Third Level, D.E. Shaw get hold of 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 the USA and Canada, and Worldwide, which primarily contains Europe, Asia-Pacific and Latin America. Its main manufacturers embrace CoStar, a world supplier of business actual property knowledge, analytics and information; LoopNet, a business actual property market; Flats.com, a platform for house 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 Price: n/a

Activist Commentary: D.E. Shaw is a big multi-strategy fund that’s not traditionally identified for activism. The agency is just not an activist investor. Reasonably, it makes use of activism as an opportunistic software in conditions the place the agency deems it helpful. D.E. Shaw seeks out strong companies in good industries and if it identifies underperformance that’s inside administration’s management, it’ll take an lively function. It locations a premium on non-public, constructive engagement with administration and consequently typically 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 typically essential. As occasions have modified, he has transitioned from the poison pen to the facility of the argument. Third Level has amicably gotten board illustration at corporations like Baxter and Disney, nevertheless it additionally is not going to hesitate to launch a proxy combat whether it is being ignored.

On April 6, CoStar Group entered into assist 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, Flats.com and Houses.com. Roughly 95% of the corporate’s income is derived from the core enterprise, which largely consists of CoStar Suite and Flats.com, which profit from excessive boundaries to entry, robust pricing energy, proprietary knowledge and subscription-based enterprise fashions that drive recurrent income and extremely predictable free money circulate. Due to these dynamics, this enterprise has traditionally traded at a premium to its info companies friends however is now buying and selling in keeping with 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 Residence.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. In consequence, capital expenditures are up 878% from 2021 to 2024, marked by 347% improve in 2024 alone.

Enter D.E. Shaw and Third Level who’ve individually entered into assist 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 a 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 how one can proceed. This one is the latter. First, the plain indication is that three administrators have 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 substitute of administrators, not an addition of three administrators, which is extra widespread in settlements, notably ones with comparatively smaller boards (i.e., eight administrators for a $30 billion firm). Second, the three administrators who have been changed have 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 effectively.  

There may be additionally a extra refined provision of the settlement that we expect affords probably the most perception into what levers for worth creation might 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 typically seen in activist campaigns – a core enterprise that’s massively worthwhile however whose income are getting used to fund an unprofitable non-core enterprise. However the plan right here is just not more likely to fully divest the Houses.com enterprise, or else we’d have seen a strategic transactions committee. This capital allocation committee will extra probably be tasked with discovering methods to fund the Houses.com enterprise with out utilizing the money circulate from the core enterprise. This might embrace a derivative 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 also be tasked with assessing worldwide growth. CoStar has already made strikes to increase 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 provided to accumulate 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 acquired. This may end in an approximate $45 billion enterprise worth versus round $30 billion immediately.

Each Third Level and D.E. Shaw are usually not purely activists, however multi-strategy companies that always use activism as an opportunistic software. Third Level, based by Dan Loeb, is a real pioneer in shareholder activism, however has used it extra sparingly in recent times as dictated by the market setting and out there 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 appearing as a bunch. That is an encouraging improvement, and it is one thing we frequently see immediately 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’d count on it to be no less than the scale 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.