New information detailing the negotiations between Centex Corp. and Pulte Homes-and two other potential Centex acquirers-was disclosed late last week in Pulte's S-4 filing with the Securities and Exchange Commission. According to the filing, as part of a directive from Centex's board of directors to find "strategic alternatives" to shore up its balance sheet and alleviate an impending crush of near-term debt, Centex CEO Tim Eller had preliminary discussions with two public home builder chief executives in addition to Pulte's Richard Dugas about a possible acquisition. The filing referred to the companies as "Company A" and "Company B." D.R. Horton has stated that it passed on the deal.
"Company B"?which could be any number of home builders with strong balance sheets and an interest in consolidation talks?emerged as a potential "merger of equals," but filings indicate Pulte's offer gave Centex shareholders more for their holdings.
This detail indicates Pulte's acquisition of Centex may be less of the one-off deal as some had suspected; an appetite for consolidation may in fact be building given the opportunity to take out more competitors, establish strong product positions, attractive pricing of assets, and the amount of cash on builders' balance sheets. However, the number of possible acquirers willing and able in terms of balance sheet strength is dwindling as the number of companies?most notably Beazer Homes, Hovnanian Enterprises, and Standard Pacific Homes?needing to recapitalize their balance sheets grows.
Discussions between Centex and Horton executives were relatively lightly entertained, despite Horton management's reputation for believing bigger is always better. According to the filing, on Feb. 13, 2009, Eller and Horton CEO Don Tomnitz, along with a Centex director and additional members of both Centex and Horton senior management teams, met for preliminary talks. A Feb. 17 phone discussion followed the in-person meeting; however, ultimately, Horton management decided to walk from the deal.
In a recent earnings call, following a question from Stephen Kim, an analyst with Alpine, Tomnitz offered more detail as to why, despite some obvious geographic and product synergies, the deal was ultimately a no-go:
"We see virtually every deal that comes to the market, and we did see that deal. I don't want to speak for either Pulte or Centex. I would rather speak for D.R. Horton. Our focus is on continuing to generate increased liquidity, continuing to adjust our inventory levels, to meet the demands in our respective markets. We are continuing to right-size our organization. We right now have about 2,900 employees. I think if you do the math on the combined entity, they have almost over three times that number of employees. They have sold in the December quarter only 66 more units than we. So, I think that is a competitive challenge that they face.
"We also are focused on an asset-like business model. We clearly are not focused on buying land. We are focusing on how we can build on other people's lots as we go forward. We are also focused dramatically on trying to reduce our debt as quickly as possible relative to our cash position, and maintaining a minimum amount of cash on our balance sheet."
Discussions appeared more serious with Company B, which Big Builder has not been able to identify. Just like Eller had approached Tomnitz to talk about a possible transaction, he also opened a dialogue with a chief executive in early February about a possible transaction. Negotiations were moving along with Pulte-by March 9, the Pulte board of directors had given Dugas the green light to submit a term sheet to Centex, which offered to exchange every outstanding Centex share for $0.90 Pulte share.
However, a special committee, consisting of four independent board directors including David Quinn, a former Centex vice chair, directed Eller to both attempt to secure a better exchange ratio, along with a few other improved terms, with Pulte and, at the same time, draft a transaction proposal for Company B.
A Centex mash-up with any number of partners would make sense for a number of the same reasons Pulte wanted to pull the trigger on an acquisition of Centex. There's opportunity to gain volume and significant market share in key markets as well as some significant operational and financial cost savings to be realized.
Not to mention with a concentration in the lower rungs of the home buyer market, Centex would offer several strong home builders with focus on move-up, second move-up, and luxury offerings a chance "to diversify away from luxury in a tough economy," according to Hector Calderon, a vice president at JMP Securities and an M&A specialist.
On March 11, Eller presented to Company B's CEO in an in-person meeting a so-called "merger of equals." However, the proposed deal would give Centex shareholders 51% ownership of the combined company and Company B stockholders the remaining 49%. In addition, the combined company board would be an even split between Centex and Company B picks, Eller would be the new company's chief executive, and the combined company's headquarters would be in Dallas.
A little less than a week later, Company B came back with a counteroffer that made the so-called merger of equals actually equal, with ownership split down the middle between Centex and Company B shareholders. Moreover, Eller would assume the combined company's chief executive role but that corporate headquarters would shift to Company B's corporate offices.
Ultimately, Centex's board decided to pursue a deal with Pulte because it offered greater value to Centex shareholders; the deal was working out to give Centex shareholders a 25% premium to Centex's stock price at the time of signing. However, given the relatively low stock values of home builders today against what they have been in years past, some shareholders are likely to not consider this much of a premium?particularly in light of the fact that Centex and Pulte had been in similar transaction negotiations in 2000 and then again in 2004, when valuations were much more robust.
But even as a Horton-Centex or Company B-Centex transaction fell through, there could be an acceleration of M&A activity to come. According to information in the S-4 document, it would appear that Pulte could be spring-loading the combined company's balance sheet to fast-track it to profitability, a very attractive proposition for other companies and a possible catalyst for deals of this magnitude. Because of a fair value accounting regulation, which is a more stringent valuation test than FASB 144, Pulte expects to write down Centex's $3.2 billion in inventory by as much as $900 million by the time deal officially transacts. The impairment could allow the company to achieve better returns, ultimately serving as a trampoline to improved profitability.