Welcome back, Don Tomnitz!
The former D.R. Horton ceo, who retired in September 2014, after 15 years, and was succeed at the helm by current ceo David Auld, is back very much in the picture of both the present and the future of America's No. 1 builder.
On Wednesday evening, D.R. Horton secured an agreement to by 75% of Forestar Group, a publicly-held mixed-use developer, for $17.75 per share, or about $560 million in cash. Forestar owns or has JVs in 50 residential and mixed-use projects, currently about 9,700 lots, spread across 4,600 acres in 10 states and 14 U.S. markets, all of them D.R. Horton markets.
The deal is set up to be a win-win for two companies, one that needs smoothly metered access to finished homesites, and one that needs capital to continue to go out and work with land-sellers to scale up and put more dirt in its portfolio. According to KBW research analyst Jade J. Rahmani, D.R. Horton sees the deal as accretive to 2018 earnings. Rahmani and co-analyst Ryan Tomasello write:
Core developed residential lot sales in 2016 were 1,705 with an average price of $72,200 per lot and gross profit of $26,500 (36.7% margin).
What's expected is that the symbiotic relationship will lead toward a reduced equity position in Forestar, well after the company builds the footprint to succeed on its own power, with Horton benefitting all along the journey as a favored-nation land acquirer. Here's how J.P. Morgan Chase analyst Michael Rehaut bullets out the Horton plan:
Strategic rationale. DHI expects this relationship to allow it to improve inventory turns and return on assets while maintaining its strategy of owning a 2-3 year lot supply and controlling remaining land through option agreements with land developers. DHI expects FOR’s lot closings and revenue sourced from DHI to grow to over 10,000 units and roughly $830 million by 2021 (along with roughly $90 million of operating profit), funded by FOR’s existing balance sheet with modest project-level debt and no new equity. By 2023, this could increase to over 15K of lot sales generating $1.2 billion in revenue and roughly $140 million of operating profit.
New land deals would be sourced through FOR’s existing land team, as well as in partnership with DHI under terms of a proposed Master Supply Agreement. Based on DHI’s proposed Master Supply Agreement, FOR would acquire, develop and sell lots to DHI and other builders. FOR and DHI’s teams would each source and present potential lot development opportunities. If deals are sourced by FOR, 50% of the lots would be offered to DHI on market terms and if DHI declines the offer, FOR could market and sell lots to other builders. For deals sourced by DHI, up to 100% of the lots would be sold to DHI and if an agreement cannot be reached, DHI would retain the opportunity.
Typically, home building companies find it exceedingly difficult to discipline their appetite for land when demand fundamentals are solid, growing, and supported by economic and policy tailwinds, such as trillion-dollar infrastructure initiatives, tax cuts, and lowered regulatory barriers. D.R. Horton, however, is not a typical organization when it comes to disciplines.
It positioned itself a decade ago to release part of its store of "dry powder" to score on some very large expanses of land for pennies on the dollar during a virtually "no-transaction" period of the Great Recession.
Now, amidst a market that shows signs of heating up, D.R. Horton is shaping a strategy of cadenced, intentional growth to keep pace with swelling demand, rather than to overextend on a lot pipeline only to have to impair its land assets if volumes hit a slowdown period and home prices don't support projected per-lot profit projections.
A statement from Horton notes:
D.R. Horton is committed to owning no more than a two- to three-year supply of lots and supplementing its land pipeline through lot purchase agreements with land developers,” the company said.
“This transaction is consistent with its stated long-term strategy of developing strong relationships with land developers across the country and growing the optioned portion of its land and lot position to enhance both operational efficiency and returns,” the company continued. “The strategic agreement with Forestar provides D.R. Horton a unique platform to accelerate this strategy.
By keeping a solid, metered pipeline of lots queued up in a managable dashboard, Horton can focus on operational excellence, local dominance, and solid relationships with trade crews who see in Horton a steadily dependable source of work through the ups and downs of the cycle.
Other builders, lacking the muscle and the opportunistic striking power of a Horton, a Lennar, or a Toll Brothers, have to play in a more congested, costlier scrum to secure the lots they need, taking care that they don't leverage up on lots they don't.
