Brokers Welcome REA Group’s European Sale

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REA Group will divorce its European portals, selling them to Oakley Capital Private Equity. Brokers welcome the tighter focus on key businesses.

-Europe envisaged taking too long to generate an acceptable return
-Increase in free cash flow should allow for higher dividends
-Online partnership in home loans with National Australia Bank
 

By Eva Brocklehurst

REA Group ((REA)) has divorced its real estate portals in Europe, with the sale to Oakley Capital Private Equity of athome.lu in France and Luxembourg and Casa.it in Italy for $189.7m. As the company has accumulated European tax losses from its venture into Britain, no tax is expected on the sale.

Morgans observes the sale will remove the long-term option values inherent in the company's ability to merge its European portals with another, thus creating synergies. Nevertheless, it would have taken another 3-5 years of investment to achieve an acceptable return. The divestments are strongly accretive to free cash flow as well as the broker's valuation.

Morgans' valuation increases by approximately $0.94 per share as a result of the divestments. As the company has good prospects for continued earnings growth in its real estate marketplaces in Australia, Asia and North America, the broker retains a Add rating. Growth prospects outside of Australia are yet to contribute to earnings per share but are expected to be mildly accretive from FY19 onwards.

The loss of the European option may disappoint some shareholders, Morgans suspects, but the increase in free cash flow will allow for higher dividend pay-outs. Earnings estimates are slightly reduced as the loss of pre-tax earnings from Europe is slightly larger than the returns the company will get in the short term through holding cash on deposit. Overall, the tighter focus should be welcomed, in the broker's opinion.

Limited Benefits From International Network

Macquarie is also positive about the divestments. The broker believes global scale does not guarantee growth and has previously argued that there is limited benefit in terms of real estate classifieds. The European assets failed to generate the returns witnessed in Australia because of different competitive positions, market structures and economic cycles. The broker observes markets evolved independently and real estate markets are more dependent on local network effects than technology.

Macquarie expects the company will enjoy an acceleration in earnings heading into 2017 because of softer comparables for listing volumes and from cost controls that were put in place in the first half. Strong longer term prospects are also expected for the domestic assets through improvements in yield and the development of adjacent businesses.

UBS observes the loss of the euro earnings will only be partly offset by interest earned at the cash rate and therefore expects the sale to be slightly dilutive to earnings per share in FY17-18 although broadly neutral for valuation.

Home Loan Partnership With National Australia Bank

Separately, the company has announced a partnership with National Australia Bank ((NAB)), to offer integrated online home loans through the realestate.com.au portal. National Australia Bank will provide funding for development as well as commissions for home settlements facilitated through the product, which is expected to be launched in 2017.

UBS expects the upfront commission rate would be lower than for other mortgage brokers, given National Australia Bank is also funding development costs. The broker expects the mortgage business, in isolation, will be slightly accretive to earnings per share in FY18, with the potential to become a more meaningful contributor from FY19.

UBS now factors in both the sale of the European assets and the new mortgage business, resulting in a slight reduction to earnings per share in FY17-18 from the loss of European earnings, and given the mortgage business will still be ramping up.

There are six Buy ratings on FNArena's database, with one Hold (Deutsche Bank, yet to report on the divestments). The consensus target is $59.34, suggesting 9.6% upside to the last share price. Not all brokers have made the effort to update their views and projections post these latest announcements.

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