourselves to deal with this decline in capital markets activity that started really nine months ago. So we have been proactive in reducing head count and producer support and administration roles, managing that headcount as best as we can despite the fact that there is activity, as Chris says, there's people looking at transactions. So being prudent there on our headcount, managing the discretionary costs in the business, travel, conferences, that sort of thing. So we've made some very good progress there. As I mentioned in my prepared remarks, $28 million in the second quarter, and we're looking for the same or better in the third and fourth quarters and that will positively impact our margin for the full year.

Thanks. How would that differ from the cost savings that you achieved during COVID? Or how different of an approach did you…

It's the same playbook, Frederic, but a different situation slightly. During the pandemic, it was actually much more black and white. Our people were at home. Transactions simply weren't being talked about and weren't being explored. So we made more dramatic cuts to those areas. I think from an overall perspective, the pandemic era cuts were significantly more in dollars, but they were focused on the same areas of our transactional business.

And just to add some additional color. Remember, we've got this decentralized partnership model. And so we've got leadership locally aligned to performance, and they're being proactive. It's a basket of businesses. And so we've got some countries performing well, some service lines performing well. So it's not looking at cost containment across the board. It's being selective and looking at those service lines and countries that are challenged and letting the ones that are going well continue to run well.

And let's not forget the highly variable nature of our professionals globally around the world, that compensation adjusts based on their production. So we feel, as you're hearing from Chris and from Christian, that this is a road we've been down several times before. The structure of our business is quite unique in this respect. And I think leadership has consistently had the fortitude to act when times like these occur, and we're doing that and the results are showing up. So we're pleased with that.

Awesome. Thank you. That's all I have.

Thanks, Fred.

Your next question comes from Jimmy Shan with RBC Capital Markets. Please go ahead.

Thanks. Good morning, guys. Just wanted to follow up on the leasing business. Capital markets revenue versus your peers were down about the same level, but leasing seems to have done a little bit better. I wondered if whether that's different asset mix, geographies, and kind of what would account for seemingly a better year-over-year performance? And then maybe how do we think about the trajectory of that business over the next few years? I know weak office, industrial is strong, but maybe if you could provide some color as to how to think about the growth beyond this year.

Yeah. This is Chris here. It is a geographic topic. So Asia Pacific leasing was up 24% year-over-year on the quarter. And this was attributed to a couple of things. One, again, I mentioned the improved performance in some of our Asia Pacific operations, Korea, Singapore, Japan. And then we've also got a growing business in India. But predominantly, it would be Australia. Again, we are the leader in the A-class landlord leasing business. And there's a whole trend of the flight to quality for office users to go to the best buildings. And so we're capturing a lot of that market in Australia, which is helping the overall leasing markets for the company.

Okay. Regarding your guidance for the year, I have two questions. One is what you expect in terms of AUM growth in the second half of the year. Additionally, is your confidence in the guidance primarily based on the cost-cutting measures you have implemented so far? Is that the main factor allowing you to maintain this guidance?

To answer your question, Jimmy, our AUM at June 30 was $99 billion. We expect to exceed $100 billion by the end of the year, likely by a few billion, driven by upcoming fundraising. We've had minimal redemption activity, so that's not impacting our valuation significantly, and while our AUM has a slight negative effect, we are not worried about it. Fundraising is the key focus for our AUM growth. Our fee-paying AUM is what generates our revenue, while our AUM figure includes leverage. For instance, if we raise $1 billion, our AUM could increase by $2 million due to the leverage in the portfolio. Regarding your other questions, cost control will remain a priority for the rest of the year, which I've mentioned several times during this call, and this is reflected in our outlook. We've also completed three tuck-in acquisitions this year, which will contribute to our results over the next two quarters. Additionally, our outsourcing business is expected to grow in the coming quarters, which will provide further EBITDA to help us meet our outlook.

Okay. That's good.

Thanks, Jimmy.

Your next question comes from Maxim Sytchev with National Bank Financial. Please go ahead.

Hi. Good morning, gentlemen.

Hi.

I just wanted to start a little bit with EMEA, if it's possible. Do you mind providing with more color in terms of the operating earnings loss in the quarter? Is it again, more of a function of the compensation structure than anything else? Or is there sort of any additional data points you can provide on that geography? Thanks.

