Acquisition Season

As the cooling-off period in the housing market continues through 2007, conditions may improve for mergers and acquisitions among the nation's leading home builders, say industry experts.

The red-hot housing market of the last decade sent prices for all things home building–related through the roof. The median sale price of new homes rose from $152,500 in 1998 to $245,500 in 2006. The price of land also shot up, as did the asking price of home building companies, scaring off would-be acquirers.

But the market proved unsustainable, and as home buyer demand waned, home prices fell, leading to sliding land values, sticking builders with excess land bought at peak prices during boom times. Because builders had so much land, there was no reason to think about acquisitions, says Margaret Whelan, managing director for home building and building products at UBS.

COMING BACK: Since June 2006, when Dubai-based Emaar properties paid $1.05 billion for Newport Beach, Calif., builder John Laing Homes, acquisition activity in the home building industry has been quiet, a slowdown from the pace of consolidation in previous years. But builders and industry analysts expect that to change in 2007, and already several deals are in the works, with more rumored to follow. - SOURCE: JMP SECURITIES

“Builders discovered that the market was slowing, and we had an unprecedented correction in demand, the magnitude and violence of [which] we've never seen before,” Whelan says. “So there wasn't any reason for deals. Why would you buy more land when you had too much already?”

Lance Ramella, senior managing director for Hanley Wood Market Intelligence, a sister division of Builder, also notes the builders' desire to unload land in a market where property values are likely to further decrease from peak times.

“Acquisitions used to occur so that builders could add land to their inventory, now exactly the opposite is true,” Ramella says. “They'd love to add the [sales] volume, but not the land, but you can't do that.”

News of BFC Financial Corp.'s January 31 announcement that it intends to buy Levitt Corp., the Ft. Lauderdale, Fla., parent company of Levitt and Sons, was quickly followed in March by reports that investor Carl Icahn made an offer to buy all of the common stock of WCI Communities, the Bonita Springs, Fla.–based home builder of mostly high-rise condos.

In late March, a far larger deal was announced with Taylor Woodrow, based in Solihull, England, and George Wimpey, based in Buckinghamshire, England, declaring a merger to create Taylor Wimpey, with combined annual revenue of $13.1 billion internationally. Wimpey currently builds in the U.S. under the brand Morrison Homes, which is No. 19 on the BUILDER 100. Taylor Woodrow ranks No. 32 on the list. Combined, the two builders would have 7,247 closings and gross revenue of $3.57 billion for 2006 in the U.S., making them the No. 15 builder on 2006's BUILDER 100.

Levitt and Sons ranks No. 50 on the 2006 BUILDER 100, but saw its closings fall 7.21 percent and announced in March that it sustained a net loss of $10.7 million for the fourth quarter of 2006 with net losses totaling $9.2 million for the year.

While Levitt has agreed to sell to BFC, Icahn's offer for WCI may just be the first salvo in what could be a long process, as he already announced plans to remove the company's entire board of directors, according to published reports. In early April, WCI's board fired back, urging company stockholders to reject the billionaire's offer. Icahn owned approximately 15 percent of the company's outstanding shares as of January. WCI ranks 40 on the BUILDER 100, but saw its closings decrease 23.86 percent and its revenue decrease 21 percent in 2006.

Expect more deals involving local and regional builders, but do not expect that to make a big impact on the industry overall, says Whelan.

“We'll see lots of that, it's just not going to move the needle,” she says. “Those guys are so tiny. If [the home building industry] sells a million houses this year, and the biggest public builder builds 30,000, they're all peanuts relative to the whole market.”

Ah, but it is those largest of peanuts that everyone's interested in and talking about. Whelan sees opportunity for change among the top 15 BUILDER 100 companies, all of which are publics.

“You could see some of the bigger companies buy smaller companies,” Whelan says. “You could see a management buyout, where the managers buy all the stock. You could see a leveraged buyout, where a financial sponsor comes in.”

POWERFUL CLOSERS: Making the jump from 143 on last year's Next 100 to 64 on this year's BUILDER 100, the closings increase winner is easily The Enterprise Cos., a Chicago-based builder. Main Street Homes made a big jump, as well, from 150 to 79 this year, and Comstock Homebuilding and Novare made the leap from the Next 100 to the BUILDER 100.

