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Trimzy
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I am equity research analyst (buy-side) at a NYC based long short hedge fund. My focus is primarily on mid to large cap, however I have also done extensive research on emerging market companies and was one of the few fortunate ones that called out the Chinese reverse mergers.
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  • Are Home builders the next target for Private Equity....... Is Pulte Home one of them? 0 comments
    Aug 24, 2011 4:53 PM | about stocks: PHM, TOL, DHI, LEN

    There have been whispers among the "smart money" in Greenwich, CT and New York regarding a major P.E firm making a move into the housing sector and taking one of the homebuilders private (rumored to be Bloomfield Hills, MI based Pulte Homes, ticker PHM). The firm appears to have taken the idea, “when there's blood in streets, buy”, to heart as there is no sector bleeding more than the housing and no company more than Pulte.

    The question is, why home builders and why now? Although I can only speculate to the real investment thesis, I can take an educated guess as to why they are interested in home builders, and more specifically Pulte Homes:

    ·         Home builders are trading at all time lows, (even below where they were trading during the 2008-09 credit crisis and in case of Pulte Homes at levels not seen since 1996), raising the possibility that they are over sold.

     

    ·         Compared to other homebuilders (KB Homes NYSE:KBH, Toll Brothers NYSE;TOL, Lennar NYSE;LEN, D.R Horton NYSE;DHI), Pulte has performed the worse in recent months, with the only exception being K.B Homes, that  is similarly trading at its lows. The key difference between PHM and KBH is that KBH has a debt/EBITDA ratio of 264.24, based on $1.7 billion in debt, which is the highest in the industry. Needless to say such a high ratio raises questions about its ability to meets its debt obligation in the medium to long term.
     

    ·         As Stifel Nicolaus analyst Michael Widner noted today, homebuilders are trading at unusually low multiples, primarily due to lack of visibility and market pricing in an expectation that home prices will fall another 10-15%. These low multiples would scare off any trader or short term investor away from these companies. When the stock broke through the support level at $4.09 (it was trading between a well defined range with support at $4.09 and resistance at $4.92), many of the traders and investors moved away from the stock, pushing it as low as $3.4 a few days ago. This makes the stock a bad pick for short term traders but an ideal opportunity for a long term investor such as P.E firm with an investment horizon of 7-10 years.

    ·         Pulte’s management has shown its mettle and has successfully weathered the crisis since the bottom fell out of housing in 2006-07. It has been running a tight ship since the crisis and has even been opportunistic in acquiring some competitors such as Centex a short while ago. The existence of experienced and capable management is a good sign as it means the P.E firm would have to make minimal investments in bringing in new management to the company.

    ·         Its diverse revenue base makes Pulte an attractive target as it operates in three major segments that are likely to have most growth in the upcoming decade. The first time homeowners, and move up homeowner segments are probably the largest within the housing market. But what makes it an interesting play is Pulte’s presence in the retirement communities through its Del Webb subsidiary, where it serves the “active adult” segment in more than twenty one states. With baby boomers starting to retire in droves over the next few years this could be a lucrative business.

    ·         In addition to being a pure P.E play it could also be a real estate play by the firm. Land acquisition has been a key strategy for Pulte for the past several years and it has entered in more than 100 land deals since 2009. Their strategy has been to retain select land assets with the expectation that entitled (zoning approved) and developed lots will be scarce when the housing cycle turns up. This could pay off big time IF the housing turns around within next 2-4 years.

    ·         Pulte currently has a market cap of $1.39 billion and as of June 30, 2011 it had a total cash balance of $1.2 billion on the balance sheet, which is just shy of its current market cap, making it look quite attractive to any P.E firm that could pay out much of that cash as a special dividend and thus recovering most of its initial investment.

    ·          Pulte has a debt of approximately $3.9 billion, which is a hefty load considering the state of housing market. However its interest expense is approximately 6-7% of revenues (considering weighted interest rate of 6.2%) which is fairly low for the industry and means it could service its debt for short to medium terms with ease. This would allow the acquirer to load further debt on the company and cash out its investment. (The $1billion debt retired by Pulte last year could be put back).

    ·         The current book value per share is $5.35, which means the acquirer can buy the company for literally nothing out of the pocket and walk away with a hefty profit within 3-5 years. Now the validity of the book value can be argued given the market conditions and the value of its assets, but what can’t be argued is the cash per share on the balance sheet, which is close to its current stock price as noted earlier.   

    I have heard rumors of a deal being struck at a price as low as $5 to $5.50, which is quite attractive as the firm can take approximately $3.1 per share out of the company immediately, sitting in form of cash on the balance sheet. Add on another $ 1 billion additional debt and they have already recovered all the plus a nice 3-15% return depending on the acquisition price;  with all of the assets and operations of the company still to spare.

    The fact that opportunities for P.E firms are dwindling in the North American market makes this an attractive opportunity. The end of the era of conglomerates also ended the era of easy money in the P.E business. The credit crisis further thinned the crowd with only the best managed and well funded companies coming out of it in one piece. As many in the business have been telling their investors that the days of excessive returns are gone and investors would have to suffice with a meager 10-15% return on their investments going forward. If you ask me, that is not enough of an incentive for me to commit my money for 7-10 years. All of these factors have pushed the firms into more and more risky deals, which at times don’t pay off.

    All of these and factors can be argued as a valid reason, why a P.E firm may be interested. I am sure they would have done a much more in depth analysis of the firm than my back of the envelope calculations. Given all of the facts, I can see the reasoning behind such a move but I am still not convinced. Would this deal be a rerun of Chryslers’ acquisition by Cerberus capital? It wasn’t that long ago that those of us in the industry saw, the once promising deal to become an absolute disaster for Cerberus.

    Only time will tell which way this deal works out. Whatever happens in the next few days, one thing is for sure; the only losers in the deal would be the equity holders in the company, who bought into the housing recovery and may never recover their full investment.




    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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