Real Estate Brokerage Royalty by juj67515


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									                                                                                         KALKIN RESEARCH GROUP
                                                                                                  December 10, 2010

                                                                                   U.S. Fixed Income Research
                                                                                   Real Estate Services

Bond Rating     Realogy                                                               December 10, 2010
Overweight      Investment Conclusion: Cost-cutting measures yield high                Nicholas Jenkins
                future cash flow potential                                   
Industry View
                We feel that Realogy‟s second lien is currently underpriced and        James Miele
                are initiating a buy rating. The market is undervaluing the bond
                for three key reasons:
                1. The market is either underestimating Realogy‟s ability to           Bond Price (12/2/2010): 109.00
                   grow with the housing market, or underestimating the housing
                   market‟s upside potential. The real estate market is localized,     YTM (%):                          10.152
                   and corporate policy will have little effect on the actual sales    Maturity:                        04/2017
                   agent whom Realogy relies on to generate revenue. Using
                   very conservative housing growth estimates we see Realogy           Issue Detail:             Second Lien
                   being able to stay out of default. In a case of zero revenue
                   growth, over the next 5 years, Realogy‟s second lien holders        Rating Data
                   will still see a sizeable recovery in bankruptcy.
                                                                                       S&P:                      C
                2. Investors are overestimating Realogy‟s chance of bankruptcy.

                   The company has enough cash to operate until 2013. Our              Moody‟s:                  Caa2
                   analysis of Realogy‟s future potential shows a very high-
                   likelihood of bottom-line improvement through 2015.                 Key Multiples
                3. Investors are failing to factor in the presence of Carl Icahn as
                   a significant bondholder. His experience in bankruptcy case        Fiscal Year       2009A        2010E    2011E
                   proceedings will expedite the process and ensure a significant     EV/EBITDA         17.9x        9.8x     12.8x
                   recovery for secured bondholders. We feel he was making a
                                                                                      Debt/EBITDA       16.0x        9.0x     12.1x
                   play to acquire Realogy‟s equity on the cheap when he bought
                   the firm‟s debt for 40 cents on a dollar in 2008. While the        EV/FCFF           -37.5x       8.5x     16.5x

                   company has fought off bankruptcy, Icahn is patiently waiting      EBITDA             0.8x        1.3x     1.0x
                   for his chance to gain equity control. His investment in            /Interest Exp.
                   Realogy is similar to the approach he took with WestPoint
                   Stevens in 2005, when he rearranged his debt position to take       Projections ($MM)
                   control of the company via equity after the firm filed for
                   bankruptcy.                                                         Fiscal Year              2010E        2011E

                The play on Realogy‟s second liens comes down to whether the           Revenue                  4,192        4,253
                recovery in the housing market can reach Realogy‟s bottom-line         EBITDA                    812          607
                before the company runs out of cash.
                                                                                       FCFE                      821          70

                                                                                       FCFF                      929          466

                                                                      KALKIN RESEARCH GROUP
                                                                               December 10, 2010

COMPANY OVERVIEW                                 We believe that Apollo‟s faith and devotion
                                                 to the distressed real estate firm will become
Realogy was formed in October 2005 after
                                                 a catalyst for future growth. For instance, in
Cendant, a New York-based real estate and
                                                 March 2009, Apollo added another $150
travel company, announced that it would
                                                 million of equity to its stake in Realogy,
split into four separate companies operating
                                                 believing that the company‟s cost cutting
in differentiated categories/industries. In
                                                 measures will only serve to boost the hedge
July 2006, the separation with Cendant was
                                                 fund‟s return in future periods. Further, this
completed, and Realogy became a self-
                                                 was at a time when Realogy‟s unsecured
operating real estate segment spinoff
                                                 subordinated debt was trading at
company. Realogy is currently the world‟s
                                                 approximately 11.5 cents on the dollar –
largest real estate brokerage franchisor, the
                                                 substantially below its current levels. With
largest U.S. residential real estate brokerage
                                                 its senior debt currently trading at a
firm, and the largest U.S. provider of
                                                 premium, we believe that the market has
employee relocation services. The
                                                 inferred Realogy‟s high growth potential,
company‟s revenues are primarily generated
                                                 and pushed the notion of default aside.
from buyers and sellers of existing homes –
and are not directly impacted by new home
starts and real estate development.
The company was taken private by Apollo
Management in early 2007 for
approximately $8.5 billion. Since then,
Apollo has forced the company to enact
serious cost cutting measures in order to
increase its weak cash flows. Realogy has
come dangerously close to not meeting its
debt obligations, but remarkably, with astute
management and accounting tactics, the
company has never failed to service its debt.

                                                                       KALKIN RESEARCH GROUP
                                                                                December 10, 2010

The company operates in four segments: Real Estate Franchise Services (RFG), Company
Owned Real Estate Brokerage Services (NRT), Relocation Services, and Title and Settlement

