FCF Capital Buys 60% of DLC



Handshake 2 FBWhen it comes to mortgage origination volume, the most successful brokerage operation in Canada—hands down—is Dominion Lending Centres (DLC). In 10 years the company has gone from zero to 5,000+ agents, 650 locations and more than 40% market share in the broker space.

FCF Capital Inc. (FCF) saw that success and decided it wanted a piece of it. So it bought 60% of DLC for almost $74 million. That pegs the entire enterprise value of the company, if you include assumed debt, at roughly $139 million according to co-founder Gary Mauris.

We spoke with Gary and FCF CEO Stephen Reid this morning. Here’s the nitty gritty…

Purchase Specifics

  • DLC shareholders get $61+ million cash plus $12.5 million in stock. The stock has a 4-month lockup. (Source)
  • FCF says it paid a multiple of 8.4 times short-term EBITDA (earnings before interest, taxes, depreciation and amortization). 
  • DLC’s 2015 net earnings were $6.8 million (This does not include the millions agents pay into DLC’s advertising fund, of which 88% is spent directly on advertising and 12% goes to administrative expenses, like figuring out where/how to advertise.)
  • Based on DLC’s 2015 revenue of $26.9 million, the multiple FCF paid is about 2.75 times.
  • FCF did a capital raise three weeks ago to generate part of the capital it used for DLC, including investments from at least eight “billionaire families.”
  • The deal did not include DLC’s budding insurance arm. “…We didn’t want to haggle about a business that hasn’t ramped up yet,” says Reid.
  • The parties hope to close by June 30, 2016, or July 29, 2016 at the latest, subject to various approvals including that of shareholders and the TSX Venture Exchange (where FCF is listed).

Who runs the show?

  • DLC will have a new board consisting of co-founders Gary Mauris and Chris Kayat, plus Stephen Reid and two other FCF nominees.
  • “…We put money in passively and have no management rights, nor do we want any,” says Reid. “…We can’t force a sale, nor do we want to.”
  • If push came to shove, “We can make (operational) changes if we need to…but I don’t know what we have to contribute,” says Reid, who notes that FCF is investing millions in DLC because it’s already well managed.
  • Reid acknowledged that certain management can be replaced if they don’t hit targets.
  • “…We’ll always take 25-50% of the upside and contractually give it to the other side forever…We make more money by giving more…The management team wins first and we win second, and that’s how we’ve always invested,” Reid says.

DLC mergerWhy did Mauris and Kayat want to sell?

  • “There’s only so much you can do with a small number of partners,” Mauris said, which prompted the company to explore bringing in capital sources. “We started reaching out to bankers to find a combination where we still own it and control it, but have new capital to grow. We wanted a passive long term partner in the business.”
  • And then, there’s the personal side. “I’m 47 years old and I’ve been on an airplane 130 days a year. It was time to de-risk a little bit.” But Mauris is careful to stress, “This is a long-term play for us…I’m not going anywhere.”
  • “We’ve had 13-14 companies who wanted to buy us outright or partner with us. These guys (FCF) didn’t buy it to run it.”
  • DLC’s founders have a big carrot to increase earnings. It’s called an inverted revenue share. They get to pocket 40% of the first $14.6 million paid annually to shareholders, but get to keep 70% of anything above that.

Why Did FCF Want DLC?

  • “We like the franchise industry and DLC is a 10 out of 10 in every single category,” Reid told CMT. “It has impeccable financials, great leadership, terrific partnerships and 650 franchisees, each of whom is a real business with a real owner who says, ‘I’m going to make my business work’.”
  • Unlike a normal venture capital firm that wants an exit (sale) in 5-7 years, FCF is in it for long-term cashflow. Its #1 objective is to pay out a low-risk, long-term yield to its investors, and it thinks DLC can spin off good cash to make that happen.

What’s Next for DLC?

