Lennar Still Looks Dreadful Even With This 50% Haircut

Dec. 04, 2007 10:33 AM ETLennar Corporation (LEN)
Reggie Middleton profile picture
Reggie Middleton

Now that I have had a chance to actually go through what Lennar's (NYSE:LEN) transaction is about, I have a lot more to say. Here goes...

From WSJ.com:

Lennar Corp. has sold about 11,000 home sites to a venture mostly owned by the real-estate arm of Morgan Stanley (MS) for $525 million, a large land sale that signals that investors have begun to pounce on bargain deals.

The sites -- in 32 communities in areas hit hard by the housing downturn -- were valued on Lennar's books at $1.3 billion as of Sept. 30. The low price the venture paid is a vivid sign of how land values have plummeted with the downturn, precipitated by defaults on subprime mortgages and tightening credit that have led to a broader slowdown in sales.

I could have sworn Lennar's CEO was just in the news saying they were going to mothball properties (sit on them) until the market turns. Maybe I was imagining it. My Voodoo post alleged Lennar was borderline insolvent. This recent news item simply reinforces that, and brings it closer to that insolvency. The assets that I used for that calculation have now been devalued by 50%, although some of it has been replaced by cash which Lennar is in desperate need of. Hence, the company has now just about arrived at full balance sheet insolvency, yet has pushed cash flow insolvency back another $525 million. I got the 50% number in lieu of the 60% number published in the media because Lennar received 20% equity ownership in the venture that it sold the company to, and retained 50% voting rights and rights of first refusal for reacquisition at market prices, which should have an optionality value of about 3%.

BUTTTTT!!! This is the kicker: Now we can mark its current inventory holdings to market, at about 50% of what was reported in its financial statements. Not that we're picking just on Lennar; the other builders are holding the same inventory, depending on geographic location, of course. Now let's run this through my fully consolidated Lennar model (the one built for the Voodoo post that consolidated a lot of the hidden off-balance-sheet debt and assets), and see what we get...

First off, we apply our market mark of 50% to raw land, work in process, and investment in unconsolidated entities (we'll put a much smaller mark on the finished sites, but valuation looks bearish in many areas). We also put the mark on goodwill (which in this situation is really Bull@#$@), and we'll leave the other assets category alone for the most part to give them the benefit of the doubt. Financial assets (mortgages - Lennar did $10.5 billion last year) in the categories of "held for sale", "held for investment" and "held to maturity" (notice how this number increased, denoting a problem selling them) will get the same haircut E-trade got. This admittedly is a gross generalization, though, if anything, conservative, since the E-trade MBS assets were likely far superior to Lennar's (who assuredly got quite aggressive pushing mortgages to move their difficult inventory) with an average FICO of 720, and 50% of them were rated AA or higher.

And what's the result? For Q307 we have $6,277,501,000 in total assets and $5,315,821,000 in total liabilities. The net equity divided by total shares outstanding gives us a book value per share of $6 (hint: the builders have been trading at a deep discount to book value - Shhh! Keep this on the down low). For the next fiscal quarter, using the model's projections, you get negative equity, or insolvency as I predicted in the voodoo post.

The good (okay, the better) news is that Lennar has pushed off cash flow insolvency for a year and marginally improved its Z-Scores with this deal. According to the new cash-infused Z-Sscores, Lennar has bought itself an extra year before bankruptcy. Since it appears many home builder investors either don't know about Lennar's off balance sheet shenanigan's or inventory valuation games, or don't care, they may actually get away with trading at $15 to $20 per share while actually being insolvent. Hey, Enron got away with it at $90 per share, at least for a while.

This article was written by

Reggie Middleton profile picture
Reggie Middleton is the personification of the freethinking maverick — the penultimate nonconformist as it applies to macro strategies, investment, and analysis. He uses his background and knowledge in new media, distributed computing, risk management, insurance, financial engineering, real estate, corporate valuation, and financial analysis to pursue, analyze, and capitalize on global macroeconomic opportunities. Finding most available research lacking, both in quality and quantity, Mr. Middleton assembled his own talented research staff. As forensic research is a lynchpin for his own investing, "to actually put food on the table," he stands behind it as doing what it is supposed to do - illustrate, elucidate and educate. He does not sell advice or research. He is an entrepreneur who exists outside of mainstream corporate America and Wall Street. This allows him the freedom to do things that many cannot—perform without conflicts of interest and corporate politics. Mr. Middleton prides himself on developing some of the highest quality, actionable research available - regardless of price. He welcomes any and all to peruse his blog of freely available analysis, opinion and participatory social media; use his custom tools, download files, interact with the community and make critical comparisons from a results orientated perspective. Reggie believes ideas and implementations are improved and fine-tuned when bounced off of the collective intellect of the many, in lieu of that of the few - in essence, a form of collaborative open source financial analysis. Visit his blog Boom Bust Blog. (http://boombustblog.com/)

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