Real Estate Franchise Services (RFG):            Company Owned Real Estate Brokerage
                                                 Services (NRT):
RFG is the franchisor of some of the most
highly recognized brands in real estate.
                                                 NRT is the largest owner and operator of
Revenues in the company‟s RFG business
                                                 residential real estate brokerages in the U.S.
segment are primarily derived from royalty
                                                 The company also operates a large
fees under long-term franchise agreements
                                                 independent real estate owned (REO)
with franchisees. The agreements are
                                                 residential asset manager focused on bank-
typically ten years in duration. The royalty
                                                 owned properties. Revenues in this segment
fees collected from franchisees are based on
                                                 derives revenues primarily from gross
a percentage of franchisees‟ sales
                                                 commission income received serving as the
commissions earned from real estate
                                                 broker at the closing of real estate
                                                 transactions. NRT has been – and will
Segment Statistics:                              continue to be – focused on acquisitions as a
 - In 2009, approximately 23% of U.S.            primary contributor to its growth.
    homes bought/sold in a brokerage
    transaction involved Realogy
 - Currently occupy 14,700 offices (740          Segment Statistics:
    owned by its NRT segment) and
                                                   -   NRT has approximately 740 company
    employ 267,000 sales associates in 100
                                                       owned brokerage offices with nearly
                                                       44,000 sales associates
 - Company has nearly 4,100 franchisees
                                                   -   Generated more than $107 billion in
    licensed under one of its 6 real estate
                                                       total residential real estate transactions
    franchise brands: Century 21, Coldwell
                                                   -   Increasing number of brokerage
    Banker, ERA, Sotheby‟s International
                                                       acquisitions – 360 acquisitions since
    Realty, Better Home and Gardens Real
    Estate, and Coldwell Banker
 - Highly diversified – none of the 4,100
    franchisees accounted for more than 1%
    of royalty revenue in 2009

                                                                        KALKIN RESEARCH GROUP
                                                                                 December 10, 2010

Relocation Services:                              Title and Settlement Services (TRG):
Realogy‟s relocation services business            Realogy‟s title and settlement business
segment operates through its subsidiary –         assists with the closing of a real estate
Cartus Corporation. Cartus is the largest         transaction by providing full-service title
provider of relocation services in the United     and settlement services to customers, real
States. The company manages all aspects of        estate companies, and large financial
an employee‟s move to facilitate a smooth         institution clients. TRG also coordinates a
transition. Cartus provides home sale             national network of attorneys, title agents,
assistance, home finding, expense processing,     and notaries to service financial institution
arrangement of household moving services,         clients. Revenues are earned through fees
and other general logistic and counseling         charged in real estate transactions for
services associated with moving. Revenues         rendering title and other settlement and non-
are generated primary from client fees paid       settlement related services. Revenues are
for services performed – however,                 also generated from providing services to
commissions from third-party service              customers who are refinancing mortgage
providers also contribute to Cartus‟s             loans.
                                                  Segment Statistics:
Segment Statistics:
                                                     -   TRG has more than 1800 employees
 -   Cartus provides moving services to                  and 375 offices across the United
     more than 140,000 employees each year               States.
 -   Cartus provided relocation services for         -   TRG is the United States‟ 5th largest
     1200 active clients (companies) in over             underwriter, and is licensed in 22
     135 countries in 2009                               states.
 -   In 2009, its top 25 relocation clients had
     an average tenure of 16 years with the
 -   Cartus helps generate revenues to other
     Realogy business segments – many
     Cartus customers utilize NRT or RFG‟s

                                                                      KALKIN RESEARCH GROUP
                                                                               December 10, 2010

The true value of Realogy lies in the
prospects for the US housing market              Currently, Realogy is losing cash at
(specifically existing home sales and            approximately $50 million per quarter. As
average price) and, Realogy‟s ability to         of the end of the 3Q 2010, they had a cash
grow with it. It is clear that the past four     balance of $235 million, and an additional
years have been tough for Realogy, as they       securitization obligation capacity of $225
have been for nearly every company linked        million. Given their current interest rate and
to the housing market. However, the              no new financing, the company will be able
management of Realogy deserves some              to keep their head above water until the end
praise for its ability to keep the company out   of 2012. In this time, we can expect to see
of bankruptcy these past few years.              the housing market begin to pick up, thus
                                                 eliminating the losses into the future. It is a
Through cost cutting measures and
                                                 race as to whether the increases in the
aggressive debt exchanges, the management
                                                 housing market can reach Realogy‟s bottom
has been able to stave off a bankruptcy,
                                                 line before the company runs out of cash.
which only 2 years ago seemed imminent
and unavoidable. However the company is          By Realogy‟s own account, the fourth
not yet out of the woods, and may face its       quarter of 2010 is going to be substantially
toughest challenges in the years to come.        weaker than the third. The now expired
                                                 homeowner tax credit artificially shifted
While the credit markets have recently
                                                 much of Realogy‟s 2010 revenue to the first
shown favor on Realogy, they still may
                                                 half of the year. Despite this November,
ultimately be what force them into
                                                 existing home sales increased 10% from
bankruptcy. The first test of this will be in
                                                 October; analysts were predicting a decline
April of 2012, as Realogy‟s $500 million
                                                 of 5%. This does not mean Realogy is out
securitization obligations expire. This
                                                 of the woods, however – the housing market
source of funding has been what Realogy
                                                 may not stay in its trough as long as
has used to meet its daily obligations and
                                                 previously predicted. Realogy‟s fiscal year
maintain an adequate cash cushion. If the
                                                 2010 makes use mildly optimistic for the
company is not able to roll this over or find
                                                 company‟s future.
another source of financing, bankruptcy will
not be far off. The next test comes in
October of 2013, when Realogy‟s $3.067
billion first lien loans come due. If the
company can make it through these financial
obstacles, we believe that the company will
remain in a stable fiscal state in the future.

                                                                  KALKIN RESEARCH GROUP
                                                                           December 10, 2010

The Housing Market

Our forecast for Realogy includes a 3%
growth rate on existing home sales. If there
is no growth in the housing market, we

project the company going into bankruptcy
in April of 2012. We feel the housing
market is set to least conservatively rise over
the next 5 years and as such Realogy‟s
bottom line will experience growth.