  • “…We have owned up to invest more money for [DLC’s] targets and initiatives,” states Reid, who is enthused about further geographic growth in Canada and more ancillary offerings that could appeal to borrowers at the point of sale, like insurance, home inspections, etc. Even the U.S. “is being considered” as another growth avenue for DLC, he adds.
  • With FCF’s vast network of resources and M&A contacts, it will assist DLC in acquiring strategic targets, including more brokerages. “We’ll continue to buy competitors. If there are well-run broker networks who want to take money off the table, we’re a buyer,” says Mauris.
  • FCF plans to move to the TSX Exchange later this year, which will improve its (and DLC’s) access to capital.
  • “We have no plans to become a lender for the foreseable future,” says Mauris. “We have learned over the years the value of having close relationships with a range of lenders.” (“We still have a position in Canadiana,” he adds.)
  • Mauris still sees lots of organic growth potential in Canada and it’s largely a function of consumer awareness. “The value that brokers give to consumers is growing because consumers are starting to understand it.”
  • Client communication is also a growth opportunity. DLC is focusing on improving “touch points” with customers to keep its brokers top of mind. “Banks are staying in touch with their customers…[but] only 10% of brokers do it consistently,” Mauris says.
  • The broker industry is also quite fragmented, Kayat says. There is power in numbers and strength in joining forces. “When you look at the banks’ advertising budgets…there is hundreds of millions of dollars of ad spend every year. consumers get bombarded by bank marketing. It is hard [for individual brokers] to educate consumers about their value.”
  • Mauris says DLC has two other initiatives on the go, including “significant tech builds” currently underway. “We’re also going to get more involved in rate sites.”
  • When asked if he believes overall broker market share (currently about a third of the market) will ever exceed 50% in Canada, Mauris was quick to answer: “I absolutely do…We’re on our way,” he said, noting that 55% of first-time buyers use brokers already.

What are the risks?

  • “We don’t see many,” says Reid, who acknowledges potential risk in a housing slowdown and declining broker margins.
  • As for the Internet’s negative impact on margins, Reid says, “…Not only could it happen, it will happen…everyone wants to go on the web and get instant access to information. We all want efficiency. Shopping for a mortgage on my own [on the Internet] will erode the business somewhat,” but he’s confident DLC’s entrepreneurial ability will overcome that. “Some people like fast food and some people like a steak dinner…There are all kinds of different models [that can succeed],” including in the brokerage business.
  • Rate sites are a factor, but Mauris believes strongly in the value of human professional advice. “When you have a product like mortgages that must be tailor fit…one size does not fit all.” He says add-on products will offset shrinking broker margins and notes that rate competition doesn’t necessarily have to drive down agent commissions on a 1-for-1 basis.

Our take

This deal puts competing broker networks on alert. Their #1 competitor has just become all the more powerful. In a business where volume and scale increasingly matter, smaller players will have to carefully assess their long-term growth prospects. Some will undoubtedly choose to not take a risk with their future valuations and merge, be that with other firms or with DLC.

One thing’s for sure. Success breed success. The company is making plays that are making its agent stronger and more recognized by the public. Once DLC pierces 50% market share (which is a matter of time in our view), it could be a psychological tipping point in the industry. Not only will it have serious bargaining power with suppliers, further internal economies of scale and more revenue to reinvest in its business, but DLC Group’s ability to recruit agents attracted by its technology, rate buying power and marketing could reach another level.

“The next 5 years should be our best 5 years,” Mauris says. With the clout of his newfound partner, that could very well be.


Click here to listen to the conference call.


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Comments

  1. Comment avatar

    Greg Williamson    

    Slow clap…Many, Many people have tried and frankly no one has really succeeded in creating a broker brand that sells for a real value.

    Good for them.

    Congratulations to Gary, Chris and their team.

     
  2. Comment avatar

    Analyst    

    Excellent analysis Rob.

    I can’t help but think Gary and Chris cashed in at the opportune time. What happens to those revenues if Vancouver and Toronto crack? Does the competition bureau get involved if DLC exceeds 50% market share? How long will banks sit back and let brokers eat into their customer base?

    So many questions. I look forward to revisiting this story in five years.

     

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