While there was speculation that home builder mergers and acquisitions would occur in 2009, those who keep tabs on the industry were caught by surprise when two of the biggest public builders were first out of the gate with barely a hint of a rumor beforehand.
After taking in the potential implications of the announcement, analysts overall said they think Centex needs the deal. "We view this deal as a necessary and positive step for [Centex] given its 56% leverage, $1.2 billion of debt maturities over the next three years, and our expectation for weak cash flow," wrote Dan Oppenheim of Credit Suisse in a research note.
Ivy Zelman, of Zelman and Associates, said the deal "cements Pulte as one of the strongest survivors of the downturn," pointing to the "diverse [footprint] with the most product breadth," but she questioned the notion that bigger as better. "We are concerned that the company will remain saddled with land that could prove to be a drag on returns if volume does not substantially improve," wrote Zelman, "and wonder whether buying legacy assets underwritten by another party is the highest potential return on investment."
Other analysts gave a number of reasons why the merger makes sense. For one, Centex is easy to acquire and has a good balance sheet with minimal change of control provisions in its management contracts and debt agreements, according to JMP Securities Vice President Hector Calderon.
Oppenheim of Credit Suisse noted that Beazer, Hovnanian, Meritage, and M/I Homes have lower-quality balance sheets and change of control provisions that would make such a deal with any of them difficult.
Pulte needed the deal as much as Centex, said Stephen East, analyst with Pali Capital. "They had too much in the Del Webb brand, and they are long on land," East said. "Getting with Centex helps them in land, gets them into the entry-level market, and gets them better volumes. … Overall, it is a good fit culturally and geographically."
The price of the deal was good for both, said East. "Centex saved face by getting one times book, and Pulte did okay because they didn't pay over book."
Focusing on the company as a whole moving forward, Calderon said the entire transaction rests on achieving synergy. "If they can't cut costs, the whole thing is for naught," he said. "When you have two massive organizations, the way you cut costs is not related to how you build a home. It's related to how you manage a company."
Zelman ran numbers and found that "based on a trailing four quarters ending March 31, the pro forma company closed 31,700 homes with an average price of $267,000 compared to the average of its peer group of $284,000." Giving an operating margin of -2.6%, compared to peer operating margin of 0.2%, she said this shows that there are cost-saving opportunities for the newly merged company.
Regarding synergy, Zelman wrote: "The combined company would have reported a core operating margin of 0.4% over the last four quarters, assuming such synergies, implying that a further reduction in costs, a resetting of land basis, and an improvement in volume will also be needed to return to normal profitability, which has averaged roughly 7% on pro forma basis for the combined companies since 1980."
Citi analyst Josh Levin said the proposed deal raised questions regarding synergy and market share, as in whether improvement would be sufficient to justify the merger. He also asked, "Given [Pulte’s] strong liquidity profile, how does purchasing all of [Centex] and dealing with the attendant integration issues compare to the opportunity cost of not just directly purchasing distressed land assets? We think this question is all the more relevant given that industry sources have told us that the bid for distressed land assets from non-traditional players has greatly diminished in recent months."
Will the deal trigger more big players to rush to the altar? Most analysts say no. But Patrick Duffy, principal at MetroIntelligence Real Estate Advisors, said there may be upcoming pressure by stockholders for other builders to put out the feelers.
Lynn Norusis is a senior editor at Big Builder magazine.