Interest Rates

Realogy‟s dependence on interest rates is
twofold. First the company has $3.5 billion
of debt on floating rate loans.
                                    Exhibit 1             EBITDA/Interest Expense
An increase in interest rates
and the subsequent rise in                                2009A   2010E    2011E
interest expense would affect      Realogy                 0.8x         0.9x          1.5x
Realogy‟s bottom loan. The         Jones Lang
current growth of the mortgage LaSalle                     4.5x         6.5x          8.8x
market is highly dependent on
affordability provided to
                                   CB Richard     Ellis    1.8x         3.9x          4.0x
lenders by low interest rates. If mortgage
rates rise, Realogy‟s top line growth may be
stunted and their bottom line may take a hit.

Credit Markets

Realogy staying out of default is dependent
on the ability of the company to go to the
credit markets and raise additional funds. In
April of 2012 $500 million of securitization
obligations expire. In October 2013
Realogy‟s $3.067 billion term loan facility is
due. The credit markets willingness to
accept new debt from Realogy will depend
heavily on the growth of the housing market.

                                                                           KALKIN RESEARCH GROUP
                                                                                    December 10, 2010

   BOND PRICING                                        the duration is 5.1 (our bond has duration of
                                                       4.52). The bond pays semi-annual coupons
   To value Realogy‟s second lien loan, we             of 4.1875% and is currently trading at
   calculated the total expected payoff, by            105.78. The yield to maturity is 7.75%.
   calculating the payoff in each scenario and         The historical default of a BB+ bond for a 7
   multiplying it by the percent chance of             year period is 8.9%, and that the recovery
   occurrence. We discounted the payoffs of            rate of a senior unsecured note is about 15%.
   each bond at the expected rate of return on a       Given these numbers and the current yield to
   comparable bond. The comparable bond has            maturity we assumed that investor‟s
   a similar maturity, duration, and is not            required rate of return is about 8.75%. This
   callable or convertible. The rating on this         is slightly higher than implied by the price.
   bond needed to imply a default percentage
   of 10%, as that is what we were predicting          Using this required rate of return, we
                                                       discounted the projected bond cash flows
   on our bond.
                                                       back at this rate, weighting each separate
   For this bond we used a senior unsecured            cash flow by its probability. The result was
                                                       an expected bond price of 119.48. The cost
   bond from International Finance Group.              of purchasing this bond today is 111.33
   The bond is rated B1 (Moody‟s) and BB+              (price + accrued interest).
   (S&P). The maturity date is 9/1/2017 and

Exhibit 2 –
Expected Payouts
            Date                  Base Case        Bankruptcy 1     Bankruptcy 2        Bankruptcy 3
        12/10/2010                    (111.33)           (111.33)           (111.33)            (111.33)
         4/15/2011                        6.75               6.75               6.75                6.75
        10/15/2011                        6.75               6.75               6.75                6.75
         4/15/2012                        6.75               6.75               6.75                6.75
        10/15/2012                        6.75               6.75                  0                6.75
         4/15/2013                        6.75                  0                  0                   0
        10/15/2013                        6.75                  0                  0                   0
         4/15/2014                        6.75                  0              66.75                   0
        10/15/2014                        6.75              26.75                  0                   0
         4/15/2015                        6.75                  0                  0                  10
        10/15/2015                        6.75                  0                  0                   0
         4/15/2016                        6.75                  0                  0                   0
        10/15/2016                        6.75                  0                  0                   0
         4/15/2017                        6.75                  0                  0                   0
        10/15/2017                      106.75                  0                  0                   0
       PV of Payoff                   $127.16              $44.02             $69.28              $31.60
   Probability of Scenario               90%                 6%                 3%                  1%

Market Price (12/2/10)                $109
Comparable Rate                      8.75%
Payoff                              $119.48
                                                                       KALKIN RESEARCH GROUP
                                                                                December 10, 2010

For our bankruptcy cases we assumed the
                                                   amount of additional debt, at depressed
most likely outcome of the situations
                                                   prices, in hopes of sitting on a large
described. The actual recovery percentage
                                                   percentage of equity when the company
in each case may vary, either up or down.
                                                   emerges from Chapter 11. Furthermore
Whenever possible we aired on the side of
                                                   Icahn‟s already large position may deter
conservatism. We assumed 10% as the fee
                                                   Hedge Funds from making a play on the
for bankruptcy. Given our business model
                                                   company before it enters bankruptcy.
and our expectations for the bankruptcy
proceedings, we expect bankruptcy fees to
be no greater than 10%.

We based our enterprise value of the
                                                   Exhibit 3 –              Probability of
company on an unlevered DCF model. We
value the enterprise on the day the company      Payout Scenarios            Occurring
goes bankrupt. For the DCF model we              Base Case                         90%
assume a capital structure of all equity, as     Bankruptcy 1                      6%
our debt will be converted to equity. For a      Bankruptcy 2                      3%
WACC we used CAPM, with a risk-free rate
                                                 Bankruptcy 3                      1%
of 2.37%, a market risk premium of 5.7%
and a beta of 1.9.

In either of our bankruptcy cases we see a
smooth bankruptcy process. The presence
of Carl Icahn as a major bondholder (he
holds 19% of the first lien loans) should
improve the efficiency of the process. We
believe Icahn made a play for the equity of
company when he purchased its debt for 40
cents on a dollar in 2008. Even though
Icahn is already sitting on a substantial
profit, we believe his true play is to acquire
the company‟s equity in bankruptcy. He has
already blocked several of Realogy‟s debt
relieving initiatives, stating the company
was only “Delaying the inevitable.” We feel
that if the company enters bankruptcy, Icahn
will make a play to acquire a significant

                                                                          KALKIN RESEARCH GROUP
                                                                                   December 10, 2010

