Why Gavel Has Hit Property Auctioneer’s Stock
A new stock issue isn’t supposed to collapse a few weeks after making its debut. But that’s what happened to shares of Santa Monica-based real estate auctioneer Kennedy-Wilson Inc.--and its owners naturally are mad as hell.
K-W went public Aug. 7, selling 3.75 million shares to investors at $7 each. By last Friday the stock was at $4 on the NASDAQ market--a devastating 43% loss to the original buyers.
Like many newly public companies, K-W looked like a hot ticket: Known mostly as a successful auctioneer of single-family homes and condos in California since 1979 (you may know the name from its splashy color newspaper ads), K-W now is barreling head-first into the commercial side of the business.
Given the number of commercial property owners that have gone belly-up in the nation’s real estate depression, K-W’s move into that arena seemed to make perfect sense. Selling property via auction can be much quicker and less costly than traditional sales methods, so it should appeal to the many distressed (or even not-so-distressed) commercial real estate owners who want to raise cash fast.
What K-W has painfully discovered, however, is that there’s a learning curve in the commercial business: Despite selling $295 million in property in the third quarter ended Sept. 30--up 134% from a year earlier--K-W on Friday said its commissions and other revenue totaled just $4.8 million in the quarter, flat with a year ago.
Worse, the firm posted a $734,000 loss for the quarter versus earnings of $1.5 million a year ago.
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K-W stock fell from $4.375 Thursday to a low of $3.875 during trading Friday, before closing at $4. Wall Street, already skittish over the departure of K-W’s chief financial officer in October (an amicable split, the company maintains), had pushed the stock down in recent weeks, anticipating bad numbers.
But that didn’t take the sting out of Friday’s loss announcement for K-W shareholder Cumberland Associates, a New York-based money manager that has accumulated a 5.3% stake, or 750,000 shares, since the company’s public offering.
Richard Reiss, a Cumberland managing partner, accuses K-W’s lead stock underwriter, Oppenheimer & Co., of “one of the worst analytical jobs ever in terms of not disclosing how sensitive the company would be to changes in (its business).”
Oppenheimer officials in Los Angeles didn’t return a call for comment Friday.
Despite his anger, Reiss insists that he still believes K-W eventually can generate powerful earnings growth. As recently as 1987, he notes, K-W’s property sales were just $66 million. This year K-W says it should sell between $900 million and $1.5 billion in real estate, half of that commercial properties.
At $4 a share for a debt-free, high-growth firm, “the risk/reward ratio from here is probably pretty good,” Reiss contends.
What’s gone wrong for K-W?
* The commercial real estate market has proven to be a much more difficult business to master than K-W may have expected. Selling single-family homes by auction is relatively simple, and the buyers generally follow through on their purchases. Not so with commercial properties, where the stakes are far higher and the players approach deals much like a poker game.
“Buyers know it’s a buyer’s market, so they know they can string the sellers along,” says James Wilson, analyst at San Francisco-based Montgomery Securities (which also was a major underwriter of the stock, with Oppenheimer). Post-auction haggling is bad news for K-W, because it means that K-W’s sales commissions can be delayed, or lost completely if the buyer walks away.
Indeed, the loss reported Friday was attributed in part to “the delay of the closing of a number of properties sold at auction,” many commercial, K-W said.
What’s more, while the commercial business is potentially much larger than the residential business that K-W knows well, the commercial side has lower margins: K-W’s commissions on commercial sales run 2.5% to 5% of the property’s price, while residential sales commissions can be as high as 6%.
* K-W’s international expansion program has caused expenses to balloon. Gearing up for the bonanza it expects in commercial property auctions, K-W now has 475 people in 22 offices in the United States and abroad--most of them opened just since 1990. Sites include London, Atlanta, Austin and Boston.
General and administrative costs alone leaped to $3.81 million in the nine months ended Sept. 30, up 51% from a year earlier.
Also, K-W has become more aggressive with “marketing assistance” programs, whereby it advances money to property sellers for marketing expenses they incur prior to an auction--with the expectation that K-W will be paid from auction results. The program makes sense as a client lure, but it raises K-W’s costs up front.
