INCREASE TARGET PRICE return for pre 12s 2016 return for pre 12s Implied cash return at PT Implied cash return at share price

Transcription

1 Europe/United Kingdom Equity Research Diversified Commercial Services The Ideas Engine series showcases Credit Suisse s unique insights and investment ideas. Rating OUTPERFORM Price (07 Jun 17, p) Target price (p) (from ) Market Cap ( m) 3,339.3 Enterprise value ( m) 3,560.4 Target price is for 12 months. Research Analysts Andy Grobler, CFA andy.grobler@credit-suisse.com Karl Green karl.green@credit-suisse.com Daniel Hobden daniel.hobden@credit-suisse.com Specialist Sales: Andrew Bell andrew.bell@credit-suisse.com IWG (IWG.L) INCREASE TARGET PRICE Space to lead: Raising our target price Competitive advantage: In this Ideas Engine, we show new data illustrating the depth and global breadth of IWGs leadership in the serviced office market, which now contains c17,000 centres globally. We quantify the structurally growing importance of serviced offices in the broader office market and forecast continued double-digit growth for the sector over the next five years. In addition to this proprietary market analysis, we assess the impact of IFRS 16 (lease accounting) on IWG's financial reporting. We raise our price target to 435p (from 320p) and reiterate our Outperform rating. Momentum improving: IWG s market dominance (2.6x the share of numbers 2 and 3 combined in 19 of the top 20 markets) gives it a tangible competitive advantage with larger accounts, while we also think it is ideally placed to grow profitably. We expect it to grow EBIT and free cash by 80-85% over the next five years, creating a mature platform offering an 18% free-cash-flow yield in 2021E. Structurally growing market: After 18% CAGR in the five years to 2016 with rising penetration in major markets, we forecast 14% CAGR for the market for the next five years. This is driven by increased demand for flexibility, the impact of the shared economy, technology and evolving attitudes from landlords seeking partnerships to participate in the growth. Valuation: Our new DCF-based price target of 435p reflects an 11-16% increase to our E estimates and higher longer-term forecasts. Our blue sky analysis indicates potential upside to 535p if cash returns generated in 2016 are sustainable. We also note that reported funding rounds for the number 2 player (WeWork) have indicated a valuation of 32x EV/Sales for 2016 vs IWG at 1.6x. Our grey sky valuation for IWG is 245p. Figure 1: Current price discounting tangible decline in cash return on net cash invested return for pre 12s 2016 return for pre 12s Implied cash return at PT Implied cash return at share price 2015 return for pre 12s 2016 return for pre 12s Implied cash return at PT Implied cash return at share price Source: Company data, Credit Suisse estimates; Pre 12s relates to all centres opened before 2012 DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 IWG (IWG.L) Price (07 Jun 2017): p; Rating: OUTPERFORM; Target Price: (from p) p; Analyst: Andrew Grobler Income statement ( m) 12/16A 12/17E 12/18E 12/19E Revenue 2,233 2,439 2,627 2,892 EBITDA Depr. & amort. (195) (206) (227) (247) EBIT Net interest exp. (12) (13) (13) (13) Associates PBT Income taxes (35) (42) (48) (53) Profit after tax Minorities Preferred dividends Associates & other Net profit Other NPAT adjustments (11) (10) (10) (10) Reported net income Cash flow ( m) 12/16A 12/17E 12/18E 12/19E EBIT Net interest (16) (11) (11) (11) Cash taxes paid (32) (40) (50) (56) Change in working capital Other cash and non-cash items Cash flow from operations CAPEX (319) (307) (409) (473) Free cashflow to the firm Acquisitions (10) (107) (20) (24) Divestments Other investment/(outflows) Cash flow from investments (300) (413) (429) (497) Net share issue/(repurchase) (36) (78) (23) (8) Dividends paid (44) (49) (53) (56) Issuance (retirement) of debt (53) Cashflow from financing (132) (78) (76) (65) Changes in net cash/debt 44 (56) Net debt at start Change in net debt (44) 56 (46) (84) Net debt at end Balance sheet ( m) 12/16A 12/17E 12/18E 12/19E Assets Total current assets Total assets 2,661 2,892 3,188 3,588 Liabilities Total current liabilities 1,183 1,258 1,342 1,471 Total liabilities 1,919 2,102 2,277 2,524 Total equity and liabilities 2,661 2,892 3,188 3,588 Per share 12/16A 12/17E 12/18E 12/19E No. of shares (wtd avg.) (mn) CS EPS (adj.) (p) Dividend (p) Free cash flow per share (p) Key ratios and valuation 12/16A 12/17E 12/18E 12/19E Growth/Margin (%) Sales growth (%) EBIT growth (%) Net income growth (%) EPS growth (%) EBITDA margin (%) EBIT margin (%) Pretax profit margin (%) Net income margin (%) Valuation 12/16A 12/17E 12/18E 12/19E EV/Sales (x) EV/EBITDA (x) EV/EBIT (x) Dividend yield (%) P/E (x) Credit ratios (%) 12/16A 12/17E 12/18E 12/19E Net debt/equity (%) Net debt to EBITDA (x) Interest coverage ratio (x) Source: FTI, Company data, Thomson Reuters, Credit Suisse Securities (EUROPE) LTD. Estimates Company Background IWG is engaged in developing, delivering and supporting outsourced workplace solutions. They run on a worldwide basis and are managed through four principal geographical segments: Americas; Europe, Middle East & Africa (EMEA); Asia Pacific; and the UK. Blue/Grey Sky Scenario Our Blue Sky Scenario (p) (from ) We assume sustainable cash returns are at 23.6%, compared to 23.6% generated by the mature centers opened pre 2012 in In addition, we assume asset growth of 15%. This compares to our core forecasts of 21.5% sustainable cash returns and 12% asset growth. Our Grey Sky Scenario (p) (from ) We assume sustainable cash returns fall to 15%, compared to 23.6% generated by centers opened before 2012 in In addition, we assume asset growth of 5%. This compares to our core forecasts of 21.5% sustainable cash returns and 12% asset growth. Share price performance The price relative chart measures performance against the FTSE ALL SHARE INDEX which closed at on 07/06/17 On 07/06/17 the spot exchange rate was.87/eu 1.- Eu.89/US$1 IWG (IWG.L) 2

