MARKET COMMENT
Regus Rockets

By Stuart Watson (TMFTiger)
November 9, 2001

This morning we published an article in our new Fool School series explaining the concept of gearing. As if by magic, the quarterly results from the managed office provider Regus (LSE: RGU) that came out at noon today provide a perfect example of gearing in action.

Regus is a relatively simple business to understand. They lease office space and then tart up the insides. Businesses of any size can then hire any number of workstations for any length of time. In fact you can even change the amount of work space you want on a daily basis. Top of the range facilities are provided, with hot and cold running coffee to boot (according to a recent visitor anyway).

So Regus's costs are largely fixed, being the cost of the property and the equipment and the administration staff they supply to support you. Businesses that have a high fixed cost base like this have what is known as high operational gearing. So each extra unit that is sold makes a big difference to their bottom line. But that works both ways. Software companies and fund managers are two classic examples of this type of business. When you own such businesses you need to be aware of how sensitive their profits can be to changes in economic activity.

In Regus's case the big variables are occupancy rates and the amount charged per workstation. After many years of growth on the back of the buoyant global economy harder times have set in. The average annual revenue per workstation has plummeted from £2,459 this time last year to £1,836 this year -- a fall of 25%. With a fall of this magnitude, Regus has not been able to cover its costs. The table below shows this in more detail. Notice the decline in gross margin (gross profit divided by sales) from 25% to just 9%, indicating that a lot of the costs included in this amount are not dependent on trading volumes.

                Q3 01    Q3 00
                   £m       £m
Sales             123      115
Cost of sales    (112)     (86)
                 ----     ----
Gross profit       11       29
Admin costs       (22)     (21)
                 ----     ----
Operating profit  (11)       8

Regus is aware it is in deep doo-doo, so it's cutting its cost base to try and be profitable and/or cash flow positive at this level of trading. A quarter of its staff are going and it is reducing the number of workstations by 11% as well.

Whether this will be enough to stem the tide is debatable. The market seems to think so. It was obviously expecting something catastrophic from today's results and the shares have rocketed 75% in response to today's announcement. At 33.5p (a far cry from its flotation price of 260p last October) the company is valued at £195m. Should the economy recover the current price could prove to be a bargain. If it doesn't then Regus won't be rocketing for much longer. On balance, the shares look pretty risky. It's worth remembering that no matter how far a share has fallen, it can still fall by up to 100%.