By Alison Rice.

The numbers sound so, well, calculated: $102.5 million for Westfield Homes USA, just one of Standard Pacific Corp.'s recent Florida targets; $82.8 million for Hammonds Homes, a Texas home builder now part of Meritage Corp.; $68 million for Sanford Homes in Colorado, bought by Beazer Homes USA last year. How does a private builder put a price tag on his life's work? The answer is, thoughtfully and impersonally. As any builder who's bought or sold a company will tell you, there's more to valuing a home building operation than simply reviewing the books and checking the latest multiples on Wall Street. Financials and land matter most, of course, but so do other, more subjective considerations, such as the cultural fit between the two companies and the selling builder's plans for the future, all of which affect the final price.

"A lot of this is an art, not a science," acknowledges Rick Beckwitt, a director at D.R. Horton, in Arlington, Texas, where he currently leads the company's acquisition SWAT team. "You want to connect all the dots."

He knows what he's talking about. In the past eight years, the builder has acquired 17 companies and, in dollars, has accounted for more than 30 percent of home building merger and acquisition activity since 1993, according to Banc of America Securities analyst Carl E. Reichardt Jr.

Selling builders aren't on such familiar ground when they put their company in play. "Private builders really don't have a good idea of what they're worth until the market tells them," says Rick Entin, a senior vice president in the Los Angeles office of Houlihan Lokey Howard & Zukin, an international investment bank specializing in middle-market transactions between $50 million and $1 billion. "The buyer looks at the value of the dirt, and the seller looks at multiples of future projections."

But intangibles matter to sellers too. Westfield executives had entered the Mamp;A arena as a buyer, not a seller — a direction they changed after meeting with Standard Pacific. "We made a decision that this was a group we could work with," says Roger Gatewood, president and CEO of Tampa-based Westfield, which Standard Pacific nabbed in June.

Finding the Fit

With the M&A trend favoring public-private transactions, private builders developing an exit strategy must consider their public counterparts. Finding the right suitor requires some research. "Mergers and acquisitions are like a marriage," Beckwitt says. "You don't want to get married to someone you can't live with."

Photo: riku + anna

Roger Gatewood, president and CEO of Westfield Homes, now part of Standard Pacific

That applies equally to a company's business philosophy and corporate culture. "Every builder has a mission and company values," says Jeff Meyers, CEO of Meyers Group, which does company valuations as well as housing market research. "You want to align with the company's values. If you do move-up, think about a Standard Pacific or a Toll Brothers. If you're into optioning lots, and you have a high return on assets because you don't purchase land, you might fit with an NVR. If you focus on hard costs and inventory control systems, then look at a KB Home." Cultural compatibility counts too. Big builders often want (and require) owners to stay after the deal's done, when they can take advantage of the chance to build homes without the business hassles they encountered as a private builder. "We're looking for people who want to be part of [the D.R. Horton] experience," says Beckwitt.

So is Lennar, which mixes corporate discipline with friendly quirks such as name badges for everyone and readings of children's books to illustrate management principles. "We're very up front about us and our culture," says Jon Jaffe, a Lennar Corp. vice president. "It's not going to be a good fit for them if they don't understand and appreciate our culture."

It's a philosophical approach, but it's also a practical one. "We're paying good money to have ongoing, viable operations, and we need to be in a position to maximize the goodwill of the business we've acquired," Beckwitt says.

Numbers Game

But making a private company attractive to a public one — and landing a tempting offer — takes more than a cultural sell. It depends on numbers, and providing the data acquirers want may require some work.

"Some of the people we talk to are very sophisticated and know all the parameters," says Larry Seay, CFO at Meritage Corp., which, like many large builders, handles due diligence internally. "Others have absolutely no idea."

That ignorance could cost them. "The companies with more advanced financial controls can get a better value," says Beth May, a managing director at Credit Suisse First Boston in New York.

If the books aren't already in order, that could take anywhere from six months to a year depending on where a builder begins. But it's time well-spent if you're putting your company up for sale. "The better your financial and reporting systems, the faster you'll get to a transaction," Meyers says.

That's what happened with Meritage's acquisition of Hammonds Homes, which closed in a lightning-fast 45 days. "We had the same accounting systems, we used the same architects, and we'd gone to the same home building school," says founder Ron Hammonds, who started his company in 1986 with a $25,000 advance on an American Express card.

"If you really want to fit like a glove," says Meyers, "operate your business like a public company."

Just don't fall into the trap of valuing your business like a public company. While the home building stocks appear to provide a framework for valuation, Seay says private builders simply can't expect the same earnings multiples as their public colleagues. "[Public builders] command a premium because they are more liquid and have more resources," he says.

Using public builders' earnings multiples to ballpark a private company's valuation is problematic for other reasons, too. Acquiring builders typically focus on cash flow, not earnings, which translates into smaller EBITDA multiples rather than the larger earnings-per-share multiples common on Wall Street.