3 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q June 2017 Key charts Figure 2: IWG market leader in 19 of top 20 markets globally Rank Country Leader Rank Country Leader 1 USA IWG 12 Brazil IWG 2 UK IWG 14 Singapore IWG 3 France IWG 15 South Africa IWG 4 Australia IWG 16 Mexico IWG 5 Germany IWG 17 Italy IWG 6 China IWG 18 UAE IWG 7 Spain IWG 19 Switzerland IWG 8 India IWG 20 Belgium IWG 9 Canada IWG 10 Japan IWG 13 Hong Kong Compass Offices 11 Netherlands IWG Figure 3: Underlying market will continue to grow double-digit on our estimates 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% E Centres top 20 countries (ex China) Source: Instant Offices Source: Instant Offices, UN, IMF, Credit Suisse estimates Figure 4: Structural growth in the serviced office market Serviced office space as percent of total US office market (sq foot) Figure 5: SG&A efficiency a significant driver of EBIT growth GBP mn 1.8% % 1.4% 1.2% 1.0% % % 0.4% 0.2% 0.0% Service office % total mkt Source: Thomson Reuters, Instant Offices, Credit Suisse Estimates Source: Company data, Credit Suisse estimates Figure 6: Current share price implying a sharp fall in cash returns 26.0% 24.0% 22.0% 20.0% 18.0% 16.0% 14.0% Figure 7: and not reflecting the growth potential of the business % 2015 return for pre 12s 2016 return for pre 12s Implied cash return at PT Implied cash return at share price Mature Growth Fair Value Price Pre 12s relates to all centres opened before 2012 Source: Company data, Credit Suisse estimates Mature centers are those opened more than 2 years before each reported year, e.g mature centers are those opened in 2014 or before. Source: Credit Suisse estimates IWG (IWG.L) 3

4 Table of contents Key charts 3 Investment summary 5 The global market 6 Global growth... 9 Structural growth in the US market What drives the structural growth Great Britain market overview Growing penetration in the UK market Cyclical dynamics Lease capitalization Valuation 26 DCF valuation Credit Suisse HOLT Cash return on cash invested Multiples Blue and Grey Sky valuations Financials 32 Changes to our estimates Financial statements Appendix 34 IWG (IWG.L) 4

5 Investment summary We raise our price target for IWG to 435p (from 320p) and maintain our Outperform rating. We show new data sourced from a range of industry sources, including Instant Offices, to illustrate the extent of IWG's leadership in the global serviced office market. As more corporates look to change how they procure real estate, this leadership is increasingly important. We illustrate the growing importance of serviced offices in the broader office market over the past 12 years and why that structural development should continue in the long term given relatively low penetration in many markets at a time when corporates and employees are looking for increased flexibility. We estimate the market can grow doubledigit for the next five years. We look at what is in the IWG price and believe that, even on a conservative basis, the current price is discounting a significant decline in cash returns over the next five years. Market leader in a growth market IWG is the clear market leader in a growing industry. It is the leading operator in 19 of the top 20 markets and on average it is 2.6x the size of the number 2 and 3 players in each of the top 20 markets (by number of centers). The market has grown 18% CAGR over the past 5 years (to 2016) and we forecast that it will grow 14% CAGR over the next 5 years. Structurally growing market The serviced office market is still small relative to the overall office market but its importance is growing. In the US we estimate that serviced office space has risen from 0.5% of the total market (by square foot) in 2004 to 1.6% by the end of This change is driven by 1) the desire from corporates and employees for increased flexibility, 2) the rise of co-working within the shared economy, and 3) a change of attitude from landlords looking to be involved with the growth of the serviced office market as the broader office market changes. We think these structural shifts are only in the early stages of development. Cost efficiency IWG made significant changes to its delivery model through 2016 as it reduced its headcount. While this had a knock-on impact to sales and execution in some segments of the business, it lowered its cost to serve and, we think, puts it in a strong position to generate strong profitable and cash generative growth in the long term. We expect an EPS CAGR of 13% from 2017E to 2020E. Lease capitalization IFRS 16 will be introduced in 2019, which will require the capitalization of lease commitments within the financial statements. This will increase accounting leverage and reduce EV/EBITDA multiples. Cash generation will not change although traditionally calculated FCF yields will rise significantly and we do not think that this will change the company's ability to generate strong cash returns on cash invested. As part of our detailed analysis, we assess how the financial statements will look pre and post IFRS 16. Valuation Our DCF-derived price target rises to 435p (from 320p) to reflect higher mid-term profitability and more sustainable growth rates. This is supported by our Credit Suisse HOLT analysis. We also look at valuation from the perspective of cash return on cash invested. In 2016 IWG's mature operations (centers opened pre 2012) generated returns of 23.6%. We think the current price implies mature cash returns fall to 17.5%, which we view as unlikely given reduced SG&A, increased partnership deals (with lower cash cost for IWG and higher return) and the competitive advantage of national networks as larger corporates look to evolve their approach to real estate. IWG (IWG.L) 5