Given the size of K-W’s third-quarter loss--$734,000 isn’t small change for a company expecting just $20 million in annual revenue--what worries Wall Street is that K-W may simply have expanded too fast.
Nancy D. Celick, K-W’s new chief financial officer (she had been CFO at First National Corp. in San Diego), says management knows that it must get a firmer handle on expenses. “We’re definitely going to set the stage for expense reductions,” she says, which may include closing some far-flung K-W offices.
But William J. McMorrow, K-W’s 45-year-old chief executive, argues that the bulk of the expansion program was justified, because the company needed to quickly lay the groundwork for the boom it expects in commercial auctions.
“We’ve added people who are going to make a lot of money for us,” McMorrow says. “But it takes six months before (new) people really begin making money.”
As for the delays in closing some third-quarter commercial sales, McMorrow contends that’s nothing terribly worrisome. Some buyers’ reticence, he says, is just “a function of people getting comfortable that the real estate market has bottomed out.”
Also, McMorrow says, “some of the sellers weren’t realistic about the prices they were asking.”
The positive spin on K-W’s third-quarter commercial sales, he says, is that “we generated a tremendous amount of interest on the part of international buyers. Fifty percent of the buyers were offshore. They’re all now coming back at us” looking for additional deals, he says.
McMorrow admits that K-W will never be able to guarantee steady quarter-by-quarter earnings growth because of the fickle nature of its business. He wants K-W investors to focus on the company’s long-term potential: Banks and insurance firms still have huge real estate holdings that they want to sell, he says.
Perhaps more important, he adds, Japanese investors “are just getting themselves geared up” to begin unloading some of their American properties.
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Of course, the key issue is whether there are buyers out there for all that real estate--and whether K-W can turn a decent profit linking buyers and sellers with the auction process.
K-W has built a strong name, but competition alone could squeeze margins in ’93. However, while there are other auction houses out there, Montgomery Securities’ Wilson notes that K-W has leaped ahead of many competitors by forming joint ventures with some major real estate brokerages, such as Jones Lang Wootton.
Still, Wilson says the best he can do in forecasting K-W’s 1993 earnings is to give a range of 40 cents to 80 cents a share. So with the stock at $4, its price-to-earnings ratio on estimated 1993 results is between 10 and five--nominally cheap.
Cumberland Associates’ Reiss, who is traveling to meet with K-W management here this week, figures that in depressing the stock to its current level, investors “have reduced the value of the company’s business to an option value”--meaning maybe it’s worth something and maybe it isn’t.
For now, Reiss figures that his bet on K-W is worth maintaining. “It seems to me that we’re ultimately going to reach ‘clearing’ prices on real estate,” he says, “and that more of that clearing is going to be done by auction.”
Kennedy-Wilson, By the Numbers Santa Monica-based real estate auctioneer Kennedy-Wilson Inc. has been hurt as expenses have soared while revenue has come in below expectations. But the firm insists that the expansion program that has sharply boosted expenses will ultimately bring in significant earnings. Despite booming real estate sales, revenue grows slowly while expenses have soared causing earnings to plunge yet the balance sheet looks healthy.
Nine months ended Sept. 30: Pct. 1991 1992 change Total real estate sales $396,931,000 $565,553,000 +42% Auction commissions 13,137,000 14,213,000 +8% Other income 434,000 1,032,000 +138% Total revenue $13,571,000 $15,245,000 +12% Direct costs $3,843,000 $5,241,000 +36% Compensation 2,761,000 3,749,000 +36% General/administrative 2,522,000 3,806,000 +51% Net income $3,946,000 $1,876,000 -52% Pro forma net income 2,422,000 1,147,000 -53% Pro forma net per share 0.22 0.10 -55% Working capital $1,677,000 $16,570,000 +888% Stockholders’ equity $2,110,000 $23,174,000 +998% Avg. shares outstanding 10,793,000 11,381,000* +5%
Source: Kennedy-Wilson Inc. * current total is 14.1 million shares
