Pulte’s Competitor Elimination Play
So much for the truism “you can’t cost cut your way to profitability.” One major “Nash Equilibrium” move later, and you’ve proved that truism untrue in the home building landscape. Maybe the phrase should be, “you can’t cost cut your way to profitability … unless you get to cut the costs of two companies rather than just one.”
Pulte’s $1.3 billion stock-for-stock purchase of Centex is probably more important right now for the cost cut-ability being bought versus the today’s revenue from Centex. Two companies’ tripping over one another for customers in so many markets for so scarce a number of buyers made getting to the finish line–past the threat of liquidity crunches, missed debt payments, and financial dislocation–a pretty scary challenge.
For when you mash two large home building companies together, subtract $250 million in overheads, and re-rationalize geographies, product lines, subcontractors, and manufacturers, you’re suddenly looking at pro formas for a grail-ish sounding below-$40-per-square-foot in direct costs. This may just be the only ticket to the finish line (a ka survival) for companies, however much they boast about their cash “dry powder.” Value re-engineering and retooling will be critical to capture the savings, but bloodletting in mass layoffs inevitably will be the biggest part of what’s going on here.
This is really two companies awakening to a recognition of reality. The epiphany? “The world needs one less of us.”
That may not be a normal mergers and acquisitions strategy, but normal mergers and aquisition strategies really don’t exist in home building. As home building industry financial consultant Ivy Zelman says, why buy legacy assets when you can buy land cheap or soft-take-down your way through the doldrums.
What companies are waking up to a third of the way through the year they hope is the worst year ever in home building is that if they want to be around on the other side, it’s going to take more than a treasure chest of cash to ensure that. Cash, after all, burns.
So we’ve got a strategic acquisition where the impetus of the strategy is “we’ve got to build houses cheaper so we can move them through the teeth of the maelstrom.” Even though the combined companies build in 59 markets today, the likelihood of that being the case in six or 12 months is almost unimaginable. Pulte’s footprint a year from now is probably far more concentrated.
Their opportunity is to scale in enough markets–entry level and first time move up–to get with the earliest waves of absorption recovery, at low enough price points to avail of tax credits, and mortgage buy downs, and FHA and agency lending, etc.
This assures Pulte of being able to concentrate more, get margins up, and avoid at all costs having to reach into its trove of cash to run everyday operations.
The other part that makes sense not only for Pulte but for other players is the potential ability to separate home building operations and merchandising from its real estate development business. We understand that D.R. Horton and Lennar have had a similar exploration–where Horton would stick to its home building operational expertise, and draw on Lennar for its real estate strategy and development skills. We’ve seen Ryland in a strategic alliance with Oak Tree. We’ll see more asset-light home builders strategically tied to land strategy and finance companies.
We know that consolidation of this ilk will occur, although, probably after a rather protracted dance of the tail feathers since there are still some big egos in the way of what makes sense strategically.
There’s pressure on every public builder to explore a public-to-public merger because this deal makes it abundantly clear that there’s lots of cost and lots of capacity that needs clearing before this thing can turn around.
An overall reduction in capacity is the only way to reintroduce scarcity into the home building supply and demand equation. We believe we will see other top 12 home building companies try follow suit, because $250 million in cost savings is going to sound pretty attractive to boards and note holders in the near term.
It’s basically saying that the 40% to 60% downsizing in people and operations that has taken place since 2006 gets home building organizations a little past half-way there. That’s quite some pain to go.
Merger Rock & Roll Begins: Pulte Gets Centex
Pulte Homes and Centex Corp. agreed to a stock-for-stock merger transaction that makes Pulte the planet’s largest home building company. Remember home building?
The Wall Street Journal reports this a.m.
Pulte Chief Executive Richard Dugas Jr. said the deal would combine Centex’s strength in the entry-level and move-up categories and Pulte’s strength in the move-up and active adult community segments, forming the largest U.S. home builder.
Pulte last month adopted a shareholder rights plan with a 5% trigger to help preserve tax assets that would be lost with an ownership change.
Under the deal, which also includes $1.8 billion of debt, Centex shareholders will receive 0.975 Pulte common shares for each share of Centex they own. Based on Pulte’s Tuesday closing price of $10.77, the deal is valued at $10.50 per Centex share, a 38% premium over Centex’s Tuesday close of $7.62. Pulte shareholders will own about 68% of the combined company, while Centex’s will own about 32%.
