William Lyon Homes (WLH) announced the acquisition of privately-held Polygon Northwest on merger Monday. The deal appears nice both in terms of strategic and financial implications, yet the built up in leverage worries me.
As the company has gone bankrupt as recently as the end of 2011, I am shocked to see such a rapid increase in leverage during the "good" years again, making it very easy for me to avoid the shares.
The Deal Highlights
William Lyon Homes announced that it has reached a definitive agreement to acquire Polygon Northwest Company LLC.
The acquisition of the largest private homebuilder in the Pacific Northwest will take place in an all-cash deal valuing the company at $520 million. The deal which marks the entrance of William Lyon into the Pacific Northwest is expected to close in the third quarter of this year.
Polygon has been operating in the Pacific Northwest for more than two decades during which it delivered 16,000 homes driven by a reputation for quality and customer satisfaction. The company is the second largest builder in markets like Seattle and Portland.
The company is showing rapid growth and corresponds with William Lyon's strategy to become the premier Western US regional homebuilder. The company anticipates to derive meaningful topline revenue growth, cash flows and sales as well as general and administrative costs leverage from the deal. As such, earnings per share are anticipated to increase following completion of the deal.
Another key attraction are the 4,200 lots which William Lyon can add to its inventory in very land-constrained markets. The disciplined land acquisition policies and the lean team with just 130 workers are other reasons to buy the company. The expansion into Portland and Seattle will furthermore reduce reliance on ¨volatile¨ states like Nevada and Arizona.
For the calendar year of 2013, the business posted revenues of $292 million and gross margins of 27.1%. The company delivered 791 new homes last year and it anticipates 850 to 900 deliveries this year which should result in revenues of about $300 million.
For 2015, Polygon sees 1,100 to 1,200 new home deliveries which should bring in revenues of $450 to $500 million.
The $520 million price tag values Polygon at 1.8 times last year's revenues and 1.7 times anticipated revenues for this year.
Valuing William Lyon Homes
Back in May, William Lyon reported very strong first quarter results.
The company ended the quarter with a $151 million in cash and equivalents while holding $622 million in total debt. This resulted in a net debt position of about $470 million, set to roughly double to a billion following the deal with Polygon.
The company has received a financing commitment to finance the deal, but failed to specify the terms of the financing.
On a trailing basis, William Lyon reported revenues of $641.6 million on which it net earned $140.4 million. This was driven by a $88.7 million tax benefit among others. More normalized earnings are seen around $30 million per annum.
Trading around $26 per share, William Lyon's equity is valued at little over $800 million. This values the company at roughly 1.25 times annual sales and 26-27 times adjusted earnings.
A Troubled Past
The company has seen a troubled past. The company has been taken private in 2006 and entered bankruptcy in 2011 following the housing crash. The company came back as a listed company following its public offering in May of last year. At the time, shares were sold at $25 per share and have roughly traded in a $20-$30 trading range.
The company has been hit very hard by the recession, reporting revenues of as much as $1.85 billion back in 2005. These are numbers it can only dream of now.
The deal is very sizable. Polygon's annual revenues of $292 million are equivalent to about 56% of William Lyon's revenues for 2013.
Combined both firms sold more than 2,100 homes on a trailing basis, generating revenues north of $900 million in the process. Given the huge growth at both companies revenues should be able to come in above a billion this year, while normalized earnings of $50 million or more seem reasonable going forwards.
So far investors like the deal with shares trading more than 5% higher on Monday to levels around $27 per share. This values the company's equity at about $850 million while the company will carry a high net debt position of about a billion.
As such shares trade at about 17 times earnings. This does not sound unreasonable given the continued growth prospects, yet note that we are in a reasonably favorable state of the housing market at the moment. Higher prices in particular, even more so than increased production, has helped homebuilders recently. Worrisome is the debt position of the firm which is simply very sizable.
Given the very troubled past experiences of William Lyon and high leverage I have no problems avoiding the shares. At this pace, the company is just an accident waiting to happen again, as I wonder if my colleague investors have learned lessons from the past.
Unless the company will reduce leverage, and/or can show significant accretion following the deal, I would not touch the shares.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.