Yes, Max. It really is that. It's the compensation structure, which has a partially fixed component in capital markets. And as you can see in the materials of the capital markets, revenues in EMEA are down quite significantly in the quarter. So that's the driver of it. The revenues are offset by growth in Outsourcing & Advisory, but those margins in Outsourcing & Advisory are sort of low double-digit area, whereas the capital markets business in EMEA is a significantly higher margin operation. And as the revenues come down, that margin deleveraging is more significant and impacts the amount of EBITDA generated as well as the operating earnings that are generated.

Okay. Thanks a lot for clarifying question. And then, Jay, maybe a bit more sort of a broader question. I mean if you listen to some of the bearish commentary around kind of commercial real estate in general, is that actually potentially the big issue dropping is kind of '25, '26 in sort of timeframe. I'm just wondering what are your thoughts on maybe counterpoints to that view of the world in terms of the potential stabilization when it comes to the value of the properties and how the sausage sort of gets made on that sort of timeframe? Thank you.

I think it's important to look at this in two parts. First, there are various asset classes in real estate that we are all familiar with. The office sector is certainly facing some challenges. However, as Chris pointed out, multifamily units and our defensive assets, like infrastructure, are performing very well. The main challenge we're facing right now is the availability of capital, but I do see a normalization starting to take shape. We still need to see some stabilization in interest rates and a shift in the mindset of both sellers and buyers who are ready to invest in quality assets. I'm hearing projections for '25 and '26, but I don't think it will take that long. I expect to see activity beginning in '24, possibly even early in that year. There are funds that need to make acquisitions and others looking to divest. For instance, Blackstone is selling significant portions of their large REIT to reinvest their capital. Overall, there's a lot happening in the market, and I believe we'll see movement in the more desirable real estate assets sooner than anticipated. While we would prefer to see this happen immediately, it will likely occur earlier than expected, as these assets need to change hands. The real estate market is more mature now than it has ever been. We're anticipating activity in '24, which may not reach record highs but will still be substantial.

Super helpful, Jay. Thank you so much. And then maybe just one last question. Obviously, you continue to build your platform in engineering and consulting. And now that you have quite a bit of size in the business. I'm wondering if you can maybe comment on, give us examples around some cross-selling successes that maybe you would have had across sort of the entirety of Colliers. Yeah, that's my last question. Thank you.

There are numerous examples, particularly in engineering, where significant prework is necessary to transform raw land into a developable asset. Our engineering segment is actively engaged with homebuilders and large distribution facility creators to prepare land, establish sewage and drainage systems, and set up transportation to allow for the sale and development of properties. Clients seeking to buy or develop land often require assistance from an engineering firm for the entitlements needed. This is just one instance. Our Engineering & Design business, which also encompasses project management, is approaching nearly $1 billion in revenue. The project management segment generates substantial business from both engineering and our commercial real estate sector as clients aim to build, renovate, or modify their properties, including office spaces. We are currently focused on understanding the optimal features of office spaces for downtown users, given the trends in remote work and other considerations. I'm happy to provide more detail if needed.

No, that's perfect. Thank you. Thank you so much for the color.

Your next question comes from Frederic Bastien with Raymond James. Please go ahead.

Hi, guys.

Fred.

Just a quick question. I noticed that the investment management margins decreased sequentially from approximately 45% to 42%. You are guiding for around 50% as we approach the end of the year. Can you explain the pressure on the margin and what caused this? Also, how do we return to the trend you have been forecasting moving forward?

Our target for margins is 50% in the next three to five years as we scale the business. This year, we anticipate achieving around 45% for our full-year margin profile. In the last quarter, we invested in our distribution capabilities and other growth initiatives, including new staffing to support new fund launches. These growth investments come with initial costs, but we are confident that they will yield positive results over time, which is why we continue to invest in our platform.

No, that's great color. No, I know you've made significant investments over time and they've certainly paid off. So thank you for that.

All right. Thanks.

Thanks, Chris.

There are no further questions at this time. Please proceed.

Well, thanks, everyone, for joining us on this second quarter conference call, and we look forward to speaking to you again during the third quarter. Thanks for participating.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating, and have a nice day.