Bankruptcy Case 1: Chapter 11

If, within the next 9 quarters, the housing          The value of the firm provides ample value
market fails to lift from the bottom it is           for both the first lien bondholders and the
currently in, Realogy will not have the cash         securitization obligation holders to be paid
needed to meet obligations and may not be            in full.
able to refinance its debt. We do not see this
scenario being very likely, as home prices
cannot stay this low for an extended period
of time. This can also represent a situation
in which Realogy was not able to benefit
from growth within the housing market.
There may be pain hidden within Realogy‟s
franchises. We feel this is unlikely as,
despite the significant cost cutting, Realogy
has been able
to retain 92%                                         Outstanding           Recovery         Recovery
                         Exhibit 4 – Bankruptcy 1
of its sales                                           Amount               Amount             Rate
agents in the         Secured Credit Facilities:
top                   First Lien Loans                    3,061               2,908             95%
performing            Securitization Obligations           552                 552             100%
quartile. This        Second Lien Loans                    650                 169              26%
scenario has a        Unsecured Credit Facilities:
6% chance of           11.5% Senior Notes                 1,688                 0               0%
playing out.           12% Senior Notes                    470                  0               0%
                       13.375% Senior Subordinated         875                  0               0%
In this case,         Fees                                                    (400)
the recovery          Total                               7,308               4029
rate is 26%.
Based on an unlevered DCF valuation, the
enterprise value of Realogy is $4.029
billion; with over more than $3 billion in
first lien loans, it is unlikely the second lien
holders will recovery everything. The chart
below shows the expected recoveries given
this scenario.

                                                                       KALKIN RESEARCH GROUP
                                                                                December 10, 2010

Bankruptcy 2 – Chapter 11

Our second bankruptcy case represents a            lien holders, we feel that the non-secured
situation where short term interests rates         debt holders will demand a payout and the
begin to rise and by 3Q 2011, the prime rate       secured debt holders will appease them to
by which Realogy‟s debt is set, is up              expedite the bankruptcy process.
100bps. $3.061 billion of Realogy‟s debt is
tied to this rate. The combination of this and     While Realogy may be able to obtain
the increased interest expense resulting from      additional funding, given this case, the
Realogy‟s most recent debt issuance cause          increased market rate will make it nearly
the cash reserves to be depleted. Under            impossible for Realogy to operate profitably
these conditions, the company‟s cash and           without restructuring. As a result we see
available credit facilities will be depleted by    them going into Chapter 11 and coming out
the start of 4Q 2012. This situation assumes       a lean, nearly debt free company.
debts will be rolled over as they come due.
There is a 3% chance that this scenario will
take place.
                                                        Outstanding       Recovery        Recovery
We ignore the fact          Exhibit 5 – Bankruptcy 2
                                                           Class          Amount            Rate
that increased           Secured Credit Facilities:
interest rates may        First Lien Loans                 3,061            2,877                94%
negatively affect         Securitization Obligations        552              552                100%
the housing market,
                          Second Lien Loans                 650              390                 60%
as mortgages will
                         Unsecured Credit Facilities
become more
                          11.5% Senior Notes               1,688              84                5%
expensive. This
                          12% Senior Notes                  470              23.5               5%
will affect the
                          13.375% Senior Subordinated       875                0                0%
housing market in
                          Fees                                              (430)
the short term,
                         Total                             7308            4353.84
however, long term
its effect will be small. The decreased
revenue may force the company into
bankruptcy earlier, but we feel the effects of
this will be negligible in the actual payout.

The resulting equity value, based on the
aforementioned unlevered DCF model, is
$4.353 billion. In this situation we predict a
90% recovery for the second lien bonds.
Because of the high payout to the second

                                                                     KALKIN RESEARCH GROUP
                                                                              December 10, 2010

Bankruptcy 3 – Chapter 7

In our third bankruptcy case, we considered     company when he purchased its debt for 40
a scenario, in which the company enters         cents on a dollar in 2008. Even though
bankruptcy and is forced into chapter 7         Icahn is already sitting on a substantial
rather than chapter 11. We feel that this       profit, we believe his true play is to acquire
case is extremely unlikely; however it is       the company‟s equity in bankruptcy. He has
necessary to look at. The company is worth      already blocked several of Realogy‟s debt
considerably more as a going concern and as     relieving initiatives, stating the company
such if the company enters liquidation the      was only “Delaying the inevitable.” We feel
recovery rate of the bondholders will be        that if the company enters bankruptcy, Icahn
significantly less than in the case of          will make a play to acquire a significant
restructuring. We can only see this             amount of additional debt, at depressed
happening if bondholders just cannot agree      prices, in hopes of sitting on a large
on the distribution. Because the value to the   percentage of equity when the company
bondholders is significantly more if the        emerges from Chapter 11. Furthermore
company enters restructuring, we feel           Icahn‟s already large position may deter
liquidation only has a 1% chance of             Hedge Funds from making a play on the
occurring. The actual bankruptcy may be         company before it enters bankruptcy.
brought on by a number of factors, but the
payout in the case of liquidation will be
about the same.

Summary of Bankruptcy Proceedings

If Realogy enters bankruptcy we see the
process as a restructuring rather than
liquidation. The value of the company as
go-concern is substantially more than the
sum of its individual parts. Realogy‟s $1.4
billion in deferred tax liabilities is a
substantial cause of this.