6 The global market By country Data from Instant Offices indicate that there are 17,000 serviced office centers globally. 75% of these sit within the top 20 countries (by number of centers) with over 20% of the global network in both the US and UK. IWG is the clear global market leader with c17% of total centers and, we believe, a higher share of workstations/rented space given that many of the competitors operate centers smaller than IWG's average 154 workstations per center (2016). IWG is the market leader in 19 of the top 20 countries (and number 2 in Hong Kong) and 16x bigger than the next largest operator (WeWork) by number of centers. For a brief overview of the competitors, see Figure 59 in the Appendix. Instant Offices was established in It helps clients procure and manage workspace typically acting as an agent rather than an operator of workspace. Figure 8: Top 20 serviced office markets center numbers, leading operators and CAGR center growth 2011 to Centres Operator 1 Operator 2 Operator 3 CAGR % Top 20 % total 1 USA 3,788 IWG We Work Premier 12% 29.9% 22.3% 2 UK 3,419 IWG Bizspace Workspace Group 9% 27.0% 20.1% 3 France 634 IWG BuroClub Team Business Centres 20% 5.0% 3.7% 4 Australia 585 IWG Servcop Asian Pacific 21% 4.6% 3.4% 5 Germany 572 IWG Sirius Ecos 25% 4.5% 3.4% 6 China 440 IWG The Executive Centre UR Work 28% 3.5% 2.6% 7 Spain 415 IWG IBC Melior Centros 30% 3.3% 2.4% 8 India 382 IWG Awfis Space Solutions The Executive Centre 44% 3.0% 2.2% 9 Canada 315 IWG The Intelligent Office The Network Hub 16% 2.5% 1.9% 10 Japan 308 IWG Biz Circle Servcop 33% 2.4% 1.8% 11 Netherlands 279 IWG The Office Operators Vastgoed Totaal 22% 2.2% 1.6% 12 Brazil 240 IWG GoWork CWK 43% 1.9% 1.4% 13 Hong Kong 202 Compass Offices IWG The Executive Centre 23% 1.6% 1.2% 14 Singapore 176 IWG Just Office Corporate Serviced Offices 29% 1.4% 1.0% 15 South Africa 171 IWG XtraSpace Flexible Workspace 39% 1.3% 1.0% 16 Mexico 167 IWG IOS Offices IZA Business Centre 24% 1.3% 1.0% 17 Italy 160 IWG Talent Garden A&B Business Centre 24% 1.3% 0.9% 18 UAE 156 IWG Servcop myoffice 25% 1.2% 0.9% 19 Switzerland 135 IWG Premium Business Centre Ecos 20% 1.1% 0.8% 20 Belgium 128 IWG Topos Officenter 33% 1.0% 0.8% Top 20 12,672 18% 74.5% Total 17,000 Source: Instant Offices IWG (IWG.L) 6

7 Market share IWG's market share varies across the major markets. Its highest market shares are in Japan, Canada, South Africa and China (at 34%, 31%, 31% and 29% respectively). The lowest market shares (of the top 20 countries) are in Spain, Hong Kong and the UK (8%, 8% and 10%, respectively). Figure 9: IWG market share (by number of centers) in top 20 countries 40% 35% 30% 25% 20% 15% 10% 5% 0% Source: Instant Offices In absolute terms, the US is IWG's largest market, followed by the UK and China. Rest of the World represents all centers outside the top 20 markets. Figure 10: The US is its largest end market by number of centers IWG number of centers by end market Source: Instant Offices When we compare IWG to the larger competition we note that it is at least twice as big as the number 2 and 3 in all 19 of the major markets where it is market leader. On average it is 2.6x the size of the combined numbers 2 and 3. In Figure 11 we show the market share of the leading 3 players (by market). It illustrates that Japan, South Africa and Mexico are the most consolidated of the larger markets with Spain, UK and Australia the least consolidated. IWG (IWG.L) 7