More on this later. What do you think? Who’ll D.R. Horton–which has stocked up $1.8 billion in cash “dry powder” pick as its dance partner? Will Lennar sit back and become a large-cap also-ran? Unlikely.
Here’s a perspective from Reuters, which notes that Pulte CEO Richard Dugas will take over as chairman and CEO of the combined company:
Experts predict more strategic stock-for-stock deals this year in distressed sectors, as they help companies reduce costs while allowing shareholders to benefit when conditions improve. With such transactions, companies in struggling industries can bulk up without having to deplete much-needed cash or trying to raise scarce and costly debt financing.
Here’s CNBC’s report and quick analysis on the merger from this morning.
David Goldberg, UBS’s Home Building & Building Products analyst, has this first-blush observation:
Although at first glance we believe the deal represents strategic advantages for both companies, we await further details on the exact benefits. That said, this deal will provide greater operating leverage as Pulte expects to realize ~$250mn in cost savings annually through reduced overhead. Further, it gives them access to high quality lots, well positioned geographically and across price points, while preserving cash.
Here’s how the companies’ press release addresses what will happen to Centex CEO Tim Eller:
Mr. Eller will join the board of directors of Pulte as vice chairman and will serve as a consultant to the company for two years following the close of the transaction. The board of directors of Pulte will be expanded and will include four current members from the Centex board, including Mr. Eller, and eight members of the current Pulte board, including company founder and current Pulte Chairman William J. Pulte.
When the Dust-Up Settles
The Wall Street Journal caught up today with what we reported here yesterday.
Clearly, calmer heads prevailed as large home building company executives met with NAHB leadership in Chicago yesterday, after flare-ups over the trade association’s strategy and effectiveness in the battle for Congress’s attention to home builders’ interests.
The agreement to agree, at least for the moment, must mean there are high stakes ahead in a continued struggle for benefits to new residential construction as a united industry. We know that a number of the largest home building companies have executives who are at the end of their patience with how their interests have been represented in Washington.
It’s a testament to the diplomatic skills of Centex CEO and NAHB high production council chair Tim Eller to win alignment among at least a dozen other home builders for continued support of NAHB as their primary lobbyist.
We’ll hear more about this as new measures to deal with the economic crisis emerge for debate on Capitol Hill.
Ten Set for the Task of Survival
Here’s the Builder magazine Top 10 list of its annual intelligence franchise on the nation’s leading new residential construction organizations. Now, go have a look at how and why who’s here and who’s missing from the list by checking out “Revealed: The Top 10 Builders for 2008” on builderonline.com.
Top 10 Builders for 2008
|
Rank |
Company |
2008 closings |
% change |
2007 closings |
2007 ranking |
|
10. |
Meritage Homes Corp. |
5,627 |
-51 |
7,687 |
12 |
|
9. |
Beazer Homes USA |
6,642 |
-42 |
11,366 |
8 |
|
8. |
The Ryland Group |
7,352 |
-29 |
10,319 |
9 |
|
7. |
NVR |
10,741 |
-21 |
13,513 |
7 |
|
6. |
Hovnanian Enterprises |
11,281 |
-25 |
14,928 |
6 |
|
5. |
KB Home |
12, 438 |
-48 |
23,743 |
5 |
|
4. |
Lennar Corp. |
15,735 |
-53 |
33,283 |
2 |
|
3. |
Centex Corp. |
18,241 |
-41 |
30,684 |
3 |
|
2. |
Pulte Homes |
21,022 |
-24 |
27,540 |
4 |
|
1. |
D.R. Horton |
23,915 |
-37 |
37,717 |
1 |
|
|
Total |
132,994 |
-37 |
210,780 |
|
Credit: Builder magazine, Hanley Wood, parent company of Housingcrisis.com.
Here’s one of editor Boyce Thompson’s key take-away observations:
The top 10 worked overtime to generate cash flow and allay investor concerns that they could not meet debt obligations. Unlike many builders in the second tier of the Builder 100, the top 10 all managed to stay in business thanks to long-term debt financing. Even companies reporting the biggest losses stockpiled large cash reserves that they hope to one day deploy to fuel growth.
Publicly held home building companies have a capital structure that may give them an advantage through protracted difficult times, but their unwieldy, decentralized manufacturing, distribution, and marketing operations and their profligate real estate strategies could make casualties of one or two of the above during the next leg of the crisis.
Who’ll be on this list a year from now? We’d guess at least two other names, possibly one or more of them an M&A combo.
Won’t You Please Come to Chicago?