In all of our bankruptcy cases, we see a
smooth bankruptcy process. The presence
of Carl Icahn as a major bondholder (he
holds 19% of the first lien loans) should
improve the efficiency of the process. We
believe Icahn made a play for the equity of

                                                                         KALKIN RESEARCH GROUP
                                                                                  December 10, 2010


                                                   Revolving Credit Facility
On April 10th 2007, in accordance with
Apollo‟s LBO, Realogy issued a senior              Realogy has been unable to draw upon their
secured loan facility consisting of a $3.067       $750 million revolving credit facility because
billion term loan facility (First Lien Loans), a   of their senior secured debt
$750 million Revolving Credit Facility, and a      covenants. Despite their inability to borrow,
$650 million incremental loan facility             Realogy, by contractual obligation, pays 50
(second Lien Loan).                                bps annually to keep this facility open. This
                                                   facility expires in April 2013.
Term Loan Facility
At end of 3Q 2010, the term loan facility had
an outstanding balance of $3.067                   Second Lien Loans
billion. Interest on the loans is the              In October of 2008 Realogy issued a total of
company‟s choice between LIBOR (3 month)           $650 million of 13.5% second Lien
plus 300 bps, or the greater of the JP Morgan      Loans. $500 million of these loans were used
Prime Rate plus 200 bps or the Fed Funds           to retire $1.1 billion of subordinated
Rate plus 50 bps. This is Realogy‟s largest        debt. These loans expire in October 2017 and
loan class and comes due in October of             are rated Caa2 by Moody‟s and C by S&P.
2013. Covenants on these loans stipulate the
company must keep a secured debt to
adjusted EBITDA of 5x (4.75x after April
2011). Adjusted EBITDA is calculated using
an average of Realogy‟s pro-forma EBITDA
over the last 4 quarters.

  Exhibit 6 – Outstanding Debt Summary                                     Coupon       Maturity
                                                   Borrowings ($MM)
Senior Secured Loan Facility
 Term Loan Facility                                       3,067             5.25%*      10/1/2013
 Synthetic Letter of Credit                                138               5.0%*       4/1/2013
 Second Lien Loan                                          650               13.5%      10/1/2017

Unsecured Notes
 10.5% Senior Note                                        1,688             10.5%       4/1/2014
 11%/11.75% Senior Toggle Note                             441              11.0%       4/1/2014
 12.375% Senior Subordinated Note                          864             12.375%      4/1/2015

Securitization Obligations
 Apple Ridge                                               313            4.341%**      4/1/2012
 Cartus Financing Limited                                   25            4.341%**      Various
*Represents interest rate on bank borrowings
** Based on weighted average borrowing cost

                                                                        KALKIN RESEARCH GROUP
                                                                                 December 10, 2010

Securitization Obligations                         BOND COVENANTS
At end of 3Q 2010 Realogy had $338                 Realogy‟s senior secured credit facility
million outstanding of their $563 million
                                                   contains a financial covenant, which may limit
securitization obligations. These obligations
are secured against Realogy‟s                      the company‟s ability to raise additional debt
receivables. For 3Q 2010, Realogy paid a           if needed. The bond covenant states that
weighted average annual interest rate of           Realogy‟s total senior secured net debt must
4.3% on these obligations. These                   not exceed 5.0x Adjusted EBITDA. Adjusted
obligations have covenants regarding
                                                   EBITDA is defined as the trailing 12-month
collectability and the creditworthiness of
those extended credit. These obligations           EBITDA plus additional cost-saving and
expire in April 2012.                              business optimization initiatives on a pro-
                                                   forma basis. Total senior secured debt
                                                   includes total borrowings under the senior
UNSECURED CREDIT FACILITY                          secured credit facility, which includes capital
                                                   lease obligations, but excludes second lien
Realogy has unsecured debt outstanding of
$3.019 billion. This facility consists of $1.688
billion 10.5% senior notes, $441 million in        A violation of its financial covenant would
pay in kind Senior Toggle notes, and $864          force Realogy to default on its debt
million in Senior Subordinated notes, with         obligations. Realogy, however, has never
varying expiration dates. On December 1st          failed to meet its bond covenants. As shown
2010 Realogy announced plans to exchange           in Exhibit 7, the company has generated
this debt for new debt issues. This exchange       sufficient EBITDA to meet the constraints
would be a dollar for dollar change for new        of its financial covenant over the past eight
debt issues with varying coupon rates. The         quarters – even with the decrease in ratio
bondholder will have the option between            guidelines during the third quarter of 2009.
accepting senior or subordinated notes. Both
                                                   In the 1st Quarter of 2011, the covenant
the old facility and the new issue have
covenants that will not materially affect our      guideline steps down from 5.0x to 4.75x
business operations.                               Adjusted EBITDA. Although this
                                                   represents a significant ratio decrease, we do
                                                   not believe that this will adversely affect
                                                   Realogy‟s business in any way. With
                                                   EBITDA projections estimated to grow at a
                                                   10% CAGR through 2015, we do not
                                                   believe that Realogy will violate its senior
                                                   secured bond covenant in the future. During
                                                   the next five years, the firm will be able to
                                                   generate sufficient EBITDA in order to
                                                   satisfy its updated financial covenant.

                                                                      KALKIN RESEARCH GROUP
                                                                               December 10, 2010

Furthermore, in the past, Realogy has had
substantial control over the inputs that
determine its ability to meet its financial
covenant. Consider the events just prior to
the 3rd Quarter close in 2009: Realogy                         Exhibit 7
entered into a Senior
Toggle Note
Exchange agreement
                                           Historical Covenant Compliance
with its debt holders                  5.35     5.35
on September 24,
2009 – allowing the
company to exchange                                        5.0       5.0     5.0     5.0        5.0
$221 million in senior
toggle notes for $150
million in second lien
loans. The company                  5.09     5.15
                            4.50                       4.94
recorded a gain on the
extinguishment of                                                4.66
                            4.25                                         4.51              4.57
debt of $75, but the                                                             4.34
true value of the           4.00
exchange came from                  2009 1Q 2009 2Q 2009 3Q 2009 4Q 20010 1Q 2010 2Q       2010 3Q
satisfying its senior
                                               Debt / Adjusted EBITDA
bond covenant. With
                                               Maximum Multiple Allowed by Covenant
$221 million less in
senior secured debt, the company safely met
its senior secured leverage ratio at 4.94x
EBITDA – just under the covenant
guidelines of 5.0x. If the company can
continue to make the necessary accounting
adjustments to satisfy its financial covenant,
we do not believe a breach of covenant will
be likely in the future. Realogy‟s control
over its debt holders and covenant-defined
capital structure will allow the company to
make the necessary adjustments in order to
avoid default.