8 Why does this matter? As the market shifts from the provision of space to companies on an individually let basis to one in which corporates are taking more strategic decisions over real estate, the existence of a leading national network is a clear competitive differentiator. For example, IWG's contracts with Uber (UK), Yell (UK) and Verizon (US) have allowed the clients to close numerous offices across the country and operate exclusively (or primarily) from the IWG network. The data indicate that no other provider can consistently (or, potentially, at all) offer this level of service. Figure 11: Market share of IWG and number 2 and 3 (by number of centers) in top 20 countries 60% 50% 40% 30% 20% 10% 0% IWG #2 #3 Source: Instant Offices By city Figure 12: Largest serviced office city market Source: Instant Offices London is the largest single city market by some distance and is bigger than the network in any other country bar the US. In Figure 12 we show the top 15 cities, CAGR growth from 2011 to 2016 and the split between serviced offices and co-working/hybrid centers. Centres Growth Serviced % of Total Coworking or Hybrid % total Workstation rates /PP/PM % of country % of global 1 London 1,136 16% 79% 21% % 6.7% 2 New York % 53% 47% 872 9% 1.9% 3 LA % 66% 34% 760 7% 1.5% 4 Tokyo % 77% 23% % 1.3% 5 Hong Kong % 68% 32% 490 N/A 1.2% 6 Shanghai % 60% 40% % 1.2% 7 San Francisco % 68% 32% 862 5% 1.1% 8 Singapore % 62% 38% 373 N/A 1.0% 9 Sydney % 59% 41% % 1.0% 10 Melbourne % 51% 49% % 1.0% 11 Paris % 62% 38% % 0.9% 12 Chicago % 64% 36% 812 3% 0.7% 13 Berlin % 29% 71% % 0.7% 14 Dubai % 81% 19% % 0.6% 15 Abu Dhabi 34 18% 97% 3% % 0.2% Top 15 3,591 18% 67% 33% 663 The fastest growing cities for serviced offices in the past 5 years have been Melbourne and New York. Along with Berlin, they have the highest exposure to co-working/hybrid centers as opposed to more traditional serviced offices (Figure 13). The most expensive workstations are in the US (4 out of the top 5 cities) and Sydney (Figure 14). IWG (IWG.L) 8

9 India Brazil South Africa Belgium Japan Spain Singapore China Germany UAE Italy Mexico Hong Kong Netherlands Australia France Switzerland Avg Top 20 Canada USA UK India Brazil South Africa Japan Belgium Spain China Singapore Germany Italy UAE Hong Kong Mexico Netherlands France Australia Switzerland Canada Avg Top 20 USA UK 13 June 2017 Figure 13: City exposure to co-working/hybrid centers 80% 70% 60% 50% 40% 30% 20% 10% 0% Figure 14: Workstation rates per person per month ( ) Exposure to coworking/hybrid centres Workstation rates /PP/PM Source: Instant Offices Source: Instant Offices Global growth Growth The top 20 countries have seen centers more than double over the past 5 years with CAGR growth of 18%. Over that period IWG moderately took share with 19.5% CAGR center growth. The fastest growing countries have been India, Brazil and South Africa, with the slowest growth from the more mature North American and UK markets (Figure 15). In Figure 16 we show similar data but as growth in the number of centers per 1m people. The distribution is similar with growth in centers 2.7% faster than growth per 1m people on average for the top 20 countries. Figure 15: Centre growth CAGR % 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% CAGR centre growth Figure 16: Growth in centers per 1m people CAGR 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Growth - centres per 1m people ( ) Source: Instant Offices Source: Instant Offices, UN, Credit Suisse research IWG (IWG.L) 9

10 Growth drivers To estimate potential growth, we look at 6 factors: 1) We take a developed market the Netherlands and then assume the top 20 countries reach the same penetration as a proportion of population. 2) We adjust the penetration for GDP per capita in 2016 and in ) The analysis is somewhat skewed by China given the size of the population and forecast (by the IMF) GDP growth. India has much less significant impact due to lower GDP/capita. 4) We do not change UK penetration but grow the UK market in line with population and GDP growth. 5) For other countries with higher penetration than the Netherlands e.g. UAE, South Africa we do not adjust as the conservative estimates here balance out the methodology in countries such as Japan. 6) We do not include potential for faster growth in relatively large, faster growing nations such as Colombia, Malaysia, Philippines, Indonesia or Vietnam that fell outside the top 20 global markets in The rest of the world accounts for 46% of the global population and 23% of global GDP. Our estimates suggest that the market can grow 13.7% CAGR over the next 5 years. That estimate is based upon the top 20 countries ex China. Figure 17: Global centers E (top 20 countries) Figure 18: Centre growth CAGR E 35, % 30, % 25, % 20, % 15, % 10, % 5, % E 6.0% E Centres top 20 countries Centres top 20 countries (ex China) Centres top 20 countries Centres top 20 countries (ex China) Source: Instant Offices, UN, IMF, Credit Suisse estimates Source: Instant Offices, UN, IMF, Credit Suisse estimates IWG (IWG.L) 10

11 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q June 2017 Structural growth in the US market Market data on the serviced office market is limited, with only intermittent snapshots of the state of the market. We have put together data from a number of sources to illustrate the increased penetration of serviced offices within the US market. In Figure 19 we show the growth in total commercial office space in the US vs the total serviced office market between 2004 and Q We estimate that market penetration has risen from 0.6% in 2004 to 1.6% by Q The square footage of US office inventory has risen 7% over the period (at a CAGR of 0.5%) with the serviced office market growing 185% at a CAGR of 9%. In Figure 20 we show the movement in serviced offices as a percent of the US office market, compared to IWG's market share. We estimate that IWG's market share has grown from 20% in 2004 (post the acquisition of HQ) to 26% by the end of This was slightly below the level in 2015 given the balance of very strong market growth in 2016 versus more moderate expansion at IWG as it undertook internal changes. IWG has grown its US centers by 270% at a CAGR of 12% over the period. In 2016 the US was approximately 84% of the Americas division with the remainder primarily in Canada, Brazil and Mexico. We assume that the US share has declined from c89% in 2011, given faster market growth rates in the other markets (see Figure 8 on page 6). Figure 19: Total office space vs serviced office market US) Square footage (millions) Figure 20: Serviced office percentage of total market (rhs) vs IWG market share (lhs) % 1.9% % 25% 23% 21% 19% 17% 15% 1.7% 1.5% 1.3% 1.1% 0.9% 0.7% 0.5% Office Space Service office mkt (RHS) IWG mkt Share (LHS) Service office % total mkt Source: Credit Suisse research, Instant Offices, Thomson Reuters Source: Company data, Credit Suisse research, Instant Offices IWG (IWG.L) 11

