Brokers Neutral On REA’S Mortgage Services

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REA Group has expanded its real estate financial services to include mortgage products via a traditional broking channel. Brokers suggest accretion is minimal at this stage.

-Expands offering to home owners that do not want acquire a mortgage online
-Headwinds are looming for the mortgage broking industry
-Mortgage broking likely to be more volatile than core business
 

By Eva Brocklehurst

REA Group ((REA)) has expanded its real estate financial services to incorporate a suite of mortgage products via a traditional broking channel. The company has acquired an 80.3% stake in Smartline, an Australian mortgage broking franchise, for $67m. Current management retains the balance.

REA Group has also announced the extension of its strategic mortgage broking partnership with National Australia Bank ((NAB)). The company previously flagged the entry into financial services with the establishment of its home loan product and co-branding with NAB, expected to go live later this year.

This model is extended to offer a more complete suite of mortgage products via a broking channel. This expands the product offering to home owners that do not want to conduct mortgage business online and seek independent advice from mortgage brokers. 

Smartline

Smartline has over 300 advisers nationally and a $25bn loan book, providing a platform that is profitable and can be scaled if warranted. Macquarie believes this reduces the risk versus trying to build or grow REA Group's own mortgage broking business. REA Group has extensive data and understands customer behaviours which places it in a good position to deliver timely leads in this area. Holding ownership of a broking business will also create options over time, in the broker's opinion.

In isolation, if the company executes well, the financial services platform should offer good returns on capital and complementary growth for the core business, albeit on a relatively small scale. In its main business, Macquarie believes REA Group is well-placed given recent price rises and a return to modest growth in property listings. The broker retains a Neutral rating on valuation grounds.
There is one clear strategic purpose in the move UBS believes, in that those willing to sign up to a residential home loan over the internet without the option of a physical broker may have been limited. Now, the company will be able to leverage this network of advisers to promote its home loans product. UBS believes it will eventually be possible to sign up to a new home loan directly on the REA websites after browsing for a home.

Nevertheless, headwinds are looming for the mortgage broking industry. There are risk to fees, where average industry commissions to brokers are around $4, 600 per mortgage. Banks may look to negotiate lower fees in coming months and, in the longer term, open data and analytics may mean the value addition from brokers becomes more marginalised.

The potential impact of these headwinds on REA Group are uncertain but UBS believes there could be offsets, as growth in loan volumes may negate any yield pressures and the Smartline back book is unlikely to be retrospectively affected.

Valuation

The transaction may be accretive to earnings but UBS does not believe incremental Smartline earnings should be valued on the existing online classifieds multiple and suspects a slight premium to Mortgage Choice ((MOC)) is appropriate for strategic value and synergies. As a result UBS considers the transaction broadly neutral to valuation.

In Deutsche Bank's opinion the investments increase exposure to what is a large, addressable market, as mortgage brokers in Australia generate revenues of around $2.2bn per annum. Nevertheless, the investment also signals expansion into what is effectively a lower-multiple business.

Deutsche Bank remains of the view that REA Group is better positioned than a traditional mortgage broker to capture share in this market given the leads it can generate from its site but this is also a business which is likely to be more volatile than the core operations. The accretion at this stage is minimal in the broker's opinion and a Hold rating is maintained.

The purchase price represents less than 1% of the company's enterprise value and Macquarie calculates the FY18 contribution to earnings of $8.5m for financial services, most of which would be derived from Smartline, represents less than 2% of group operating earnings (EBITDA) prior to the acquisition.

Macquarie agrees there is some risk that any growth in market share a volume of business written could face offsets from fee pressures over time as there is some risk with the industry pertaining to two separate reviews from both the ACCC and Sedgwick.

FNArena's database has two Buy ratings, four Hold and one Sell (UBS). The consensus target is $63.43, signalling -4.7% in downside to the last share price. Targets range from $56.75 (Deutsche Bank) to $72.50 (Citi, yet to comment on the acquisition).
 

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