                                                                            KALKIN RESEARCH GROUP
                                                                                     December 10, 2010

                                                        2010, with the sales-enhancing homebuyer
Realogy operates in the United States
                                                        tax credit ending on April 30, 2010. As
residential real estate industry. The
                                                        Exhibit 8 shows, the homebuyer tax credit
company‟s revenues are primarily dependent
                                                        was responsible for increased homesales
on the volume and price of existing
                                                        during April, May, and June of 2010. The
homesales. While the housing market has
                                                        homebuyer tax credit increased the demand
encountered severe economic turbulence
                                                        for houses in April, as many homebuyers
over the past few years, recent results from
                                                        rushed to sign contracts for home purchases
the National Association of Realtors may
                                                        just before the end-of-month deadline, and
prove that the housing market has reached
                                                        subsequently increased homesales for the
its trough and is finally beginning to
                                                        next two months when transfers of
stabilize. The number of people who signed
                                                        ownership were completed.
contracts to buy homes increased 10.4% in
October – a figure well above the
expectations of economists and financial
This is an outstandingly positive sign for a
market that was thought to have maxed out
its demand for housing in the 1st half of
                                                                    Exhibit 8

                       United States Monthly Home Sales




                                   April 30, 2010:
  200,000                          Homebuyer Tax Credit ends


              Jan-10      Feb-10        Mar-10      Apr-10      May-10      Jun-10     Jul-10

                                         United States Home Sales

                                                 KALKIN RESEARCH GROUP
                                                          December 10, 2010

The obvious rebuttal to the National
Association of Realtor‟s positive news
release is: What about prices, especially
future prices? As Exhibit 9 reveals,
consistent with what someone might expect,
the increased housing demand as a result of
the homebuyer tax
                                                    Exhibit 9
credit drove up the
asking price for
houses through July
2010. After July,
however, prices
dropped by
approximately -6.2%
into November, and
reverted back to
their pre-homebuyer
tax credit sales
levels. With this in
mind, we believe
that a substantial
increase in home
purchase agreements
in November
(+10.4% increase) will yield meaningful
home sale price increases over the next few
months. A combination of increased home
sales and increased prices during the 1st half
of 2011 will propel Realogy‟s revenues,
allowing the company to easily meet its
financial covenant and easily avoid default.

                                                                        KALKIN RESEARCH GROUP
                                                                                 December 10, 2010

Although the housing market has recently
been battered by falling prices and existing
homesale declines, we believe that the
market‟s future growth looks promising as
national home prices finally reverted back to
their mid-2003 levels. The housing market
is surely in a recovery                                                     Exhibit 9
phase – but well
beyond its deep                                 Projected U.S. Home Sales
trough in May 2009        5,800,000
when prices were
3.2% below their
current levels.           5,400,000
Exhibit 9 provides
evidence of an            5,200,000
                                                                       3% CAGR
expansionary housing
market. The
homesale projections      4,800,000
were estimated using
a simple average of
Fannie Mae‟s              4,400,000
estimates and                           2010E     2011E       2012E     2013E     2014E     2015E
research performed                                        Total U.S. Homesales
by the National
Association of Realtors. Between 2010 and
2015, existing homesales are expected to
increase a 3% compound annual growth rate
(CAGR). This growth, combined with
average homesale prices increasing at a
1.6% CAGR during this same time, will
allow Realogy to increase its revenues and
improve its currently laggard financial

                                                                                   KALKIN RESEARCH GROUP
                                                                                            December 10, 2010

As a real-estate service conglomerate,              company will benefit from improved market
Realogy‟s business diversification insulates        conditions in the future, and ultimately
the company from fierce competition with            return to a stable financial condition – with
any one particular firm. Instead, Realogy is        positive net income and increased net
forced to compete with particular business          margins – by 2015.
segments of individual firms, rather than the
firm as a whole. Two of its largest
competitors, Jones Lang LaSalle (JLL) and
CB Richard Ellis (CB), offer the                                                      Exhibits 10 & 11
most services in common with
Realogy, and as such, were used                                    Gross Margins
for comparative purposes.             60.0%     53.0%                                                    53.7%

Exhibits 10 and 11 display the        50.0%                                                                              42.9%
                                                                41.2%                      41.9%
gross and EBITDA margins of           40.0%
Realogy, Jones Lang LaSalle, and      30.0%
CB Richard Ellis from 2009 –          20.0%             34.5%                      35.0%                         34.7%
2011E in chart form. JLL‟s and
CB‟s forward looking margins
were estimated using analyst          0.0%
                                                    2009A                      2010E                         2011E
consensus forecasts. As
evidenced by the chart, Realogy‟s               Realogy           Jones Lang LaSalle               CB Richard Ellis
forward looking gross and
EBITDA margins look much                                        EBITDA Margins
healthier than its competitors‟       25.0%
estimated figures. Its 2011E
EBITDA margin is 260 bps              20.0%
higher than its closest competitor,                                                                      14.3%
and its 2011E gross margin is 108               11.8%                                                                    11.2%
bps higher. We believe this is a      10.0%                     8.0%
very encouraging sign for a
                                                                                   11.5%                         11.7%
company that has experienced          5.0%              10.0%

significant net losses in recent
years. If Realogy can continue to     0.0%
                                                    2009A                      2010E                         2011E
generate sufficient cash flows to
service its debt obligations over               Realogy            Jones Lang LaSalle              CB Richard Ellis
the next few years, we believe the

