Realogy, the operator of Century 21 and other real estate businesses, is the Rocky Balboa of corporate America. Left for dead in the financial crisis, Realogy has not only survived but is now in a Rocky-like comeback, planning an initial public offering.
The company's recent history is also an illustration of how private equity firms - in this case, Leon Black's Apollo Global Management - can save, not destroy, companies, making money for themselves in good times and bad.
Apollo bought Realogy for some $7 billion in the spring of 2007, contributing about $2 billion of its own money and borrowing more than $6 billion to pay for the deal and to refinance debt.
Private equity may be considered smart money, but this acquisition took place at an extraordinarily bad time. Not only was the deal struck as the housing market was crashing, but Apollo saddled Realogy with too much debt. The company was left nearly bankrupt.
Net revenue plummeted to $4 billion in 2010 from about $6.5 billion in 2006. As revenue declined, the company hemorrhaged cash to pay roughly $600 million a year in interest. By 2009, the company was cash flow negative, kept alive only by additional borrowing.
Investors viewed the company as virtually insolvent - its debt traded at less than 10 cents on the dollar. At the time, Apollo's $2 billion stake seemed to be worthless. I remember having a conversation in 2009 with a hedge fund manager who couldn't believe the company was still in existence.
So Apollo tried some financial wizardry.
First, the private equity firm publicly asserted that it would provide further funds as necessary to keep Realogy's business alive. Apollo also doubled down on Realogy by buying up its debt on the cheap.
Apollo then engaged in multiple efforts to restructure the company's debt aggressively. It took on hedge funds holding Realogy's debt, leading a battle against Carl C. Icahn and other hedge fund opera tors who were opposed to Realogy's restructuring plan.
Apollo's first restructuring attempt was successfully blocked by Mr. Icahn. Forced to rejigger its refinancing, the private equity firm still succeeded in reducing Realogy's debt and, more important, in extending the maturity of most of the company's debt out to 2016 and beyond. This bought Realogy more time.
Meanwhile, Apollo also kept its word, buying more than a $1 billion in new Realogy debt, providing the company needed support.
The result was that Realogy was kept alive on the operating table, allowing it to further restructure its business. Management savagely cut costs through the downturn. Total expenses are now $4.5 billion a year, compared with almost $6 billion in 2006. The number of employees was reduced by a third and over 350 brokerage offices were closed or consolidated.
Realogy is now stable and its bonds are trading at par - a 900 percent return on the debt alone.
Still, al l is not well with Realogy. As the housing market struggles to recover, the company has had to borrow to survive. Last year, Realogy lost $190 million in cash from operations and needed to draw the difference in debt financing put in place by Apollo.
Ever willing to use the capital markets to help make a return on Realogy, Apollo is now planning the next stage in the company's restructuring, an I.P.O. The current plan is for the company to issue as many as 46 million new shares, raising $1.08 billion. The money will be used to pay down $2.8 billion in Realogy's debt. Convertible note holders led by John Paulson's hedge fund will also convert $1.9 billion in notes into shares.
If the I.P.O. is successful, the company's debt load will go to $330 million from $672 million, making it cash flow positive and also profitable. And as a plus, Realogy has $2.1 billion in tax credits from prior losses that it can use to offset any future profits.
There is no guarantee that Apollo can pull this I.P.O. off. For investors, Realogy is really a bet on an upturn in housing. In its prospectus, the company says that its earnings will increase as housing sales go up. But if there is no housing recovery, a post-I.P.O. Realogy will still have significant debt and historically flat revenues - not the makings of a great investment.
Still, even if the I.P.O. does not happen, Apollo has accomplished the extraordinary. If not for its efforts, Realogy would be bankrupt. The private equity firm had the knowledge and wherewithal to keep working the capital markets and continuously restructure Realogy's debt to ensure its survival. Apollo also stepped up and was willing to risk even more money to support the company.
Being private also probably provided room for Realogy to act quickly and make necessary cuts, something which would have been harder for a public company to do.
Of course, Apollo had no one to blame but itself for Realogy's pr ecarious situation, having loaded it up with debt in the first place. Nevertheless, the story of Realogy shows how private equity firms can use financial wizardry to save a company, not pillage it. Private equity firms can also lend their excess cash and expertise.
Realogy's survival jibes with at least one study that found that companies owned by private equity firms default on their debt less often than public companies. The authors attribute the reason to the presence of a sophisticated owner with the wherewithal to help, certainly the case here.
This leads to the second remarkable thing about the Realogy deal. Apollo is probably in the black on its investment. If the I.P.O. succeeds, Apollo will still own about 48 percent of the company with a stake valued at about $1.6 billion. There are also the big gains on the bonds Apollo bought.
Then there is the management fee of $15 million a year that Realogy has been paying to Apollo and the $40 million that R ealogy is paying Apollo to terminate that agreement in connection with the public offering.
Combined, this means that Apollo is not making a huge return but has very likely profited on its $2 billion investment. That the equity alone here is worth so much only a few years after Realogy almost went bankrupt - and on an investment made at the height of the real estate bubble - is miraculous.
Realogy's Hollywood-like comeback shows how private equity firms can succeed even when they make the wrong call. The firms can use financial engineering to create Rube Goldbergesque financing structures that frankly appear to create their own money. Realogy has more than 15 different types of debt instruments alone. The case of Realogy shows private equity can be a company's savior during even the worst of times.
