From the beginning, Meritage has done business a little differently than the average builder. Created in 1997 from a merger of alter egos—Scottsdale, Ariz.-based custom builder Monterey Homes and Plano, Texas-based production builder Legacy Homes—Meritage and respective principals Steve Hilton and John Landon have made a practice of defying convention and some say the odds.
Playing off each other's strengths, Hilton and Landon continue to run Meritage jointly, as co-chairmen and co-CEOs. Each operates out of separate offices, while also overseeing respective regional businesses. Distinct among most public U.S. corporations in listing dual headquarter offices, Meritage resembles in many ways the equivalent of a double-barreled corporation.
Even its path to the New York Stock Exchange was unusual. Prior to the merger, Hilton, then CEO of Monterey Homes, negotiated a deal with a troubled REIT called Homeplex Mortgage. Hilton merged Monterey into Homeplex and changed the name—completing a reverse merger that included $25 million in assets and equity, a NYSE listing, and a $54 million net operating loss carried forward. “It allowed the company to go public without doing a traditional public offering,” says Meritage CFO Larry Seay, and keep “the earnings for growth instead of using a portion to pay federal taxes.”
Today, Meritage has strongholds in 10 major markets in Steve Hilton, left, and John Landon, co-chairmen and co-CEOs, Meritage Corp. Arizona, California, Texas, and Nevada. And while the company may not have the size or geographic diversity of most other public builders, Meritage is raising eyebrows for more than its distinctive management style. Judging by the breakneck speed of growth it has achieved since 1997, Meritage's two-pronged focus on organic growth and acquisitions is paying off.
Since going public, Meritage has increased its annual sales at a five-year compound annual growth rate of 43 percent and its net income by 54 percent. In 2003, the company posted $1.5 billion in revenue—an increase of 31 percent over 2003—surpassing its stated goal of doubling in size (by revenue) every three to four years. And it would appear Meritage has plenty of room to run.
Living up to its reputation as an aggressive acquirer, Meritage broke out of the blocks early this year, when it announced the January 7 purchase of the home building assets of Orange County-based Citation Homes of Southern California. As of Dec. 31, 2003, Citation controlled approximately 900 lots in the Inland Empire market. And the company remains on the prowl for builders generating $25 to $200 million in sales and holding a three- to four-year supply of land in key markets. “Given a steady economy and moderate mortgage rates,” and its latest purchase, “we anticipate the number of our 2004 home closings should range between 6,600 to 6,900, generating revenue between $1.7 and $1.8 billion,” says Landon. That's a far cry from the 917 closings and $189 million in revenue posted just six years ago.
Although Meritage lacks the name recognition of some other public builders, it appears the rest of the business world is starting to take notice. In January, Standard & Poor's added MTH to its S&P SmallCap 600 index. And in 2003, Meritage was ranked No. 11 in Fortune magazine's top 100 fastest-growing companies and was included in The Bloomberg 100 “Hot Stock” list, compiled by Bloomberg Personal Finance magazine.
With more than two-thirds of the company's sales in the first and second move-up segments, Meritage's home prices averaged $275,000 in 2003. But with its legacy of luxury homes in Scottsdale, the base price of Meritage's product mix ranges from $91,000 to $900,000. Regardless of the product, Meritage's approach remains the same: Cater to the meat of the market by offering people a lot of value and more visual appeal, and make more money doing it. Hilton and Landon both say they believe in zeroing in on the basics and focusing relentlessly on what Landon sees as “the disciplines involved in determining the right product at the right price in the right location” to find the ideal “value equation.”
Dynamic Duo Despite the outwardly calm personae of Hilton and Landon, their fiercely competitive nature is reflected in the company's culture along with an unrelenting focus on the building side of the business.
When you take a close look at Hilton and Landon, the parallels are obvious. Both come from financial backgrounds—with Bachelor of Science degrees in accounting from the University of Arizona and Louisiana State University, respectively. Both are well rounded by the experiences that come from building their own companies. Both are bound by strong family ties; citing their parents as personal heroes and spending time with wives and children to unwind. And both shoulder the gamut of responsibilities that come with the title of CEO. “When they go out, together or alone, they can handle the crowd from A to Z,” says Hays.
While Hilton oversees California, Nevada, and the Monterey Homes and active adult operations in Arizona, Landon carries the responsibility for Legacy, Hammonds, and the Monterey Homes operations in Texas as well as Hancock communities in Arizona. “Two heads have been much better than one,” says Hilton. “We can cover more territory and grow faster.”
By dividing the business along regional responsibilities, the chain of command is very clear. Though the two top executives are based in different states, they manage the corporate level together and are in contact almost daily to share information and draw on the other's opinions.