And among the overall top five home builders? “I think there are some management teams who are getting tired, who have made their money and probably don't have the drive they had five years ago,” Whelan continues.

While not looking to sell his company, Toll Brothers CEO Bob Toll tells BUILDER that he'll be on the lookout for a good acquisition target in 2007. Toll is No. 14 on the BUILDER 100.

“I would be disappointed in 2007 if we didn't do some larger-than-ordinary acquisition,” Toll says. “Acquisition of either land or builders, because it's a good time to do it. Smaller builders are having a much tougher time than larger builders because we've got the equity.”

Tony Avila, managing director for home building, building products, and real estate at San Francisco–based investment banking firm JMP Securities, says that as of March, JMP is brokering four deals with home builders. JMP has one signed letter of intent, one purchase agreement in negotiation, and two cases where the potential buyers and sellers are evaluating each other, he says.

“The M&A market has a pulse again,” Avila notes. “A lot of private guys, both small and large, are talking with the better capitalized publics. That's where we're spending a lot of our time.”

Avila sees more deals being announced in the second quarter and then closing in the second half of 2007. Whelan sees “a lot of deals in the back half of 2007 and into 2008. It'll be like dominos.”

But some builders are not as sure. Centex CEO Tim Eller says that while the market is still adjusting, which it is, acquisitions can be too risky.

“Land prices still haven't adjusted yet this cycle and until they do, and we have some confidence around where land values are going to be, it would be difficult to acquire companies because we won't know how to asses the value of their land,” Eller says.

As housing and home building markets continue south through 2007, the high prices some builders have placed on themselves could come down, creating conditions conducive to acquisition, says John Burns, president of John Burns Real Estate Consulting. Burns attributes high asking prices to optimism in the industry, a sentiment that “is going to go away,” he says.

CAPITAL GAINS: Not surprisingly, Main Street Homes and The Enterprise Cos. lead the list of big revenue gainers. Bill Clark Homes is the only BUILDER 100 company to make this list the last two years—in 2006 it checked in with 71% revenue growth.

But where many see the most likely acquirers coming from the ranks of the BUILDER 100, Burns sees a world economy flush with capital, primarily from Asia and the Middle East, and named foreign companies as the most likely acquirers. Such a deal would not be a first: In June 2006, Dubai-based real estate company Emaar Properties paid $1.05 billion for John Laing Homes, based in Newport Beach, Calif., by far the largest deal of the year.

Burns says well-capitalized private builders looking to gain geographic diversification also are among the most likely to be active.

Despite BFC's push to buy Levitt, Burns thinks the likelihood of a big private-equity group buying a major builder is slim.

“More and more of that equity is going to learn that this is likely to be a prolonged downturn instead of a short-term downturn and probably won't make that investment,” Burns says. “The capital that is bullish on our industry is going to pull back over the next 12 months.”

But even many smaller builders are well-capitalized at this point, and have the ability to chase targets if they see a good fit, say builders and analysts.

Las Vegas–based builder Astoria Homes, which fell from 80 on the BUILDER 100 to 113 on the Next 100, considered buying a builder to expand into Phoenix in 2006, but resisted, says company president Tom McCormick. While Astoria plans to focus internally in 2007 and start a luxury division, the same volatile market that kept Astoria from buying in Phoenix could well keep other builders from being as active as many industry experts are predicting in 2007.

“I don't think these national companies have decided to sit still [or] that they're happy with their size,” McCormick says. “Eventually the market will shake it out, and there will be stronger players and some weaker ones. But nobody really knows where the bottom is in valuations, and everyone's waiting to see who the right buy-out targets are.”

And the fundamentals of making a deal still make sense. In spite of taking on more land, acquisitions may be one of the few ways large builders will be able to continue growing in a faltering market, says UBS's Whelan.

“Say that you're KB Home and you're the biggest builder in Vegas. Instead of adding 20 new communities because we already have a supply/demand imbalance, instead of compounding that issue, buy out a smaller private guy,” Whelan says. “The [buyer] gets the growth. [The seller] get to cash out. And the buyer controls more volume and more pricing as the market turns around again.”