12 What drives the structural growth We see a number of factors driving demand for serviced offices. Flexible working Corporates want to reduce cost and be more agile. Estimates on costs savings are impacted by the client size, the extent to which existing real estate costs are sunk costs and location, but a 2015 estimate from Send Business Centre suggested some clients could save 30-78% on real estate costs. In Figure 21 we show the key drivers for flexible working. In addition, many employees and corporates want greater flexibility in their employees' working life. Employees want to work closer to home, reduce commuting time and have more control of their working life. The motivation for corporates is partly a reaction to employee demands as they seek to attract and retain key talent. The nature of work is also moving to being more project-driven. This changes the employee hiring processes and also the real estate requirements. Projects, by definition, do not require long-term inflexible leases. They need shorter-term real estate that has the flexibility to grow and shrink as the project evolves. Corporate locations also need to be adaptable to the nature of the projects in order to maximize both the ability to attract talent and profitability of a given project. One fixed office solution to all eventualities no longer works. Figure 21: Drivers of flexible working % of respondents noting factor as a driver of flexible working Figure 22: Percentage of professional workers working outside main office for 2.5days+ a week Reduce office costs Workers want to work closer to home Workers demanding remote working Agility Avoiding fixed leases Scale staff numbers more flexibly Reacting to market changes Improve staff retention Hoping to attract top staff Expanding abroad 0% 10% 20% 30% 40% 50% 60% Australia Netherlands UK Japan Canada USA Germany Belgium Global S.Africa France India China Brazil Mexico 0% 20% 40% 60% 80% Source: IWG 2016 report and accounts Source: IWG The sharing economy The broader shift towards the sharing and/or gig economy has been apparent for many years (see The Sharing Economy, published September 2015 for a fuller discussion). We think this structural shift in the way people interact and work will continue to support demand for shared office spaces, particularly co-working sites such as Spaces (IWG's coworking brand) and WeWork. Co-working is a philosophical evolution in the way people work. It is more than just working in a shared space to reduce cost but very much an approach based on IWG (IWG.L) 12

13 interaction, networking and learning in a flexible and collegiate manner. This is not only for small startup operations but also for larger corporates looking to attract and retain talent while remaining a la mode in fast-moving sectors such as media and technology. In 2016 WeWork noted that 14% of its members are employed by companies with 500+ employees. These companies included Dell, Salesforce.com, McKinsey and Microsoft (source: Bloomberg, 4 November 2016). Landlords The growth of the serviced office sector (see Figure 20 above) is changing the attitude of landlords who are looking to be involved in the growth of the sector in order to maximize returns on their fixed asset base. IWG has noted an increase in partnership deals with landlords where IWG's net capex investment is significantly lower than conventional deals in return for sharing a portion of revenues or profitability with landlords. IWG benefits from higher return on cash investment (lower EBIT margins more than offset by lower capital invested) while landlords improve yields on the total cost (sunk cost of building plus a portion of the fit out of the serviced center) of the assets. Until recently (see below), there had been no noticeable unilateral entry into the serviced office market from landowners. They have preferred to partner with service providers such as IWG. This raises the question as to why landlords will accept non-recourse leases (IWG's standard practice) and invest upfront capital rather than go it alone. We think there are 4 main factors: 1) Landlords do not have a brand and sales network in order to attract and effectively manage a dynamic and diverse client base. Even IWG as the clear market leader has not yet optimized its marketing and sales process across global corporates, in our view, highlighting the challenges for any new entrant. 2) Real estate management is an inherently different business model to the service industry and many operators do not have the personnel or experience to move into another area. On a similar theme they do not have the infrastructure to operate a cost effective and efficient serviced office model offshore shared service centers, receivables management, dynamic pricing models etc. 3) Landlords are typically local in nature and do not often have the national or regional networks to attract larger corporates. 4) They are able to enhance yields through partnerships so the risk adjusted return is greater than the self-operated mode. The recent exception was British Land. Last month it announced that it would launch a flexible workspace offer as management believes it will enable us to capture incremental demand from the increasing number of small businesses taking space in London as well as meeting a growing need amongst our existing occupiers for flexible space for specific projects and teams (source: Financial Times, 17 May 2017). The initial offering will be in 25,000sq feet with a further 80,000sq ft space already allocated. At a local level, the serviced office may add competition for IWG, with the location being at 4 Kingdom Street and IWG having an existing center at 2 Kingdom Street W2 6BD. Tangential to the dynamics of landlords' approach to serviced offices is the potential impact of IFRS 16, which we discuss in more detail in the sections below. As leases are brought onto corporate balance sheets we expect that this will increase the desire to move to serviced offices, rather than take on long traditional operating leases, since serviced offices will take some, or all, of that liability off the client balance sheet and transfer it to the serviced office provider. IWG (IWG.L) 13