As a result—but to the surprise of many—a co-CEO structure seems to thrive at Meritage. Steve Hafener, former president and CEO of Sterling Communities (the first company acquired by Meritage), says he was skeptical at first about the reporting structure of two CEOs. “I questioned it up front, but it works fine. They critique and help each other. And each is certainly very cognoscente that any decisions are under the eye of the other.”
According to Hafener, the give and take between Hilton and Landon is a result of the experience each executive brings and the confidence that they have in eachother. And there is no room for egos in this equation. “They are thorough individuals,” says Hafener. “When you know what backup and material needs to be provided to make John Landon or Steve Hilton comfortable, the process works very smoothly ... [but] it takes incredibly unique individuals to make it work.”
Former UBS analyst John Stanley, who worked closely with Meritage since it went public, agrees that the co-CEO arrangement is unusual. But given the company's success, he finds it difficult to argue with any element of their strategy. “I would guess that somewhere out there when the company is much larger that it will have to evolve to a more normal [title] structure,” says Stanley, who now works as a financial consultant to builders under the company name StickSpin. “But for now it seems to work well, judging by the results.”
Competitive Force Hilton and Landon clearly prefer to focus more attention on what's selling. Keeping a close eye on the competition has been standard practice for Hilton since founding Monterey in 1985, when covert missions included walking through competitors' models with a pocket camera to capture design and decorating ideas.
Today, when Meritage moves into a market, “there is a conscious decision to spend a certain number of dollars to be better than the competition visually,” says Hafener. Whether it is with pop-out bay windows, a little nook, or other design features, the idea is to include special touches that the immediate competition does not have. While it adds some real appeal, it doesn't add a lot of cost. “If it's thought out up front, it's the kind of thing that costs you a hundred dollars and it looks like it's worth a thousand.”
According to Hafener it's also critical to have savvy, experienced builders in the field. “Whatever you put in is going to be copied within six months. So you are constantly reinventing, reassigning, and coming out with a new gimmick.” As a result, acquiring key personnel becomes critical—like luring away Ron French, former president of Richmond American's Phoenix division to become president of its Hancock/Meritage Phoenix division in January. “Ron's extensive knowledge of the local markets will allow Meritage the opportunity to significantly expand its operations in the Phoenix area,” says Landon.
While some builders try to make decisions from the home office, Meritage empowers field staff with the authority to make decisions. “[From the home office] it is really difficult for builders to maximize their profits,” says Hafener. “They can do well, especially with good land plays, but they will never know what profits they lost by over-specing or making things look too expensive for the marketplace. That's a common error.”
Financial Future Though credit is due for impressive expansion, analysts question whether their rapid growth may have come at a price. In a report released in the fall, analysts with FBR note that “when MTH first went public, returns on invested capital and inventory turns were near the top of the peer group … [but] have steadily deteriorated over time, dropping to or below peer averages. Although FY ‘02 margins were flat with those in FY ‘98, by contrast, the [company's] peers saw a 300-basis-point increase on average.”
Larry Seay, Meritage CFO, points out that it's not a matter of the company's returns deteriorating, it's that others are catching up. “Our goals have been to show a 10 percent-plus, pre-tax margin, and we've done that,” says Seay. In fact, over the past three years, Meritage's return has averaged closer to 14 percent.
“Builders that have high margins now didn't always,” says Hilton. “It's because they bought all this land five or 10 years back. If you can make a good solid 10 percent-plus margin without carrying a lot of land, you are showing you can make good money as a builder—not a builder/developer. A lot of our competitors are builder/land developers. We want to be builders.”
This doesn't mean Meritage isn't forced to play the “land game” when it comes to location. “We're very sensitive the risks associated with land in this business,” says Landon. “And we try to minimize those risks wherever possible.” But it's the way they choose to finance the lots that sets them apart. Currently, 85 percent of the company's 28,500 lots are optioned. With the industry averaging 50 percent to 55 percent, this is by far one of the highest percentages in the public builder sector. “We're looking at the risk/reward trade-off, and we're willing to pay for that in our margins,” says Seay.
As an investor, Anthony Botte, western region senior vice president for Hearthstone, appreciates the company's approach. “Performance-wise, they're a good investment for us. It's the sophistication level that they have; they've been able to [buy] smart builders in local markets to tie up the right projects.”
StickSpin's Stanley predicts that margins will approach average as Meritage becomes big enough to start generating the cost leverage of its largest peers. He sees the company “re-establishing itself as one of the more profitable builders [measured by return on capital] because of its more aggressive use of land options.”
Hilton and Landon have Meritage on track to get big fast. With revenues projected to grow 20 percent to 25 percent over the next five years, and growth plans targeting $4 billion in sales by 2008, Meritage may soon be earning attention for much more than its dual-leader management approach.