                                                                  KALKIN RESEARCH GROUP
                                                                           December 10, 2010

Realogy‟s outstanding equity was purchased     The company‟s forward-looking
by Apollo Management in April 2007 – only      EV/EBITDA multiples (13.7x ‟11E & 14.2x
a year and a few months after the company      „12E) reveal that Apollo‟s purchase of
was formed – for $8.5 billion. The             Realogy may have been due to its future
economic turbulence caused by the housing      cash flow potential, and its subsequent
market clearly had adverse effects on          ability to pay down high debt balances.
Realogy‟s operations, and a private equity
intervention was needed to help the business
remain viable.
The private equity deal was highly
leveraged, with Apollo using
                                   Exhibit 12 - LBO Financial Details
only $1.99 billion of its own
equity. Exhibit 12 details the     Equity from Apollo                                $1,990
financing specifics of the
buyout. Apollo submitted an
                                   Term Loan (revolving credit loan and
                                   secured facility)                                  4,270
initial offer of $29 per share on
November 21, 2006, but
increased its final offer to $30
                                   Senior unsecured loan                              2,750
per share shortly after.           Senior subordinated loan                            900
As Exhibit 13 reveals, Apollo       Replacement relocation      receivables
paid a slight premium (11.6x        securitization facilities
2006) for Realogy on an
Enterprise Value-to-EBITDA basis when
compared to similar residential real estate
industry acquisitions. This, however, does
not necessary mean that Apollo overpaid for
the distressed real estate company.

Exhibit 13 – Implied LBO Multiples                       1Q 2006 EV / EBITDA

Realogy at $30/share                                                  11.6x
Residential Real Estate                    Mean                        8.4x
Industry                                   Median                      8.1x

                                                                       KALKIN RESEARCH GROUP
                                                                                December 10, 2010

SUBSEQUENT LAWSUIT                                 improve the bondholders‟ likelihood of
In November 2008, Realogy announced a              principal recovery. Existing bonds,
debt exchange program that could have              however, would have been effectively
potentially reduced the company‟s                  subordinated to new term C/D loans under
outstanding debt by $592 million, and              the exchange agreement.
allowed the company to satisfy its bond            Carl Icahn, owner of High River LP, in
covenant more easily. The terms of the             conjunction with the trustee that holds the
exchange allowed senior unsecured or               Realogy bonds, Bank of New York Mellon,
subordinated bondholders owning $1.1               sued the real estate company on November
billion in debt to swap their securities at a      26, 2008, shortly after the debt exchange
discount for as much as $500 million in            program was announced. Mr. Icahn,
principal of new second lien loans that            through High River, owns Realogy‟s senior-
would have matured in 2014. As Exhibit 14          secured debt, which, at the time, was the
reveals, debtholders of certain tranches           first to get paid if the company filed for
could have exchanged their unsecured or            bankruptcy. Icahn believed that the debt
subordinated notes for as much as 50 cents         exchange unfairly pushed his senior bonds
on the dollar – a very material discount even      to the back of the repayment line. He also
for a firm with cash flow insufficiencies.         claimed that the program would violate
The exchange agreement would have                  certain provisions of the company‟s credit
benefitted both Realogy and its subordinated       agreement.
or unsecured bondholders, but put certain
existing bondholders at a steep
disadvantage. Realogy benefitted by
reducing its leverage; bondholders who
exchanged benefitted by increasing their
position in the capital structure and reducing
the default risk of their security. In addition,
if Realogy did default, the increased position
in the company‟s capital structure would

                      Exhibit 14 - Debt Exchange Agreements
Amount                                       Coupon Due          Exchange Agreement
Senior Subordinated Notes                     12.38%   2015               36/100
Senior Unsecured Notes                        10.50%   2014               50/100
PIK Toggle Notes                                       2014               47/100

                                                                          KALKIN RESEARCH GROUP
                                                                                   December 10, 2010

 THE VERDICT                                         ICAHN’S PLAY
 In December 2008, a Delaware court ruled            Carl Icahn has made a career for himself as
 in favor of Mr. Icahn, and stated that              a corporate raider – an investor who buys
 Realogy must obtain agreement from the              large interests in a corporation and then uses
 majority of its bank lenders to amend or            the acquired voting rights to benefit
 waive provisions of the credit agreement.           shareholders (i.e., himself) by increasing the
 Realogy soon cancelled the debt exchange            firm‟s equity value. We believe Mr. Icahn‟s
 program after losing the lawsuit. As of             original position in Realogy‟s second lien
 December 31, 2009, High River owned                 debt was the first step in a series of
 approximately 19% of Realogy‟s                      transactions that would allow him to use his
 outstanding first lien bank debt, but had           corporate raider tactics, and eventually take
 eliminated its entire position in Realogy‟s         control of the distressed real estate firm.
 second lien debt. Mr. Icahn, in a letter to         Take for instance his activities in the 2005
 High River shareholders at the end of the 4Q        bankruptcy of WestPoint Stevens, Inc.:
 2009, stated that liquidating its second lien       Icahn was the largest first lien debt holder,
 debt position in Realogy was to “take               and bought into the second lien loans when
 advantage of the credit rally,” and not a loss      he was trying to acquire the company. With
 of faith in the real estate company. Mr.            Chapter 11 reorganization, Icahn was able to
 Icahn further explained that High River             receive asset value equal to his debt stake in
 continues “to believe that Realogy‟s                the company, and ultimately took control of
 business model and franchise will be well           the company via auction. As a study from
 positioned when the real estate market              Wharton noted, second lien lenders will
 bounces back.” While Mr. Icahn may                  often buyout the first lien position to
 believe in Realogy‟s business model, we             expedite reorganization negotiations.
 believe that he may have ulterior motives for       Second lien creditors are primary hedge
 his investment.                                     funds who trade into their positions with the
                                                     sole intention of taking control of the