"Nothing's perfect, but to us, cash flow is the best number to watch," says Seay, who looks for companies with valuations of four to six times cash flow.

Cash flow isn't the only metric buyers use. They'll calculate a host of financial equations while looking closely at a builder's most important asset: its inventory of homes and land. Ideally, that would equal a two- to three-year pipeline of lots, with entitlements in place. While public builders need land, they're not eager for the risk associated with a 10-year land supply.

That inventory will provide the foundation for a company's value. "At the end of the day, the price of a home is relatively the same, and the residual value of the real estate is very ascertainable," says Jaffe, who has been involved with Lennar's California acquisitions, including Pacific Century Homes and Winncrest Homes. "There's not a lot of mystery in the underlying value of a company. There has to be a strategic reason why a company's worth more [than book value]."

Sometimes, but not often, that comes from a builder's brand. "There are very rare examples where brand plays into strategic value," says Jaffe, citing U.S. Home and Del Webb. "In most cases, the brand is what attracts buyers, but it doesn't add to the financial valuation of the company."

When it comes to a price beyond book value, it's up to would-be sellers to prove that their company warrants extra consideration. Be prepared to demonstrate "strong double-digit" growth for multiple years and multiple areas, including revenue, closings, margins, and overall profitability, Entin advises. "Growth rate really goes to the issue of whether a company can command a premium over inventory and dirt," he says. "If you've grown year over year, the buyer is more apt to believe you will continue that growth."

Who Stays?

The question of who will lead that growth is an important one, because the answer can affect the price and terms of a deal. "If all the seller is interested in is cashing out," says Beckwitt, "we'll value the company as a purchase of inventory rather than as a going concern."

Advice From the Front

It raises other issues, too. Public companies like to use stock for mergers and acquisitions and will often offer a higher price when stock is accepted as part of the deal, but a seller planning to leave the business may not want his net worth based on the performance of a company with which he's no longer involved. That's not such a worry for builders who plan to stick around. "If you have faith in your company, and the acquiring company has a good management team, you make an assumption that the stock will do well," says Westfield's Gatewood. What's the right amount of stock to accept? "It depends on the objectives of the seller," says investment banker May. If stock represents a large portion of the purchase price, a builder may want a voice in the newly enlarged company and a seat on the board of directors. There are trade-offs, though — a director usually doesn't have the same flexibility as an average shareholder if he wants to sell any of his holdings.

To solve that tricky equation, a selling builder may want to retain an investment banker for advice and alternatives. Other questions worth taking to a banker: employment agreements, and earn-outs, which provide additional compensation to a seller for achieving certain financial goals. Earn-outs may also be the tool to get the deal done when expectations don't match up. "It can be a way to bridge a valuation gap," May says.

Investment bankers can assist earlier in the process, too. "Home builders are very adept at packaging and marketing individual projects, but they typically have never been in a position to do that with a whole company," says Entin. "An investment banker can package the company, position it, identify prospective buyers, create a controlled auction scenario, and structure and negotiate the transaction."

While that's not appealing to every potential buyer ("we do our own spadework," says Meritage's Seay; "we prefer not to be involved in the auction process"), it certainly benefits selling builders big enough to warrant professional advice.

"You may get a higher price if you have representation," May says. "The reality is, when someone approaches you, you may get a better value if they believe you have other alternatives."


Buyer Date Deal Value Terms

Del Webb

Pulte Homes 5/01 $1.7 billion stock, debt
Schuler Homes D.R. Horton 10/01 $1.6 billion cash, stock, debt
Crossmann Communities Beazer Homes USA 1/02 $637.0 million cash, stock, debt
The Forecast Group K. Hovnanian Enterprises 12/01 $235.5 million cash, stock, debt
Emerald Builders D.R. Horton 7/01 $193.6 million cash, stock, debt
Westfield Homes USA Standard Pacific Corp. 6/02 $102.5 million cash, stock, debt
Westbrooke Homes Standard Pacific Corp. 4/02 $95.0 million cash, debt
Hammonds Homes Meritage Corp. 7/02 $82.8 million cash, debt

Hancock Communities

Meritage Corp. 5/01 $77.1 million cash, debt
Sanford Homes Beazer Homes USA 8/01 $68.0 million cash, stock
The Fortress Group D.R. Horton 5/01 $53.0 million cash, debt
The Fortress Group Lennar Corp. 6/02 $50.7 million cash
Colony Homes Standard Pacific Corp. 5/02 $35.0 million cash, stock, debt
The Fortress Group Wilshire Homes 6/02 $23.0 million cash
Sources: Company Reports
Here's a sampling of recent home building mergers and acquisitions, listed in order of estimated deal value.

Published in BIG BUILDER Magazine, October 2002