Here is a direct quote from last Wednesday night from one of the principals embroiled in a conflict the Wall Street Journal reports today is “a firestorm that could cost [National Association of Home Builders CEO Jerry] Mr. Howard his job.”
As a close observer of the recent legislative activities and the subsequent give-and-take that has occurred, I know you can appreciate the importance of unity for the future success of our industry. That’s why we are actively engaged in a constructive dialogue with our trade association. We all want to ensure that home builders are recognized for the important contribution they make to the economy and to our way of life here in America. Having a cohesive voice in Washington has never been more important.
- See two previous Housing Crisis.com posts on the NAHB/big builder struggle over laws that would extend NOL tax carryback provisions. One is “BIG HOME BUILDERS VS. NAHB BRUSH-UP UPDATE,” and the other is “HOME BUILDER TRADE GROUP GOES PUBLIC, OR RATHER, GOES AT ITS PUBLIC MEMBERS.”
Conciliatory, careful almost to the point of mincing, this from-the-horse’s-mouth phrasing–which we believe will rule the day amid more hot-tempered militant voices–concludes with this line:
While we would differ with the approach that was taken and with the characterizations contained in the information published by NAHB recently, we believe it is best to focus on the future and how we can be more effective and successful as an industry. We are looking forward to having solutions-based conversations with the leadership of NAHB and anticipate a productive outcome.
You’d scarcely read into those words the stunning speculation reported by Michael Corkery in the WSJ article:
Executives from some of the trade group’s largest home-building companies are scheduled to meet Monday in Chicago with the NAHB leadership to discuss the possibility of ousting Mr. Howard, according to people familiar with the meeting. An NAHB spokesperson declined to comment.
At the meeting in a private club at Chicago’s O’Hare International Airport, representatives from KB Home, Centex Corp. and Pulte Homes Inc., some of the largest home builders in the U.S., may call for Mr. Howard’s ouster or threaten to break away from the 200,000-member trade group, these people said. A Pulte spokesman declined to comment. Executives from Centex and KB Home couldn’t be reached.
“According to people familiar with the meeting” could mean many things. Last week, we talked to some home building company senior level executives who were so aggrieved by the NAHB leadership’s behavior that they mentioned calling for his ouster as a condition to their agreeing to remain part of the trade association. But as we reported more extensively among public company leaders, we were told calmer heads would prevail, and that a very likely outcome would be a note of compromise.
Among the issues are economics. Association members pay dues according to a sliding scale, which puts a disproportionate onus on larger companies to ante up more for local home builder association and national dues each year. Big companies think that since they pay so heavily into the association’s interest, the last thing they should expect is the kind of treatment they received as the net operating loss tax carryback measure surfaced for final consideration as part of the $787 billion stimulus program passed by Congress and signed into law last month.
What’s more, the association went for a referendum among its 200,000 members last week, seeking support for its lobbying strategy and tactics as a point of proof to the largest companies that rank-and-file builders fear the big guys will get unfair advantages with an extension of carryback allowances to five years.
Ultimately, we believe that the big builders’ conversations with NAHB will be “solutions-based.” We’re just not certain that the solutions can or will be status quo solutions. In so many ways, the top 10 or 11 public company peers in home building resemble other Fortune 500 manufacturing and marketing organizations more than they share kinship with home builders who construct 10 or 12 homes a year.
Now that there’s talk of yet another gargantuan stimulus package in the planning, there’s not a shred of doubt that as one of the key players in the drama says above, “Having a cohesive voice in Washington has never been more important.”
If policy on housing hopes to offer a measurable improvement over the next couple of years, it’s certainly going to need to get high volume home builders back into the business of high volume building and marketing more affordable home products to home buyers. If that means getting rid of land that cost too much before, and buying it back at a lower price later so that the entire cost base of a home can be lower, then that may be what it takes for all of housing to claw its way back.
Home Builder Trade Group Goes Public, or Rather, Goes at Its Public Members
Home builders met with only flashes of success after their big, exhausting fight on Capitol Hill for stimulus and business tax programs they believed could help the economy help itself. They won an $8,000 tax credit for first-time home buyers. They wanted as much as $15,000 for new or existing home buyers, and they wanted a mortgage buy-down program to jolt demand. They didn’t get nearly that.
For the moment, the battle for more substantial stimulus measures has run its course.
Now, it seems, some of them are going after each other. For, in the wake of the charged, 24/7 lobbying blitz that concluded with Congressional reconciliation of a $790 billion stimulus bill on Friday, Feb. 13, second-guessing and defensiveness have flared up, opening up chronic wounds among long-polarized parts of the industry group.