“We continue to believe that Realogy‟s business model and franchise will be well
positioned when the real estate market bounces back. We will continue to
evaluate the risk/reward scenario that Realogy presents to [Icahn Capital].”
                                 –    Carl Icahn, Icahn Capital, 4Q 2009 letter to shareholders

                                                                        KALKIN RESEARCH GROUP
                                                                                 December 10, 2010

The similarities between the beginnings of         yield very profitable returns in future
Icahn‟s play in Westpoint Stevens in 2005          periods. With FCFF expected to increase at
and now in Realogy in 2010 are striking.           a 4.8% CAGR from 2011E – 2015E, Icahn
Icahn‟s addition of Realogy‟s first lien debt      was certainly interested in taking advantage
was identical to his move in the Westpoint         of the firm‟s future cash flow potential, and
Stevens case. This cross-lien ownership            wanted to maximize his profits by acquiring
may provide enough evidence to deduce              the company at a very low price.
Icahn‟s true motive. As the abovementioned         Undoubtedly, if Icahn acquired a large
study noted, when hedge funds have a cross-        equity stake in the company, management
lien position, it is typically a sign that the     changes and operational cuts would have
hedge fund is pursuing equity control.             ensued. Realogy‟s management, however,
Adding first lien Realogy debt to his              had other ideas for the potentially profitable
portfolio was, undoubtedly, a clear                firm, and went ahead with their debt
indication that Icahn had a serious interest in    exchange program.
reorganizing the firm. In our opinion, we
believe that Icahn‟s lawsuit was a direct                                        Exhibit 15
result of the
financier not being                            EBITDA and FCF Growth
able to fulfill his
ultimate plan for          900                                                            +8.3% CAGR
the company. He            800
became infuriated
that the company
prevented – or was         600                                                            +4.8% CAGR

attempting to
prevent –
impairment of its          400
first lien loans,          300
which resulted in
Icahn being unable         200

to acquire an equity       100
position in the firm.
It is quite likely              2011E        2012E       2013E       2014E          2015E
that Icahn realized
an equity position
in a reorganized                                     EBITDA        Free Cash Flow
Realogy could be

                                                                       KALKIN RESEARCH GROUP
                                                                                December 10, 2010

DCF VALUATION                                      An analysis of historical Capex yielded
                                                   inconclusive results. Based on the business
A Discounted Cash Flow (DCF) model was             model of Realogy, as well as what is
used to determine Realogy‟s value as a             transpiring within the housing market, we
Going Concern and in the case of a                 felt that projecting future Capex as a
bankruptcy restructuring.                          function of sales was most appropriate. This
Realogy‟s future revenues were forecasted          method would most adequately capture the
from a sales analysis used to project industry     relationship between growth in the housing
and company retail sales on a quarterly            market and necessary investment.
basis. This data was then used to forecast an      The statutory tax rate for Realogy is 35%,
Income Statement, Balance Sheet, and Cash          however the actual tax rate, as implied on
Flow Statement for 5 years. The DCF                the Income Statement and reported in the
technique is based on the perpetual growth         10-K, has varied considerably. As a result,
model, and thus, all financial projections for     we assume Realogy will be paying its
the final year were then grown into                statutory rate of 35% into the future.
The historical Income Statements,
Balance Sheets, and Statements                      Exhibit 16 - DCF Calculation
of Cash Flow were used to create
common-size statements. Each          NPV of FCFF for Partial Year 10E & 11E - 15E          2,200
item was forecasted using its         NPV of Terminal Value with Growth                     6,760
                                      Total NPV of Firm                                     8,960
most likely driver. In some cases
                                      Less: Net Debt, End of Period (2010E)                 7,073
historical averages were used,
                                      Total DCF Equity Value                                1,887
however, for some items, more
advanced statistical tools,
                                      Weighted Average Cost of Capital                      8.08%
including regression, were used..
                                      Terminal Growth Rate                                   2.0%

Exhibit 17                                          Free Cash Flow to Firm
                                       2010E      2011E    2012E 2013E          2014E      2015E
FCFE                                      821         70      166        71        139         120
Interest * (1-Tax Rate)                   397        396      397       404        403         402
New Debt - Repayment                      289          0      100      (50)          0        (50)
Free Cash Flow to the Firm                929        466      463       525        541         571

Discount Period                            0.05     0.50      1.50       2.50      3.50      4.50
Discounted FCF Values                        93      448       412        432       413       403
Undiscounted Terminal Value                                                                 9,589

                                KALKIN RESEARCH GROUP
                                         December 10, 2010
Exhibit 18 – Income Statement

                             KALKIN RESEARCH GROUP
Exhibit 19 – Balance Sheet            December 10, 2010

                          KALKIN RESEARCH GROUP
Exhibit 20 – Cash Flows            December 10, 2010

                              KALKIN RESEARCH GROUP
                                       December 10, 2010
Exhibit 21 – Revenue Growth

                                KALKIN RESEARCH GROUP
                                         December 10, 2010
Exhibit 22 – Enterprise Value

    Exhibit 23 – Margins

                                   KALKIN RESEARCH GROUP
                                            December 10, 2010

  Exhibit 24 – EBITDA

Exhibit 25 – Covenant Compliance

                                              KALKIN RESEARCH GROUP
Exhibit 26 – Comparable Multiples & Margins            December 10, 2010

        Exhibit 27 – Monthly Home Sales

                                        KALKIN RESEARCH GROUP
                                                 December 10, 2010
Exhibit 28 – Free Cash Flow to Equity

Exhibit 29 – Free Cash Flow to Firm


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