Toll Brothers announced late last night it had reached agreement to buy California's highly-prized, 5,200-lot Shapell Homes for $1.6 billion, on the heels of TRI Pointe's Weyerhaeuser home building empire purchase for $2.7 billion.
Here, we take a look into details of the Toll Brothers $308,000 per lot coup, and tries to look yet further around the corner at what comes next in home building's frenetic mergers and acquisitions.
First of all, what a week! The two m&a transactions, totalling about 32,200 lots equates to an average of about $134,000 per home building lot, some of which are raw, unentitled, and undeveloped. We've been hearing the expression "at or above peak" a fair amount lately, and it seems that the land sellers party, at least in California where about 22,000 of the combined deals' total maps, is raging on.
That's for starters. Let's now take a quick peak back to August 22, when we tried to surmise who'd be likely candidates for the two biggest m&a prizes of the moment.
- Toll Brothers: the Toll-er-verse would be nicely expanded with the Weyerhaeuser brands, and the culture would work. Too, Toll is antsy to expand its California activity, which is a higher profit-margin, stronger jobs growth geography. This makes Toll a strong candidate not only for the Pardee and Quadrant Homes segments, but for the Shapell Homes assets as well.
- TRI Pointe: backed by Starwood Capital's Barry Sternlicht, never-say-never about a possible TRI Pointe coup. The growth spurt would be much faster than the brain-trust of Doug Bauer, Tom Mitchell, and Mike Grubbs would have mapped, but they're young and hungry to be No. 1 in the game.
That was late August. Now, as impressive as the one-two punch quality of these two transactions may be, an important issue is to understand the particular specific vs. the broaders motivators of the transactions.
On Tuesday, we explored some of those particular specifics of the TRI Pointe-Weyerhaeuser combination, noting that the operational, geographical, and financial structure fit between the two organization. Toll's Shapell buy has a tremendous amount of specific sense to it, especially its exposure to the higher volume, higher-end, higher-profit margin California markets that are leading the recovery from a jobs and household income standpoint.
ISI Research partner Steve East has some further insight into the Toll-Shapell combo:
- Price was $1.6B for 5,200 coastal lots. This takes TOL's CA lots to 9200, overall to about 52,000.
- Avg Price per lot: $308K
- Shapell has closed 347 units to date this year, with an ASP of $791K That implies lot costs of about 39% of ASP. However, we don't yet know how many lots are finished vs. raw. Also, TOL sells above this ASP, so our initial take is that the lot cost won't be extraordinary.
- TOL believes it will be accretive the first year, excluding acquisition costs. Also, significant ROI the first 18 months.
- TOL will finance with its $1B Revolver, Debt and Equity. It also secured an add'l $500M temporary Revolver.
- Equity issuance would be about 10%-15%, or 160M-240M. That is 3%-4% Dilution.
- TOL plans to quickly sell off about $500M in land.
- If TOL sells off land as expected, New Debt of about $900M will be added to the new Equity.
- Incremental Interest Expense initially would be roughly $75M or about 37c per share.
- After land sales, that would drop to about 25c/sh.
- We expect most, if not all would be capitalized.
- Gross Debt/Equity will climb to about 80%, then about 70% after land sales.
- Net Debt/Equity would be about 58%-60% initially, 50% after land sales.
- We view the leverage as quite manageable.
- If TOL Closes 500-1000 units per year at $1M/unit, Revs are $50M-$1billion.
- We would expect CA margins remain above the Co. avg of 7%.
- At 10% to 15% OM, implies about $500M-1B revs, $50M to $150m Operating Income
And here is Wells Fargo analyst Adam Rudiger's back-of-the-enveloped take-away:
1) The Shapell deal was widely discussed in the media and TOL was rumored to be a front runner, so the transaction does not come as a total surprise.
2) Shapell appears to fit with TOL's strategy in our view; it has a long land supply (approx. 10 years at the annualized 2013 YTD pace) in land constrained markets.
3) On a per-lot basis, TOL is paying $307K, or 39% of Shapell's YTD average closing price, which does not seem unreasonable in our view, considering land as a percentage of home price tends to be higher in California than elsewhere in the U.S.
So, Toll's bee-line for the "new geography of higher-paying jobs" is clear and decisive. It's not insignificant, of course, that Bob Toll himself has been spending a lot of time in California of late, and that the Toll press release casts focus on the familiar nature of the Shapell culture.
Robert I. Toll, executive chairman, stated: "We have long respected the Shapell family and what their company has accomplished. We believe this is the right acquisition at the right time in the right location for Toll Brothers. We believe this positive side of the housing cycle has significant distance to run, and that this acquisition should mesh well with the strength in the market."
Still, amid profound uncertainty around a broadly distributed jobs and household income recovery, we expect hyperbolic home builder m&a activity to continue in the choppy, lumpy, break-through markets that are attracting capital, talent, and multiplier effects around new technology, the "internet of things," healthcare, education, and energy.
The new hurdle for more-than-passing interest among national public companies in a metro area is around 4,000 or 5,000 permits per year, which we've heard can attract as many as six or seven big publics even if there haven't been any in a market previously.
So just as the Shapell team picked fourth quarter 2013 as its moment to decide it would do no better to wait, many other private home builders and land sellers must go through the same soul-searching process, and decide whether--given continued constraints on acquisition and development capital via traditional lenders and investors--they have the stomach to compete ever more fiercely for lots, suppliers, and home buying customers in markets narrowed to a very finite number of thriving areas where jobs and incomes are growing.
Again, we'll not be surprised to have to try to keep up on reporting on a dozen or more private home builder acquisitions by publics, as well as big land deals, new capitalization moves, and other combinations all by the end of December. In early 2014, we'll see a continuation of m&a, and even the addition of one or two more private companies going public.
All of this, of course, is being triggered by the fact that global capital has declared itself ready and raring to move in anticipation that the most powerful force that drives housing recoveries--the simple addition of many people without the addition of new homes for them to live--will kick fundamentals into a higher gear in the months ahead.
Learn more about markets featured in this article: Los Angeles, CA.