This week, National Association of Home Builders leadership broadcast to its 200,000 members an aggressive defense of its strategies and its record of effectiveness among elected officials and new Adminstration policy-makers.
At the same time, the trade group distributed a series of documents and has them posted on the members-only pages of the nahb.org Web site that appear to try to rally member support amid a divisive exchange with a small but powerful part of the home building universe–high production builders.
The documents chronicle a controversy whose most recent focus is a scrap over whether net operating loss carry backs would be extended. It’s an issue that home builders have been fighting for among elected officials practically since many of them started reporting quarterly losses in the second half of 2006. But this latest go-round has had a particular sting to it.
Here’s why. At the 11th hour in lobbying and deliberations, on Wednesday, Feb. 11, NAHB President and CEO Jerry Howard wrote to Speaker of the House Nancy Pelosi saying that, as crafted, a measure that would extend NOL carrybacks from 24 to 60 months would give public home builders an unfair advantage at the expense of small home builders. Howard attached a Wall Street Journal article that appeared that morning, which focused precisely on the issue of how extension of the NOL provisions to five years could damage smaller builders’ chances of survival in an already hostile market.
A letter dated March 2, 2009, from NAHB Chairman Joe Robson to High Production Home Builders Council chair and Centex CEO Tim Eller, asserts that the timing of the appearance of the Wall Street Journal article and the case Jerry Howard wanted to put before the Speaker of the House was coincidental.
Robson
The article by Mr. Corkery in the Wall Street Journal on Wednesday, Feb. 12 [editor's note, Wednesday was Feb. 11] highlighted this potential for abuse in the NOL legislation. This was not a onetime occurrence by Mr. Corkery. Attached is a series of Mr. Corkery’s articles on NOL and housing since January, 2008.
NAHB had information about the potential for an article by Mr. Corkery, by way of his inquiry to interview some of our members and asking for a quote from Jerry Howard. We did not know what angle the article would take, who he would quote nor the timing of the article. NAHB has numerous and similar press requests on a regular basis. Obviously, Mr. Corkery’s article was published on the very day the Conference Committee on the Stimulus Bill was to begin.
The events of Wednesday, February 11, 2009, were unprecedented, ending in a four hour Conference Committee on the largest spending Bill in the history of this country.
The morning began with Mr. Corkery’s article. On your regular FHF conference call, Bill Killmer, as replacement for Jerry Howard, who had another engagement, discussed the article and a possible fix to the NOL legislation to prevent abuse. Clayton Traylor in your office volunteered to help write the legislative fix. Jerry Howard in his capacity as President and CEO of NAHB wrote the letter to Speaker Pelosi supporting NOL but requesting a fix to potential abuse which could result in further deterioration of real estate values.
There was not time to review or edit as the events of the day were unfolding at such a rapid pace. I saw the letter after it was sent. If I had the opportunity, I would have edited the tone and order of the letter but not “the ask” as I believe there was an opportunity for abuse.
At the end of the day, I do not believe the article, Jerry’s letter or anything our lobbying staff tried to do could have saved NOL in the Stimulus Bill.
Here’s what the Wall Street Journal reported the following day, on Feb. 12. “Stimulus Bill Deals ‘Major Blow’ to Big Homebuilders.”
The final version of the bill, hashed out in conference between the House and Senate Wednesday night, dropped a tax measure that would have allowed large corporations to claim write-offs on taxes they paid five years ago, instead of a two-year carryback allowed under the current law. The stimulus bill only allows for a five-year carryback for companies with under $5 million in revenue, leaving the larger builders out in the cold.
Big builders are expected to use the current tax law, allowing a two-year carryback, to reap as much as $2.4 billion in cash this year, far more than they will generate from selling houses. But small builders complained that the law, if extended to five years, would encourage their large competitors to dump land to obtain tax write-offs. That would continue to depress values across housing markets, they argue.
The stimulus also axed another home builder plum: a proposed $15,000 home buyer tax credit. The bill includes an $8,000 credit that does not have to be paid back, up from the current $7,500 credit that did have to be repaid, which builders have declared entirely inadequate at spurring demand. In a research note, housing analyst Ivy Zelman called the downsized credit in the bill “a major blow to builders.” Share of the large builders had slipped in morning trading by as much as 10%.
We can only regard the appearance of Corkery’s piece on the polarizing effects of the NOL issue, and the way it was presented as an attachment to Jerry Howard’s letter to Pelosi as highly intriguing timing.
