Lieutenant Island Views : Commentary About Finance, Politics and Baseball

Pulte Buys Centex-Rumors of Hombuilding’s Demise are Greatly Exaggerated! | April 8, 2009


To paraphrase Mark Twain, “Rumors of the demise of the homebuilding industry are greatly exaggerated”. The recently announced acquisition of Centex Homes by Pulte Homes is a bold move that speaks volumes about where the business is going. Several points worth noting about the deal include:

1) It is a stock for stock transaction-Centex directors want to capture some of the upside which is created. They are not heading for the door.

2) The synergies are huge, probably amounting to $.75-!.00 per share annually. On a net present value basis over five years, this represents between 30-40% of the purchase price.

3) The structure materially improves the pro forma company’s balance sheet

4) Centex had near term (ie next 18 months) maturities in excess of $500 million. This has not been talked about by analysts but must have been an important consideration for their management and board. The questions around the debt included:
a) Could Centex refinance all of the debt?

b) What would be the cost to refinance the debt if it could be refinanced ? Arguably the cost would have been a coupon in the mid to high teens with limited ability to call if a deal could be done? And that is a HUGE if!

c) What sort of operating constraints would the banks put on Centex in terms of revolver availability etc? Banks do not like bondholders paid out in front of them. They would have forced the issue and turned a $500million maturity problem into a portential muli-billion dollar issue. Any impairments or other issues which caused bank covenant violations would have led to truly significant problems for Centex.

d) Could the problem have forced them into some sort of bankruptcy proceeding?
This writer believes that the debt issue played significantly into Centex’s thinking. They opted to be pre-emptive rather than risk that someone would beat them to Pulte and leave them a universe of less likely acquirors, forcing them to suffer the vicissitudes of a prolonged bad debt market

5) Centex’s bonds did not have a change of control clause (“COC Provision”). This basically would allow a buyer to assume the Centex bonds as part of the transaction rather than having them “put” at 101 and forcing a major refinancing. This was a major transaction advantage to any buyer. That said, it was also something of a “wasting” asset which could be lost if Centex were to default on its bank debt and trigger a cross default with the bonds. It is very likely that Pulte viewed the lack of a COC provision as a major attraction to Centex. Centex probably viewed it as a “use it or lose it” opportunity and chose to use it.

6) Did Centex have alternatives to Pulte? Looking at the other big builders, Pulte and, to a lesser extent, NVR were clearly the most logical. Pulte had a relatively high stock price in terms of PE and multiple to book. Moreover, it only has $25million in near term maturities vs some $318million for DR Horton and over $500million for Lennar. While NVR has the industry’s most enviable balance sheet and stock multiples, it has generally operated with a “land light” strategy and high margin construction strategy. Buying Centex could have hurt their multiple and been a huge undertaking for them operationally. This was less the case for Pulte where it was much better set up to cut employees, plug Centex subdivisions into their infrastructure and play. From my soundings around the industry, Centex did not do a significant market test, opting to cut the best deal it could with Pulte and then hope that the combined entity’s stock performs.

7) Could Centex have achieved a higher price? Maybe. To do so would have involved a game of corporate “chicken” with Pulte. The odds were not stacked in their favor as most strategics (ie other builders) were not likely buyers and the size and industry precluded private equity from becoming engaged. My guess is that Pulte started at a price below book and was worked up to book value. Going above book value in this market, with attendant goodwill and impairment issues was a bet Centex could only make if it were willing to “walk from the deal” and continue on a stand alone basis. They also knew that the odds were high that their bet would be called.

8) Is this a harbinger of other deals? If so, who is next? The answer is a resounding maybe! The same issues of debt maturities, form of consideration and price will be at play. Pricing will be tricky because of all of the usual constituencies involved including common shareholders, bondholders and banks. Fair deals for all will work. Banks and bondholders do not want to operate homebuilders and, in many cases, managements own significant stock (ie Toll, Lennar, MDC, Horton, Hovnanian et al.). Land positions, size and the quality of management will also be issues

All in all, this looks to be a decent deal for Centex shareholders relative to the downside risk. They traded off a low price for their shares for comfort that they would not be crushed by their near term debt maturities. They also believe that they will still have terrific upside in Pulte shares due to the synergies and general deal structure. They are probably correct in this thinking. For the same reason, the biggest winners will likely be the Pulte shareholders

PS The bank lenders, many of whom were lenders to both Centex and Pulte, will also be very happy because they will probably be able to significantly reduce their aggregate exposure to the combined entity.

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About author

Mr Thaler is currently the Managing Partner of Lieutenant Island Partners, an organization providing corporate finance advice and general consulting to corporations and not-for-profit organizations. Mr Thaler retired as Vice Chairman of Deutsche Bank Securities in early 2008. His background includes experience as an investment banker, senior manager, business builder, college professor, not for profit board chair and trustee. In his thirty plus years as an investment banker for Deutsche Bank and Lehman Brothers, he has been involved in numerous significant debt and equity financings, mergers & acquisitions, leverage buyouts, restructurings and cross border transactions. Of particular note, Mr Thaler has been one of the most active participants and strategic advisors to the homebuilding industry. In a period of significant turmoil and losses, he was one of the few active bankers to the industry who did not have either a loss or credit write down. He is currently advising several public builders on strategic matters and is an adjunct professor of finance at Morehouse College in Atlanta, Georgia. Though he lives in New York, he is a life long Red Sox fan! www.LieutenantIslandPartners.com

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