In a fast-growth year for the housing industry, big builders grew still bigger as they continued to acquire smaller, strategically positioned builders throughout 2003. The number of acquisitions may have moderated somewhat and the deals may have been marginally smaller than in 2002. But the engine of industry consolidation maintained momentum heading into 2004, fueled by mandates to hit corporate growth targets, the need to keep land pipelines full, and the willingness of smaller builders to exercise exit strategies.

By most counts, big builders completed nearly two dozen deals in 2003 with one or more year-end announcements expected as BIG BUILDER went to press. A definitive number is difficult to determine since not every deal between privately held builders is made public. By the same token, the values of the majority of transactions that took place in 2003 were not generally disclosed.

While the biggest deal of 2003 was Lennar Corp.'s merger with Newhall Land and Farming Co., Hovnanian Enterprises was 2003's biggest dealmaker with four acquisitions. Pulte Homes, Lennar Corp., Technical Olympic USA, Toll Brothers, and Canada's Mattamy Homes also completed multiple deals in 2003.

The broad majority of those deals effectively put greater control over available land reserves into the hands of the top 10 builders, adding new capacity and clout to their expansion efforts.

Ara Hovnanian. 2003 Acquisitions: Brighton Homes (January); Summit Homes (April); Great Western Homes (August); Windward Homes (November) Courtesy Hovnanian Enterprises Deals Galore

The acquisition year began quickly with the January purchase of Houston-based Brighton Homes by Hovnanian Enterprises for an undisclosed amount of cash. Brighton was listed number 78 in the 2002 Builder 100. The Red Bank, N.J., builder went on to purchase Summit Homes, of Canton, Ohio, a build-on-your-own-lot builder, for cash in April. In August, Hovnanian entered the Phoenix market with the acquisition of the assets of Great Western Homes, of Mesa, Ariz., in another cash transaction of undisclosed size. And in November, the builder entered the Tampa market with its purchase of Windward Homes, a first-time and move-up builder that was expected to close some 700 homes by the end of the year.

Florida--Jacksonville in particular--seemed to be on every builder's acquisition list in 2003. Standard Pacific Corp. acquired Coppenbarger Homes, based in Jacksonville, in a cash transaction. Coppenbarger was expected to deliver some 450 homes by the end of 2004, according to the Standard Pacific announcement. With this deal, Standard Pacific continued its aggressive expansion into Florida markets. In 2002, the company bought three builders in the state: Westbrooke Homes, in south Florida; Colony Homes, in Orlando; and Westfield Homes, in Tampa.

The Coppenbarger deal came on the heels of Toll Brother's September acquisition of Jacksonville's Richard R. Dostie and the July announcement that Ontario, Canada's largest builder, Mattamy Homes, was acquiring Jacksonville's Atlantic Builders, northeast Florida's sixth largest builder. The deal was Mattamy's second move into the U.S. this past year after picking up Homes by Chase, a Minneapolis-St. Paul area builder, in March.

Technical Olympic USA was another active acquirer last year. In February, the firm bought The James Co., in Denver, for some $30 million in cash and entered the Las Vegas market by purchasing Trophy Homes for approximately $36 million cash plus future performance-based payments. The previous November, Technical Olympic bought Masonry Homes, entering the Baltimore market.

The biggest catch of the year was KB Home's purchase of Colony Homes in March. Colony ranked No. 36 on last year's Builder 100 list. With 8,200 lots in reserve in and around Atlanta, Raleigh, and Charlotte, Colony gives KB a coveted new beachhead for expansion. KB also made news moving into the Midwest with its acquisition of Zale Homes, a 300-unit Chicago area builder, for $33 million.

Another transaction of note was the cash sale of Sivage-Thomas Homes, of Albuquerque, N.M., (ranked 61 on the Builder 100 list) to Pulte Homes. Sivage-Thomas delivered some 1,100 homes in 2002.

Miami-based Lennar Corp. made two direct purchases in 2003: Seppala Homes, operating in a number of South Carolina metro areas; and the real estate assets of Coleman Homes. In July, Lennar announced a $900 million merger of Los Angeles-based Newhall Land and Farming Co. and an entity owned equally by Lennar and LNR Property Corp. The transaction, scheduled to close in mid-2004, will give Lennar access to some 36,000 acres that Newhall Land owns in southern California.

More deals are surely in the works. Tony Avila, managing director of JMP Securities, a San Francisco investment bank, reported that as of October, JMP had been retained by two public builders and three private builders interested in finding suitable partners. JMP Securities worked with Sivage-Thomas when it sold to Pulte and with Brighton Homes in its sale to Hovnanian. Additionally, it's been involved in three recent deals in the Jacksonville market alone.

Closer Scrutiny

While the pace of merger and acquisition activity in 2003 proved comparable to recent years, market analysts noted some subtle changes. There were somewhat fewer deals made by public builders, and they tended to be smaller, they say. "Absent a big public-to-public deal, the year was fairly typical of what we've seen over the last several years," says John Stanley, industry consultant and former market analyst. There was "a steady, high level of public builders buying smaller, local guys," he says.

