Third Level, D.E. Shaw acquire agreements with CoStar. How the activists can construct worth

Enterprise: CoStar Group is a supplier of on-line actual property marketplaces, info and analytics within the property markets. It manages its enterprise in two segments: North America, which incorporates america and Canada, and Worldwide, which primarily contains Europe, Asia-Pacific and Latin America. Its main manufacturers embody CoStar, a worldwide supplier of business actual property information, analytics and information; LoopNet, a industrial actual property market; Residences.com, a platform for condo leases; and Houses.com, a residential actual property market.

Inventory Market Worth: $32.64B ($77.39 per share)

D.E. Shaw Possession: n/a

Third Level Possession: 2.04%

Common Value: n/a

Activist Commentary: D.E. Shaw is a big multi-strategy fund that isn’t traditionally recognized for activism. The agency will not be an activist investor. Fairly, it makes use of activism as an opportunistic instrument in conditions the place the agency deems it helpful. D.E. Shaw seeks out stable companies in good industries and if it identifies underperformance that’s inside administration’s management, it is going to take an lively function. It locations a premium on non-public, constructive engagement with administration and because of this usually involves an settlement with the corporate earlier than its place is even public.

Third Level is a multi-strategy hedge fund based by Dan Loeb, that can selectively take activist positions. Loeb is among the true pioneers within the discipline of shareholder activism and one in every of a handful of activists who formed what has turn out to be modern-day shareholder activism. He invented the poison pen letter in a time when it was usually obligatory. As instances have modified, he has transitioned from the poison pen to the ability of the argument. Third Level has amicably gotten board illustration at corporations like Baxter and Disney, but it surely additionally won’t hesitate to launch a proxy battle whether it is being ignored.

On April 6, CoStar Group entered into help agreements with D.E. Shaw and Third Level in reference to a board refreshment and company governance enhancements. This contains the addition of Christine McCarthy, John Berisford and Rachel Glaser as administrators to the board; the retirement of Michael Klein, Christopher Nassetta and Laura Kaplan from the board. It additionally contains the appointment of Louise Sams as impartial board chair and the creation of a capital allocation committee. D.E. Shaw and Third Level agreed to abide by sure customary standstill and voting provisions.

CoStar Group is a supplier of on-line actual property marketplaces, info, and analytics within the property markets. It manages main manufacturers together with CoStar Suite, LoopNet, Residences.com and Houses.com. Roughly 95% of the corporate’s income is derived from the core enterprise, which largely consists of CoStar Suite and Residences.com, which profit from excessive boundaries to entry, sturdy pricing energy, proprietary information and subscription-based enterprise fashions that drive recurrent income and extremely predictable free money stream. Due to these dynamics, this enterprise has traditionally traded at a premium to its info providers friends however is now buying and selling according to them.

This regression within the firm’s valuation largely stems from CoStar’s aggressive funding in its residential market enterprise, Houses.com, which it acquired in Could 2021. In contrast to its core CoStar Suite and House.com companies, Houses.com lacks clear aggressive benefits and faces intense competitors from well-established friends like Zillow. However, the corporate is diverting roughly 75% of its $1.3 billion of earnings earlier than curiosity, taxes, depreciation, and amortization from its core enterprise to fund the $900 million of losses from Houses.com. Because of this, capital expenditures are up 878% from 2021 to 2024, marked by 347% enhance in 2024 alone.

Enter D.E. Shaw and Third Level who’ve individually entered into help agreements with CoStar in reference to a board refreshment and company governance enhancements. This contains the next: (i) the addition of Christine McCarthy (former CFO of Disney), John Berisford (former president of S&P World) and Rachel Glaser (former CFO of Etsy) as administrators; (ii) the retirement of Chairman Michael Klein, Christopher Nassetta and Laura Kaplan from the board; (iii) the appointment of Louise Sams as impartial chairman; and (iv) the creation of a capital allocation committee, which Berisford and McCarthy will be part of. In activism, there are settlements that are supposed to appease an activist investor to maintain them quiet, and there are real settlements that signify actual settlement with the activist on find out how to proceed. This one is the latter. First, the apparent indication is that three administrators had been changed on an eight-person board, which is a big refreshment (roughly 40% of the board). However much less apparent and extra telling is the construction of the settlement and who was changed. First, the deal was structured as a alternative of administrators, not an addition of three administrators, which is extra frequent in settlements, significantly ones with comparatively smaller boards (i.e., eight administrators for a $30 billion firm). Second, the three administrators who had been changed had been three of the 4 longest-tenured administrators, excluding the CEO, and one in every of them was the chairman of the corporate since 1987. Furthermore, the brand new chair of the board is the second latest director previous to the settlement. This isn’t solely a board refreshment in title, however in substance as nicely.  

There’s additionally a extra delicate provision of the settlement that we predict presents essentially the most perception into what levers for worth creation could comply with – the formation of a capital allocation committee, which can consist of 4 administrators, two of whom would be the new D.E. Shaw/Third Level administrators. This can be a clear state of affairs of one thing that’s usually seen in activist campaigns – a core enterprise that’s massively worthwhile however whose earnings are getting used to fund an unprofitable non-core enterprise. However the plan right here will not be prone to utterly divest the Houses.com enterprise, or else we might have seen a strategic transactions committee. This capital allocation committee will extra doubtless be tasked with discovering methods to fund the Houses.com enterprise with out utilizing the money stream from the core enterprise. This might embody a by-product of the enterprise with CoStar retaining some possession, a sale of part of the enterprise to a strategic investor or taking in some third-party capital. The capital allocation committee can be tasked with assessing worldwide growth. CoStar has already made strikes to broaden internationally, together with the acquisition of OnTheMarket.com in late 2023, one of many UK’s three most visited residential property portals. The corporate additionally not too long ago supplied to amass Australian actual property classifieds agency Area Holdings. The capital allocation committee will definitely consider this potential transaction in addition to others and make suggestions to the newly reconstituted board. In the end, the objective right here is to emerge with the core CoStar enterprise with worldwide progress prospects being valued on a a number of of its $1.3 billion constant to the 30+ EBITDA a number of it traditionally obtained. This might end in an approximate $45 billion enterprise worth versus round $30 billion right this moment.

Each Third Level and D.E. Shaw are usually not purely activists, however multi-strategy corporations that usually use activism as an opportunistic instrument. Third Level, based by Dan Loeb, is a real pioneer in shareholder activism, however has used it extra sparingly lately as dictated by the market setting and obtainable alternatives. D.E. Shaw is comparatively new to activism, however the agency has proven over the past a number of years that it’s as proficient at activism as it’s on the different methods it has been so profitable with at its multi-strategy fund. Whereas they each settled with the corporate in their very own agreements, the 2 are definitely like-minded, however not performing as a bunch. That is an encouraging improvement, and it is one thing we frequently see right this moment however would hardly ever see 15 years in the past: It places stockholder worth above ego. Third Level disclosed that it has a 2.04% place in CoStar. D.E. Shaw didn’t disclose its place, however as a $70 billion hedge fund, it doesn’t take small activist positions: We might count on it to be a minimum of the dimensions of Third Level’s.  

Ken Squire is the founder and president of 13D Monitor, an institutional analysis service on shareholder activism, and the founder and portfolio supervisor of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.