14 Population Demographic dynamics are generally positive for IWG. In the top 5 markets (US, UK, France, Australia and Germany) it will see growth in the 25- to 44-year-old cohort who are more likely, in our view to embrace/demand flexible work solutions. The most rapid growth is in the over 65s. While a smaller proportion of the future workforce, we expect that proportion to increase and for the older generation to react positively to flexibility. In a 2015 survey by IWG, it found that 84% of respondents believed that flexible working is a major factor in encouraging people to work post retirement (source: The Demographics of Flexible Working, June 2015). Across the top 20 markets (weighted for 2016 number of centers), there is growth in all cohorts over 25 as growth in emerging markets (notably China, India, Mexico and Brazil) more than offsets declines in western economies. These are also economies where a higher proportion of workers already work away from the main office (see Figure 22 on page 12). Figure 23: Growth in population by cohort E for top 5 serviced office countries US, UK, France, Australia and Germany Figure 24: Growth in population by cohort in top 5 and top 20 markets E 30% 25% 20% 15% Top 5 countries 28% 40% 35% 30% 25% 20% 15% 36% 28% 10% 5% 0% -5% 5% 1% -3% < % 5% 0% -5% 5% 4% 5% 1% -1% -3% < Top 5 countries Top 5 countries Weighted top 20 countries Source: United Nations estimates, Credit Suisse research Source: United Nations estimates, Credit Suisse research IWG (IWG.L) 14

15 Technology We think that automation and Artificial Intelligence will become an increasingly important theme in the coming years as business models and labour markets are disrupted (see our previous Ideas Engine, Generalist Staffing: Automation's impact underestimated, 24 May 2017). We think technological change is a net benefit for IWG but, as in most cases, it's not binary. On the positive side, we note 1) Technology enables greater flexibility in working practices. It allows employees to have multiple work locations including serviced/co-working offices. 2) Technological change encourages business creation (even if there are losses in existing businesses) that are more likely to use serviced offices. 3) In periods of economic disruption, more traditional businesses will need to restructure. Real estate will increasingly, in our view, be part of that process to an extent that was not realistic 10+ years ago. 4) Technology has made the western world more mobile. Not only does it enable flexibility from a practical perspective, it encourages it from a cultural point of view. 5) In a flexible world, corporates continue to want oversight of their workforce. Working in serviced offices, as opposed to hotels/coffee bars/home enables this oversight as well as improving cybersecurity relative to some other flexible alternatives. 6) While employees can be flexible, they do not want to be isolated. Serviced offices provide a flexible and lower cost solution that also remains social. On the negative side: 1) We think that automation will negatively impact employment. A smaller workforce could affect demand for serviced offices. 2) Disruption to traditional business models may see vacancy levels rise in traditional working environments with negative implications for rental yields. 3) The pace of change may lead to a larger portion of traditional serviced offices becoming antiquated more quickly, requiring increased portfolio churn and renovation cost. IWG (IWG.L) 15

16 Cumbria Somerset Derbyshire Lincolnshire Buckinghamshire Essex Cambridgeshire Hampshire Wales Northamptonshire Worcestershire Devon Lancashire Herefordshire Cheshire Kent Yorkshire West Sussex Berkshire Scotland West Midlands Wiltshire Leicestershire East Sussex Greater Dorset Staffordshire Average Tyne and Wear Norfolk Nottinghamshire Merseyside Surrey Bedfordshire Oxfordshire Shropshire Gloucestershire Cleveland London Greater 13 June 2017 Great Britain market overview There were just over 3,400 serviced offices in the UK (source: Instant Offices) in 2016, including 23 in Northern Ireland (source: Instant Group, Flexible Workspace Review 2016). In Figure 25, we show that 33% are in Greater London and 17% in the South East of England. On average, there is one serviced office center per 25,000 of population. This is not smoothly distributed, with one center per 42,500 people in Wales compared to one for each 9,500 in Greater London. Clearly the numbers in London are impacted by the significant commuter base entering the city for work. When we split the population/center into data per county, there is a broader spread of data. Counties such as Somerset and Cumbria have very few centers, while counties such as Gloucestershire (Bristol) and Cleveland (Durham and Middlesborough) have a high proportion per population. Figure 25: Great Britain serviced office market % of centers Figure 26: Population per center within regions 3% 7% 17% 15% 6% 8% 4% 33% 7% London Greater Scotland Greater Manchester North East North West South East South West Wales Midlands 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Population per centre Source: Credit Suisse research, Instant Offices Source: Credit Suisse research Figure 27: Population per center split by county/country 120, ,000 80,000 60,000 40,000 20,000 0 Population per centre Source: Credit Suisse research, Company data, Instant Offices IWG (IWG.L) 16

17 Herefordshire Buckinghamshire Berkshire Cambridgeshire Hampshire Yorkshire Northamptonshire Wiltshire Cheshire Scotland Lancashire Essex Devon Bedfordshire Surrey Tyne and Wear West Midlands London Greater West Sussex Greater Nottinghamshire Gloucestershire East Sussex Cleveland Wales Kent Worcestershire Lincolnshire Leicestershire Merseyside Shropshire Oxfordshire Norfolk Staffordshire Somerset Dorset Derbyshire Cumbria Cornwall 13 June 2017 IWG's position in Great Britain We estimate that IWG has 318 centers in Great Britain (and some in Northern Ireland), which is a c10% share of the total centers. This does not differentiate between the size of the centers and as we note below we estimate that its share in terms of rented space was closer to 16% in Its primary exposure is to London (31% of centers) and the South East (22%). On average, IWG has a center for each 185,000 members of the population across the UK (Figure 30). In terms of share of centers, IWG has significant share in counties (all near London) such as Herefordshire, Buckinghamshire and Berkshire but no exposure to areas such as Dorset, Cumbria and Cornwall. Figure 28: IWG regional exposure in Great Britain Figure 29: Population per IWG center in Great Britain IWG Population/IWG centre 2% 13% 5% 22% 31% London Greater Scotland Greater Manchester North East North West South East % South West 5% 10% 3% Wales Midlands Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Figure 30: IWG share of centers in each county 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% IWG Share Source: Company data, Credit Suisse estimates IWG (IWG.L) 17

