On Winkworth ($AIM.WINK) and Valuing Changes in Capital Allocation
Winkworth ($AIM.WINK or "the Company") is a franchisor of real estate agencies largely in London and other parts of the UK. There are currently 104 total Winkworth branded agencies, of which 2 are wholly owned by the Company. Main services offered by these agencies include Property Sales (~54% of the Company's FY22 income) and Lettings/Renting & Management (~46% of the Company's FY22 income).
While not immediately familiar to me (a downside when looking at international companies), the Winkworth brand appears to be fairly well known in the UK, particularly in London - for example, the Company cites that they are the 2nd largest agency by number of properties in Central London (~62% of FY22 income). This is important given the industry is highly competitive, with relatively low barriers to entry and minimal differentiation between players. For what it's worth, Winkworth is the second result (after Foxtons) when typing "London Real Estate Agencies" into Google.
Purely anecdotally, some brief browsing of forums online shows multiple instances of individuals indicating relatively more positive experiences with Winkworth vs. other agencies, but this isn't a strong data point by any means.
Being a franchisor of an established, reputable brand is a great business - franchisors charge franchisees fees simply for using their brand name. In Winkworth's case, the Company earns 8% on all sales and lettings income generated by franchisees with minimal associated expenses, resulting in ~80% gross margins, ~25% EBIT margins, and ~25% FCF margins. Capital intensity is low with revenue greater than total assets, ultimately driving ~30% ROE.
While historically an incredibly consistent, generally predictable business, recent financials have seen material revenue increases as a result of the decision to increasingly allocate capital to the new 'owned offices' portfolio from FY19 onwards (~47% and ~45% revenue growth over FY19 in FY21 and FY22, respectively). This reflects Winkworth's equity investments into select franchisees that are either already high performing or can be improved to this high performing level (based on location, operator, etc.). There are currently two such owned offices, making up a sizable ~30% of revenue today. While a significant driver of growth, owning a real estate agency seems to be a naturally worse business than being the franchisor of one. That said, the real question is whether this is a good use of capital relative to other opportunities.
How should one value a company like this? Again, a company's value should be the present value of all future cash flows. Such cash flows are directly dependent on the ROI of a company's investments AND its ability to reinvest those returns into other investments. As a result, I think one should attempt to ascribe a different valuation to the franchise business vs. the owned office portfolio based on ROI of each segment and revenue growth/reinvestment opportunities. It's also important to look at median metrics across a housing cycle (normalizing for rebounds post the GFC, Brexit, etc.) and discount post-COVID results. True earnings power is obfuscated by volatility in today's housing markets.
Starting with the franchise business, this segment has historically grown revenues at a ~3.7% CAGR from FY06 to FY19, presumably with the majority of this driven by pricing/mix (~1.1% franchise agency unit CAGR from FY09 to FY19). A good indication of the Company's ability to reinvest and grow revenue going forward is management's targeted number of 6 new franchise agencies per annum (down from 8 targeted in FY21). The Company generated ~£60k in revenue per average office from FY17-FY19. Using this as a starting point for the annual revenues generated by franchises at maturity would indicate £0.36m in incremental revenues from new units alone (representing ~6% of FY19 franchised revenues) if we believe the Company can hit its targets.
However, this target is not net of closings - I don't have very high confidence that the Company will be able to grow by 6 net units annually given net agencies grew by only 10 from FY09 to FY19 (i.e. 1 net new unit a year). Overall, I'm hesitant to give the Company much credit for volume growth and think it would be more prudent to assume growth in line with long-term inflation going forward (let's say 3% a year).
This segment has had incredibly consistent EBIT margins in the ~25% range from FY06-FY19. Capital requirements are also very low (minimal CapEx and NWC needs). As a result, I'm comfortable using EBITDA margins to imply normalized FCF (D&A materially exceeds CapEx annually). Median EBITDA margins over the same time period were ~32%. Assuming a 25% UK corporate tax rate gets us to a ~25% normalized FCF margin for this segment (the Company has no debt).
A business with these characteristics should probably trade conservatively at ~3.5x EV/revenue (derived from the multiples discussed in my recent Spyrosoft article). In this case, I have high confidence in my assumptions given the lack of variability in historical results. Applying this to 102 franchised offices at ~£60k in revenue per average office gets us to an intrinsic value of £21.4m.
The owned office portfolio is more difficult to value. Unfortunately, we have a limited track record (no information pre-COVID) and also limited financial disclosures here. At this time, the Company has indicated that they will be opportunistic with this initiative, choosing not to provide a specific number of targeted owned offices a year given it's dependent on finding the right operators to back (which makes sense to me). As a result, It's difficult to judge how much capital the Company will be able to deploy into owned offices and thus hard to predict expansion.
On the flip side, the owned office portfolio does appear to have quite a high ROI (albeit on a small base of investments). Average EBIT margins for the segment in FY19-FY21 were in the ~15% range. Assuming 25% UK corporate tax rates and minimal required capital investments gets us to an ~11% normalized FCF margin for this segment. The statement of cashflows does not seem to separately break out investment into acquiring franchises. This is directional, but if we were to (conservatively) assume that all investing cashflows since FY19 were attributable solely to the owned portfolio, then the investment into this segment would be ~£1m. An 11% normalized FCF margin on FY22 segment revenues gets us to current earnings power of ~£0.3m, or a ~30% ROI (this is likely higher in reality). Obviously, Winkworth is getting quite good deals when taking these equity stakes.
I would have to see more capital deployed in this way to give the Company credit for further owned portfolio expansion, but so far this has been a good use of some capital by the Company. For now, assuming revenue growth in line with inflation for the owned portfolio, this business should probably trade for ~1.75x EV/revenue. Applying this to FY22 segment revenues (which could be argued are overstated given current macro) gives us an intrinsic value of £4.9m.
Total value for the Company thus seems to be around the £26m range. I get to equity value per share of £2.34 which compares to the current stock price of £1.53, reflecting ~53% upside (i.e. trading at ~65% of intrinsic value). At these prices, Winkworth appears undervalued to me, bolstered by a very strong balance sheet. I tend to (arbitrarily) target companies trading at close to 50% of intrinsic value, however I think the owned offices portfolio could represent upside that I'm not currently factoring into my calculations. While not discussed above, insiders are aligned here with the Agace family owning ~47% of shares (Dominic Agace is the CEO with ~6% ownership and Simon Agace is the non-executive chairman with ~41% ownership).
This is one I'm going to continue to monitor and read more about, as well as study competitors. There's still some uncertainty in my mind about capital allocation here - it doesn't seem like the Company will be able to materially deploy capital back into the business, even in the owned offices portfolio, however returns across the business appear strong. The current share price offers an interesting opportunity, but this doesn't yet seem to me to be a screaming buy.
P.S.: If you're wondering why I'm passing on a Company that has upside based on my calculations, it's worth noting that my intrinsic value is directional at best and does not represent a price target or anything of the sort. Something like a 50% trading value to intrinsic value threshold gives me enough margin of safety to be wrong on certain assumptions but (hopefully) still be right about the business. In any event, these calculations are more meant to force me to ascribe a value to a business (thereby practicing valuation) and to express my opinions in the context of that value (ensuring I stay as rational as possible). When making investment decisions, I ultimately think about how much I understand the business, who I'm doing business with, and my confidence in the assumptions I'm using to come to a particular valuation.