Interestingly, when you do the math on which “small companies” wound up qualifying for the extended NOL provision–those with annual sales of less than $15 million–it takes 60 houses a year at $225k to get there. So, there are quite a number of home builders, even in the broader NAHB universe, that lost out as a result of the ultimate dollar threshold contained in the stimulus that passed.
It should be noted that HousingCrisis.com and sister publication Big Builder are in a delicate situation that we should disclose. Our parent company Hanley Wood has ongoing business relationships and long-standing association with the NAHB.
Our questions have to do with the need for aggressiveness and clear antagonism toward the large companies in the association’s membership. For example, association leadership and the Fix Housing First Coalition leaders were said to have had a daily 9 a.m. call most days a week for months. Still, according to Robson’s letter, the NAHB felt that larger company members of the coalition were pursuing their own agenda.
From the beginning, NAHB was to take the lead on strategy, lobbying and the media. You mentioned instances where by the leadership of the HPHBC were miffed by NAHB’s negative reaction to some efforts to promote the Coalitions goals.
In any effort of this magnitude, coordination of efforts is key. Sending the right message at the right time by the right people keeps the message and ask consistent. We all knew a perception problem existed. Many members of Congress, the media and the general public believe that home builders, most notably the large national builders, created the housing bubble and subsequent bust. I certainly do not agree with that, but perception is reality in most instances.
From the outset, FHF was to have a broader appeal than just the home building industry. The message was to stem the further devaluation of most American’s largest single investment, their home, by curtailing more distressed inventory from coming on the market and stimulating demand so that a floor in prices could be achieved and the free market in homes could begin again. When Mr. Hovnanian, without prior approval from the Coalition, went on Fox Business News and CNBC, it had the appearance and was perceived by many that those who caused the problem were asking for a government bailout. This was the exact opposite of the message FHF was trying to send.
Subsequently, Mr. Miller’s presentation to the National Association of Realtors(NAR) to join the FHF, again without approval of the Coalition, did not follow trade association protocol of not interfering in each other’s business and created a credibility and relations problem for NAHB leadership and staff with the NAR. We live in America and everyone is entitled to free speech. However, when a coalition is formed, ground rules set and then not adhered to, frustration sets in and more damage than good is the result.
Again, if there’s a sincere hope on the part of the association to work through these issues in a sincere, good faith way, one would think there might be more politic ways to talk about differences and misunderstandings that may have arisen. We called Jerry Howard to discuss the tone and substance of these communications to NAHB members, 200,000 of them, and he declined to talk, saying it was an “internal discussion.”
This comes across as a shot-across-the-bow not intended to offer olive but to inflame.
Here’s how Robson’s letter concludes:
We have many challenges facing our industry and I fear many more with this Administration and Congress. The High Production Builders are a significant and an important segment of our industry and of NAHB. I hope this letter will set the frame work of the HPHBC and NAHB leadership discussions in the near future. We, the leadership of NAHB, are available by either conference call or a face to face meeting at your earliest convenience.
The documents from the NAHB leadership to its membership represent chronologies of events and assertions as factually correct and true. Clearly, though, there is another side not represented in these chronologies of events and assertions. That of the companies and individuals mentioned.
From what we hear, a meeting under the auspices the NAHB’s High Production Home Builders Council will take place within two weeks. Senior management from among the top home building companies will be individually keen on a framework of discussion that may find common ground or not.
Here’s Centex CEO Tim Eller’s only response for the moment to questions about the controversy:
“We’ve have been having and continue to have an active dialogue with the NAHB leadership on industry issues which has been one of the roles of the High Production Home Builders Council from the start.”
We do know that there is anger and aggrievement among CEOs of a number of the companies, who believe they’ve been wronged in the way they’re represented in these materials.
Is NAHB chief Jerry Howard on the hot seat? Not likely. His board and the minions of committees and executives that comprise association leadership support him. But if 20 to 30 of home building’s largest companies had their say, it might be a different story.
We could go so far as to speculate that long-standing differences may just cause a split-off of the biggest home building organizations from the NAHB, an agreement to disagree, and perhaps to part ways. So many of the ways the industry has already consolidated bifurcate the interests of the largest companies from the rest.
And the next round of consolidation has not even begun yet.
Fortune Still Shines on Some Home Builders
|
Most Admired
Contenders
|
Of course, it’s who this list leaves off that causes intrigue, even to the point of second-guessing our friends at Fortune’s methodology. Where are M.D.C. Holdings and Meritage, companies we admire more than some on these lists above?