18 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan June 2017 Growing penetration in the UK market We estimate that the UK serviced office market has grown by over 200% between 2005 and 2016 in terms of the number of centers. That compares to just 6% growth in the available office space in the UK (in millions of meters squared, see Figure 31). This implies that the penetration rate in the UK has risen from under 2% in 2005 to over 5% by We estimate that IWG s share has risen from just over 10% in 2006 to 16% by 2016 in terms of available space. This is higher than the data shown in Figure 30 above, reflecting our view that IWG centers are typically larger than the market average. The growing usage of serviced offices in the UK is also reflected by recent data from Savills on London s West End market. It noted that 8% of office take-up has been serviced office providers in the year to date. This is similar to the last 4 years but well ahead of the average of 4% over the past 17 years (source: West End Office Market Watch, 30 May 2017). Figure 31: Total office space and serviced office space in the UK Figure 32: UK penetration of serviced offices, as a proportion of available office space % 5.0% 4.0% 3.0% 2.0% 1.0% Serviced office penetration 0.0% Office space - sq m (millions) (LHS) Service office sq m (millions) Source: Government statistics, Instant Offices, Credit Suisse research Source: Government statistics, Instant Offices, Credit Suisse research Cyclical dynamics Office rental markets continued to grow in the US and UK through 2016 although the rate of growth slowed in both markets, most notably in the UK. Through 2017 and into 2018, we expect the UK market to turn negative, particularly in London, and the US market to continue to grow, albeit at a reduced rate. IWG's operating metrics have lagged behind the broader office market trends in recent quarters, particularly in the Americas. While some of this is mix (notably Latam) and cannibalization resulting from rapid expansion in 2014 and 2015, an element is a result of disruption and weaker execution following the SG&A reductions in both regions. We think most of these issues have now annualized. UK The rental value index in the UK continued to grow in late 2016 and into early 2017, although the rate of growth has slowed. When we compare the total rental value of the UK property market to REVPOW (revenue per occupied workstation) at IWG, there was a clear relationship through the recession and the subsequent recovery. As rental values have continued to rise, REVPOW in the UK has remained stable in recent months. Occupancy in the broader UK office market declined in H (post the referendum) but picked up marginally in early 2017 in both the London markets and the rest of the country (Figure 35). IWG's UK mature occupancy has declined, most notably in 2015 (Figure 36). IWG (IWG.L) 18

19 Nov 2007 Jun 2008 Jan 2009 Aug 2009 Mar 2010 Oct 2010 May 2011 Dec 2011 Jul 2012 Feb 2013 Sep 2013 Apr 2014 Nov 2014 Jun 2015 Jan 2016 Aug 2016 Jan-08 Aug-08 Mar-09 Oct-09 May-10 Dec-10 Jul-11 Feb-12 Sep-12 Apr-13 Nov-13 Jun-14 Jan-15 Aug-15 Mar-16 Oct-16 Dec-99 Oct-00 Aug-01 Jun-02 Apr-03 Feb-04 Dec-04 Oct-05 Aug-06 Jun-07 Apr-08 Feb-09 Dec-09 Oct-10 Aug-11 Jun-12 Apr-13 Feb-14 Dec-14 Oct-15 Aug-16 Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11 Jan-12 Sep-12 May-13 Jan-14 Sep-14 May-15 Jan-16 Sep June 2017 Within the IWG data, there are a number of moving parts. The number of workstations grew rapidly (+96% in the UK from 2012 to 2016) and the movement of some of the 2013 openings (when UK grew 43%) into the Mature segment diluted mature UK occupancy. Acquisitions, regional shift and the building of a broader national network have all impacted occupancy. The shift of some meeting rooms to workstations has a short-term dilutive impact on occupancy metrics. We would note, however, that mature gross margin in the UK was stable from 2014 to While the UK rental value index has continued to rise, we think that headline rental prices, mainly in London, are masking increased incentives, such as longer rent-free periods at the start of the lease offered by landlords to attract tenants in uncertain times. We expect that economic prices in London will fall through 2018 and 2019 and that vacancy rates will marginally increase. In total, we expect a c10-15% cumulative headwind in London s office market to the end of 2019E. While uncertainty will, in our view, support the shift towards more flexible workspace solutions, there will be a knock-on impact to pricing and demand in IWG s business in both London and the broader UK. Figure 33: UK rental value index Figure 34: UK rental value vs RGU/IWG UK REVPOW Rental Value growth RGU - UK REVPOW (LHS) UK mkt - Rental value Source: IPD Figure 35: UK market occupancy Source: Company data, IPD Figure 36: UK mature occupancy for IWG % 84% 82% 80% 78% 76% 74% 72% 70% 68% Office - London - City Office - London - Mid Town & West End Office - Rest of UK IWG Occupancy Source: IPD Source: Company data IWG (IWG.L) 19