Acquirers seemed to be taking a somewhat closer look at target companies as well, says Rick Murray, analyst for Raymond James, a St. Petersburg, Fla., investment bank. Merger and acquisition activity "seemed to be more selective in that companies appear to be targeting markets that make a lot of strategic sense for them, either from a portfolio diversification aspect or to further their market share in an already established market," he explains.

Many big builders have already expanded their geographic reach, which affected their approach to M&A targets last year, he adds. It's likely to be a greater influence in the future, too, as more large builders establish themselves coast to coast.

As always, the price independent builders ask for their companies has a definite impact. "We've been hearing in the marketplace that private companies are still asking a pretty penny," says Carl Reichardt, senior research analyst for Wachovia Securities, in San Francisco. This is hardly surprising in 2003's record-setting housing market. But, "public companies that are concerned with adding goodwill to their balance sheets, or are concerned about diluting returns on capital, have been more reticent of doing those deals," Reichardt says. "I think you see a generally slower public-to-private acquisition market last year, relative to a pretty active 2002."

Tiered Concentration

The result of the M&A activity in 2003, not surprisingly, was greater market share for the large public builders. Because their share of market varies widely from market to market, analysts say, deriving an overall number doesn't always tell the whole story. Jim Wilson, CFA, and director of research for JMP Securities, says the big builder average share of market in the top 50 markets is about 25 percent. Public builders hold 66 percent of the Denver market and 89 percent of the market in Austin and minor shares in cities such as Atlanta, Seattle, and Kansas City, he points out.

Bruce Karatz from KB Home. 2003 Acquisitions: Colony Homes (March); Zale Homes (September) Courtesy KB Home What is certain is that concentration of acquisitions among the top 10 big public builders continues to turbocharge their rate of growth, as well as gains in market share.

Acquisitions contributed to 58 percent of the total increase in closings of the top 10 builders during the years from 1994 through 2002--and even higher percentages from year to year--according to a new NAHB industry report on market consolidation due to be released this month (see chart).

Combined with organic growth, acquisitions contributed significantly to the rise in the market share of new homes sold by the top 10 builders, which has climbed from 8.8 percent in 1989 to 19.7 percent in 2002, according to the study. In contrast, the market share of builders ranked 11-20 barely budged over that same period, increasing from 4.0 percent to 4.8 percent; and grew less than half a market share point, to just 2.9 percent, among builders ranked 21-30. The remaining builders in the top 60 marginally lost market share. The report noted that as of 2002, the top 100 builders had some 35 percent market share overall, a number that will surely rise when 2003 figures are finalized.

Home builder mergers and acquisitions are likely to continue at a rapid pace because their fundamental rationales persist. The most basic is growth. The top 20 public builders had some 250,000 closings in the 12 months ending September of 2003, notes Avila, based on research compiled by JMP. Assuming these builders want to grow by 20 percent as a group, they'll need some 50,000 added closings in the next 12 months. But only half that number is likely to come from organic growth, based on the builders' current rates. They'll have to continue to buy smaller builders to grow by more than roughly 10 percent, Avila figures.

Larry Mizel from MDC Holdings. 2003 Acquisitions: Crawford Homes (September) Courtesy MDC Holdings Deal Drivers

The need for land and capable people are also perennial drivers. "Land is the thing they are looking at first, and the people second," Stanley says, and others, such as Murray, concur. "A lot of these acquisitions have been to bolster their land positions in an effort to gain market share," Murray says, but adds that many of the home builders that have been acquired, "generally have seen most, if not all, of their management teams remain in place."

If anything, big builders seem to be placing more importance on the talent they can find in target companies, explains Wilson. Large builders can do "the commoditized part of the business" better than smaller builders, he points out. What they need from an acquisition target is "not just the availability of land, but also the people with the skill sets to find the right land, get it approved and titled, and with those sorts of 'good ole boy' relationships that the big guys aren't going to have when they walk in the door. I think a lot of the builders have learned that you need the local management expertise," Wilson says.

NAHB Housing Statistics, Mergent Online, BUILDER/BIG BUILDER Magazine The opportunity to keep management teams together is no less important to builders thinking of selling.

The drive to find and retain great local management talent has certainly been a factor behind Hovnanian Enterprises' acceleration into the acquisition fast track. The company's reputation for keeping acquired management teams in tact, opting to get "out of the way and let them do their thing," in the words of CEO Ara Hovnanian, has been a deciding factor for independent builders in signing deals with Hovnanian despite offers from other well-heeled builders.

But a number of public companies are also "looking for a good cultural fit," Reichardt says. "I think it is becoming increasingly important to certain public builders that the companies can work together." He cites Lennar as an obvious example of a public builder that considers cultural integration "as an important criteria beyond the value of the land," he adds.

