A recent Big Builder digital newsletter featured a post by Jamie Pirrello, entitled “Measure for Measure: Home Builder Mergers and Acquisitions. An exploration of why acquirers use fair market value to price a home building company.” He concluded that acquirers value builders based on the fair market value of the assets acquired, both tangible and intangible. He also concluded that home builders generally have little in the way of intangible assets and that as a result, “home builders today are valued at the fair market value of their tangible assets.”
We, at Michael P. Kahn & Associates, strongly disagree with his assessment of home builder values. We have closed 106 merger and acquisitions since 1988, representing both seller and buyers. We’ve closed 11 since 2012 alone, and numbers 107 and 108 are under contract, so we feel we know a little about how home builders are valued. Every transaction we closed since 2012 has a significant capital gain component (75%-94.4%), ergo significant goodwill. To put it another way, in every deal we’ve closed since 2012, buyers have always paid more than the fair market value of the tangible assets.
What Jamie overlooks is that every buyer values a builder differently. A successful buyer’s motivation for acquiring a builder can, and almost always does, result in a determination that a seller has significant intangible value to them which may not exist for other buyers. Intangible value that does not exist if one values a builder in a vacuum, which it appears that Jamie is doing.
- A buyer may not have a presence in a market that they feel they need to enter. They can do a start-up and hence pay the dreaded “dumb tax” or they can do an acquisition and hit the ground running, generating book profits almost, if not, immediately. The value they attach to avoiding the dumb tax adds to the price they would be willing to pay, even if it generates goodwill
- The acquisition may be defensive in nature. By acquiring a builder in a market they already have a presence in, the acquirer may be able to keep a competitor from entering that market. This has a value to the buyer which adds to the value of the seller.
- A buyer may be able to gain significant market share in an existing market. If the “8oo pound gorilla” in a market is for sale, a buyer can become the 2,000-pound gorilla giving them a significant advantage in, among other things, land acquisition. This also can also have the effect of keeping others from entering a market.
- A buyer may have a weak management team in an existing market, whereas the seller has a highly respected and talented management team with great relationships with the major land sellers. Again this is an intangible assets which adds value to the seller. These are but a few examples of what we have seen. There are many more, but space dictates that we cite only a few.
From experience we know that every potential buyer will value a builder differently for the reasons outlined above and that’s why we reach out to about 30 potential acquirers when we represent a seller. If Jamie was right we should only have to go to one buyer as all buyers should value a seller the same way and come to the same value. This is clearly not what happens.
At Michael P. Kahn & Associates, our process when working with a potential seller includes a Phase I Valuation Exercise using three valuation metrics which try to take all of the above into account. We won't move into Phase II Active Marketing unless our client has approved our valuation. As we’ve closed over 100 deals we have the luxury of being able to measure our valuations against actual performance, not surprisingly, so far so good.
Rest assured, the value of a good builder in a good market is always greater that the fair market value of their tangible assets, perhaps not to all potential buyers; but then we need to find one who agrees with our valuation. We almost always do.