20 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q June 2017 The Americas In the US, the office rental market has continued to grow (Figure 37), although the rate of growth slowed during IWG's gross margin tracked the market through 2006 to 2014 but has deviated in the past two years. We think there are 3 reasons for this relative weakness: 1) Deflationary pressure in Latin America, which led to faster reduction in REVPOW than could be compensated by lower rental costs. This is the primary reason why Americas REVPOW has not kept pace with US market rent (Figure 38). 2) Execution by management at a time of considerable change in the employee structure. SG&A was reduced by 25% in the US in the past two years and that had a negative impact on operational performance. The company believes that much of this change has now been addressed. 3) Some cannibalization from rapid growth. Workstations grew 31% in the Americas between 2014 and This led to a decline in mature occupancy in the US. Figure 37: US office market revenue proxy versus IWG gross margin Figure 38: US market rent vs REVPOW in USD 23 40% 15, % 30% 25% 20% 15% 14,000 13,000 12,000 11,000 10,000 9, US market revenue proxy IWG GM (RHS) Regus Americas REVPOW (LHS) USD Mkt rent ($ sqr ft) Source: Thomson Reuters, Company data. Office Market revenue proxy calculated as average occupancy x average rent per square foot Source: Company data IWG (IWG.L) 20

21 Lease capitalization IFRS 16 is due to come into force in 2019, which will have a significant impact on the financial statements and ratios for IWG. In the sections below, we show our estimates of how these statements and ratios are likely to look. Calculation of implied interest and depreciation charges In Figure 39, we show our calculation of capitalized lease value and the split between interest and depreciation charges. The methodology is as follows: 1) Use full year lease P&L cost. Figure 39: IWG lease capitalization calculation GBP in millions, unless otherwise stated 2) Multiply by the capitalization factor to get to 4.8bn capitalized value (i.e. PPE equivalent), which IWG management has noted would have been the capitalized value of leases for 2016 under IFRS 16. This figure of 4.8bn compares to the 4.4bn reported in the 2016 accounts for lease obligations (page 109 of 2016 accounts). This number is, however, based on the lease life to the next break clause and is not discounted. 3) We apply an average interest charge of 4% to the capitalized value to ascertain an implied interest charge. 4) We deduct the interest charge from the lease cost to calculate an implied depreciation charge for the leases asset. 5) This implies an average asset life of 7.2 years ( 4.8bn divided by depreciation at 670m). 6) The increase in EBITDA impacts the FCF to equity calculation. We estimate implied capex by multiplying the change in depreciation multiplied by the lease life. We return to this on page 25 below. 2015A 2016A 2017E 2018E 2019E 2020E 2021E Lease cost ,015 1,117 1,225 1,337 Capitalisation factor Capitalised value 3,887 4,800 5,243 5,646 6,214 6,820 7,438 Interest cost (assumed) 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% Implied interest charge Implied depreciation ,039 Average Asset life Source: Company data, Credit Suisse estimates IWG (IWG.L) 21

22 P&L In Figure 40 we show the P&L under current accounting standards and our estimates for how this will look under IFRS 16. There are 5 factors to note. All elements below the PTP level are unchanged. Lease rental costs ( 862m in 2016) are removed from the cost of goods sold. This boosts EBITDA by the full amount. The rental cost is split between implied interest charge and depreciation charge (see Figure 39 above). Interest charge increases by the 192m in 2016 and EBITA rises by the same amount. PTP, tax, net profit and EPS are unchanged. Figure 40: IWG current P&L plus P&L adjusted for IFRS 16 GBP in millions, unless otherwise stated 2015A 2016A 2017E 2018E 2019E 2020E 2021E 2015A 2016A 2017E 2018E 2019E 2020E 2021E Revenues 1,927 2,233 2,439 2,627 2,892 3,173 3,461 Revenues 1,927 2,233 2,439 2,627 2,892 3,173 3,461 Lease Depreciation Lease Depreciation ,039.0 Total Depn Total Depn , , , ,322.1 Amortization Amortization Rental Cost , , , ,336.6 Implied rental cost , , , ,336.6 % Sales 36.2% 38.6% 38.6% 38.6% 38.6% 38.6% 38.6% % Sales 36.2% 38.6% 38.6% 38.6% 38.6% 38.6% 38.6% Operating exceptionals Operating exceptionals Pre exceptional Pre exceptional EBIT EBIT Margin 8.3% 8.3% 9.2% 9.6% 9.7% 9.3% 9.8% Margin EBITA EBITA Margin 8.9% 8.9% 9.7% 10.1% 10.1% 9.7% 10.2% Margin EBITDA EBITDA 1, , , , , , ,972.0 Margin 15.8% 17.0% 17.6% 18.2% 18.2% 17.8% 18.4% Reported EBIT Reported EBIT Operating lease Interest Lease Interest Interest charge (pre excep) Interest charge (pre excep) PTPA pre exceptional PTPA pre exceptional PTP pre exceptional PTP pre exceptional PTP post exceptional PTP post exceptional Tax exceptional Tax exceptional Reported tax Reported tax Tax rate 16% 20% 20% 20% 20% 20% 20% Tax rate 16% 20% 20% 20% 20% 20% 20% Tax on exceptionals/ammor Tax on exceptionals/ammor Reported net profit Reported net profit Adjusted net profit Adjusted net profit Company adj Net profit Company adj Net profit Basic average shares Basic average shares Basic diluted shares Basic diluted shares Reported EPS Reported EPS Adjusted EPS Adjusted EPS Source: Company data, Credit Suisse estimates IWG (IWG.L) 22