Greater Efficiencies

Big builders, at least for the time being, continue to use acquisitions to enlarge and diversify their market areas. Lennar, for example, made a series of deals that changed the shape of its market coverage in California and developed some operational efficiency, explains Wilson.

Richard Dugas from Pulte Homes. 2003 Acquisitions: ColRich Communities(April); Sivage-Thomas Homes (July) Courtesy Pulte Homes "Lennar tacked on where they were building up through Los Angeles and down through parts of Sacramento and Stockton. Then they decided if they bought into Fresno and Bakersfield, which aren't very big markets, they would meet in the middle and cover the whole state," he adds.

KB Home is another builder gaining geographic diversification through acquisition. "Historically, they have been West Coast centered," says Avila. But they did, "what I like to call reverse manifest destiny by going to Atlanta and Florida via acquisitions."

Acquisitions also help to diversify product lines. Standard Pacific is an example of a builder who is doing both. At one time, the company was focused on the move-up market, Avila notes, but today it has entry- level and some active-adult products, too. Recent deals also have diversified the company from its West Coast roots into the Carolinas and Florida.

Steven Scarborough from Standard Pacific Corp. 2003 Acquisitions: Coppenbarger Homes (October) Courtesy Standard Pacific Corp. Faster Consolidation

All this means is that the industry can expect more of the same this year, no matter how the housing market may fluctuate, analysts say. A continued strong market will tend to make big builders even stronger and enhance an already formidable cash position. (The top 10 builders alone have some $6 to 8 billion available between the cash on their balance sheets and what they can draw from credit lines, one analyst says.) And a downturn is only likely to create acquisition opportunities for large builders.

"Given their financial wherewithal, a downturn in the market would enable the public builders to capitalize on what could be many extremely attractive opportunities that will certainly benefit them in the future," Murray says. In turn, their success will help fuel future success. "Their market share gains are one of the reasons the public builders are going to be able to continue to grow, even through modest fluctuations in the overall housing market," Murray adds.

Tony Mon from Technical Olympic USA. 2003 Acquisitions: The James Co. (February); Trophy Homes (February) Courtesy Technical Olympic USA Some, including the NAHB consolidation study, conclude that the number of builder acquisitions is likely not only to continue, but increase during the decade as big builders face the need to maintain growth on ever-increasing numbers. The NAHB study projects that "mega builders producing 100,000 units a year may happen in the next three to five years with a merger of two of the top five builders." It also predicts the top 10 builders are likely to build some 35 percent to 40 percent of the for sale market in the next 10 years.

But there are counter influences, too. Reichardt points to "an increasing disparity between what the public builders want and are willing to pay for and what the private builders are asking." Additionally, big builders have established comfortable land positions that relieve the pressure to acquire. Public builders have extended the supply of lots they control--in the neighborhood of four years supply for the public builders based on Reichardt's calculations--"which has obviated a need to buy companies," he adds.

Robert Toll from Toll Brothers. 2003 Acquisitions: Richard R. Dostie, Inc. (September); Manhattan Building Co. (October) Courtesy Toll Brothers The performance of the shares of the public builders in equity markets also will affect merger and acquisition activity, Reichardt says.

The P/E Factor

"Broadly speaking, investors are looking at the stocks of home building companies that not only grow at a reasonable clip, but also produce strong returns on capital as the ones to own," he says. But companies that are rapidly acquiring other companies sometimes boost their growth rates at the expense of returns. "The market has gradually begun to look more askance at that business strategy," Reichardt explains. "I think we have seen the market reacting more positively to companies that are considered to be internal growers."

On the other hand, greater separation between P/E ratios could promote public-to-public deals, Wilson explains. The current spreads "don't suggest a smart acquisition," he says. But a spread of four to five multiple points begins to make public-to-public deals more attractive, he says. Whether such a spread is in the cards anytime soon is purely speculation.

Laurence Hirsch from Centex Homes. 2003 Acquisitions: The Jones Co. (January) Courtesy Centex Homes "Historically, you've had P/E multiples separate more when the home builders took off, like in the early '90s and in '97 and '98 when they separated quite a bit as the big guys got much higher multiples than the small guys," Wilson says.

At the most basic level, mergers and acquisitions will be a feature of the home building industry for some time because the industry lends itself to consolidation.

"This is a good business to get bigger at," Wilson says, because of the "service-related factors that I think get better as you get bigger. And this is a consolidation process that is good for everyone: good for the buying company, good for the selling company, and, I believe, better for the customers," he adds.

Reichardt has a similar view. "This is a big, big business, and it takes a long time for it to consolidate," he says. "This is a business where there are still low barriers to entry. Getting in isn't difficult. But getting big is. It is never going to look like the automobile business. Given how fragmented this business is, I think we can expect to see consolidation for the foreseeable future."

*Centex-Jones Co. deal announced in 2002, closed in 2003; Lennar-Newhall deal scheduled to close in 2004. Company reports; BIG BUILDER estimates

Learn more about markets featured in this article: Los Angeles, CA.