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Big Builders Will Be Less Acquisitive in 2006
Following a big year for mergers and acquisitions, large public home building companies will be a bit more cautious in 2006, according to Michael Kahn, president of Michael Kahn and Associates in Ponte Vedra Beach, Fla. Speaking at the International Builders’ Show in Orlando, Fla. last month, Kahn added that for the relatively few private builders who will be purchased, the qualifying standards will remain rigorous.
Nineteen transactions took place in 2005, Kahn said, and there probably will be fewer of them this year because the housing giants will be cautiously “tapping the brake” until they figure out exactly what is happening in today’s changing marketplace. Finding the stability they are looking for will take roughly three to six months, he estimated.
“They can operate in good and bad times, but they don’t like to operate when they don’t know what’s going on,” he said.
With stock prices for the giant builders down 30%-60% over the past six months, Kahn said, many are thinking that maybe they should be buying back their own stock at low valuations.
Earnings, however, are not a concern for the big builders because they already have a year of production in the bag, he said.
In the transactions that do get done in 2006, Kahn predicted that there will be less cash paid at the closing and more paid over time, based on performance, as the companies settle into more normal times for acquisitions.
Among the prerequisites for being a successful acquisition candidate, he said:
- The company needs to be building at least 200 units a year in a marketplace delivering no less than 5,000 homes a year.
- The builder must be profitable and able to defend business projections.
- Good accounting and reporting systems need to be in place. The builder needs to be able to demonstrate that “you’re in control of the business and know what’s going on,” Kahn said.
- The land pipeline needs to be controlled. The rule of thumb is that there should be at least a three-year land inventory, with at least 18 months’ worth entitled and 18 months on the way to entitlement.
- A good management team is a must.
“You have to know your business well so you can answer questions,” Kahn said. “Be prepared for a lot of due diligence. The buyer will give you 15-30 days to put it together on a list of diligence items.
Kahn also recommended candor. “What’s the worst thing that they will hear about you? Bring it up and deal with it on the surface.”
Further advice for those who are waiting to be tapped for acquisition: “Most big builders today are patient; they are not asking the builder to change. Keep doing what you’re doing.”
Geographically, acquisitions are generally out of favor in the Midwest. Big builders are also looking askance at Washington, D.C. and other markets where there is the beginning of a perception that housing is overpriced and prices are coming down.
On the other hand, “Florida, Florida, Florida is hot as a pistol.”
Public builders will continue to have a healthy appetite for expansion, Kahn said. They have high retained earnings, low debt-to-income ratios and access to impressive lines of untapped credit.
It’s relatively easy for a builder who constucts 300 homes annually to meet a goal of growing by 15% in a year, but for a big builder who is in the 30,000-40,000 unit range, 15% growth is the equivalent of 4,500-6,000 units, and that increase is hard to achieve organically.
The big builders will be expanding into different types of products, such as high-rises, but they won’t be interested in pursuing asset-driven businesses such as commercial or multifamily development.
By 2010, at least one of the housing giants will be able to build 100,000 units in a year, Kahn predicted, while noting that four builders are close.
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