News & Moves: April 24, 2008

To gauge how differently the current housing downturn is affecting public home builders in comparison to private giants, we asked one of the top housing stock analysts on Wall Street, David Goldberg, a few questions. Goldberg is a director who covers the building and building products sector of UBS Investment Research.

1. Are the public builders in more trouble than the large private builders?
   They're in less trouble than the privates because they're less leveraged. They have longer-duration debt, whereas the private builders have more two- and three-year bank debt, with balloon payments at the end. Capital is not a big advantage. Everybody can get capital, especially if you know someone in Dubai. But in the short term, if you can't access the capital markets, liquidity becomes a problem.
2. Are you concerned that the public builders' primary product — suburban single-family homes built four to the acre — may be obsolete?
   I think that product is in trouble not just because of buyer choice, but because of land costs. The cost basis on much of the land held by the public builders is too high for that traditional product. It can't be sold at a profit. They need to develop it to higher densities, but obviously they have to build something people will buy. If your land is all in far-out suburban locations, it's a problem. Location is now more important than ever.
3. Can public builders find a way to mass-produce housing if their products have to be more diverse, perhaps even site-specific?
   Even in a worst-case scenario, where everything the public builders produce has to be site-specific, why would they be at a disadvantage, compared to the private guys? The public builders were trying to build their top lines to create economies of scale. But if that goes away, they're still on equal footing with private builders.
4. Will we see more public builders file for Chapter 11 bankruptcy protection?
   TOUSA (Technical Olympic USA) is already in court-supervised restructuring, and we hear that WCI is close, but we don't cover either of those companies. Beyond those two, I don't think we'll see any more filings in 2008. It really depends on what happens to house prices. If they continue to fall, somebody else might be in trouble — but if it happens, I think it will be an '09 event.
5. Will the current market contraction in lead to more mergers of public builders?
   I don't think we're there yet. We'd have to get some visibility on how the market is going to settle out before you could pencil a deal. Right now, nobody knows what the assets are worth. And the public builders are all dealing in super-cheap stock—getting cheaper every day. But they keep building up their cash. Toll has $1 billion in cash and $1.2 billion in unused credit on their line. Pulte has more than $1 billion. Lennar has less (than $1 billion in cash), but they're about to get $500 million in tax refunds. Centex is also generating cash. That trend is not going to stop anytime soon.
6. Will more public builders follow Gen. William Lyon's move to take his company private?
   Why do that? They went public for a reason. Why lever up and buy out the share-holders? That's a lot of risk. What happens if private builders can't get bank financing anymore? The largest private builders are fine; they can access private equity money if they need it. But if I'm a mid-sized or smaller private builder, right now I'm worried about where I'm going to get financing. I certainly want to make sure I'm generating positive cash-flow.
   Many private builders who relied on traditional two- to three-year bank financing have seen it cut off. The credit lines are being pulled in. If you got an A&D (acquisition and development) loan in the last two years, the collateral assigned against that loan is under water. Those loans are now at 120 percent or more in loan to value ratio. What chance do you have of paying that loan back? There are a bunch of banks out there in deep trouble because of bad loans to builders.
   Most private builders have to be nervous right now about liquidity issues. Nervous is the word that comes to mind.
7. Why are you more bullish on Toll Brothers than most other public builders, even though that firm holds a 14-year supply of land?
   Toll is a high-end builder. Most of their land is in more desirable areas—closer in and in the best school districts, close to transportation corridors. And they bought it better. It's holding its value better than most. They also do their own entitlement work, which adds value. Toll has a lot of liquidity, and it doesn't compete with Pulte, Horton or Lennar. It competes with small custom builders, who have no liquidity.
8. Will Lennar's tax-advantaged land deal with Morgan Stanley be a trendsetter?
   I'm surprised it isn't already, but the builders are being offered 20 or 25 cents on the dollar for their land, and they just don't want to sell that cheap — even if the tax benefits bring the bottom line on the deal up to 50 cents on the dollar. But we do hear now that most of the large public builders are biting the bullet and trying to sell land.
   Still, we don't yet see land at real fire-sale pricing. We need for those capital constraints to kick in on the small private guys, developers, land bankers and all the others still holding land. They have to feel the pain before they'll get the prices down to where they should be. But Lennar got that land off its books. They generated cash and tax benefits. And they still have the option to get the land back, in the future, if they want it.
   With the number of public builders in similar circumstances, you'd think more would have followed Lennar's lead. But it hasn't happened yet.
9. When will the public builders recover?
   I think mid-'09 is about right for the trough. We're undersupplying the market right now. It will take a while for that to show up in the data, but the starts pace is about one million units a year right now. Demand is about 1.7 million units, when you include all types of housing, including rental. That undersupply will show up eventually.