Monday, September 24, 2007

Standard Pacific Troubled; Hovnanian Almost as Bad

Standard Pacific announced today that they are going to offer $100 million of convertible notes.

The Company intends to use the net proceeds of the notes offering to repay a portion of the outstanding indebtedness under its revolving credit facility.

The notes will bear interest at a rate of 6.0% per year... an initial conversion price of approximately $8.75 per share of common stock...

Concurrently with the offering of the notes and the convertible note hedge transactions, the Company intends to enter into a share lending agreement with an affiliate of Credit Suisse, pursuant to which the Company will lend shares of its common stock to such affiliate. Under the share lending agreement, the share borrower will offer and sell the borrowed shares in a registered public offering and will use the short position resulting from the sale of such shares to facilitate the establishment of hedge positions by investors in the notes to be offered.

On September 14, 2007, and in contemplation of the proposed notes offering, the Board of Directors of the Company eliminated the Company's quarterly cash dividend. This action will save the Company approximately $10 million per year.
It looks like an extremely ugly way of raising money. SPF is going to lend its own shares to whomever buys the notes, so that the buyer can sell the stock short. I don't think SPF is long for this world.

Standard Pacific is one of the worst homebuilders based on three key metrics:
  • Debt-to-backlog. Having debt that is a higher multiple of backlog (the dollar amount of outstanding orders for homes) is troublesome. Consider that the amount of cash for paying down debt is going to be a fraction of the backlog, and that significant numbers of orders in the backlog will probably cancel.
  • Debt-to-market cap. A measure of the amount of financial leverage.
  • Altman Z-Score. Lower scores are worse; used to forecast the likelihood of bankruptcy.

(click to enlarge) Z-Scores are from this article.

One thing to keep in mind is that this table does not consider off-balance sheet debt. Standard Pacific, for example, has loads of debt in special purpose joint-ventures that they may be liable for.

Also, it looks like Hovnanian is the next worst of these builders after SPF. (Not counting TOA, BHS, or BZH, since they are so difficult to short.)

Finally, I took a stab at what SPF's equity would be after hypothetical markdowns.
(Keep in mind, they amended their Consolidated Tangible Net Worth covenant to require "the sum of (a) $1,000,000,000 plus" a proportion of net income and equity sales.)

For this experiment, I made the following major assumptions:
  • Land owned is worth 50% of book value. My understanding is the bids for lots and land in SPF's markets are very, very low.
  • Completed and model homes are worth 80% of book value.
  • They will be walking away from all land options.
  • A generous assumption that they will be able to walk away from the JV's and such at only a complete loss, when they may actually have to pay those structures' debt, and thereby be liable for more than their initial investment.
  • Mortgage loans in the portfolio are worth book value. If it turned out that SPF was writing shoddy loans in order to move houses, the loans would require a huge discount.

(click to enlarge)

In this scenario, their book value is negative $1.28 per share.


Anonymous said...


While your analysis is assuredly correct in that SPF will have to take more writedowns, you failed to consider the tax effects of such events.

Assuming your $1.7 billion total writeoff is correct, a $627 mm deferred tax asset is created (based upon a 38.4% tax rate, and excluding goodwill write off).

So instead of your -$1.28 per share estimated book value, SPF's real book value would be somewhere around $8.50 after correctly accounting for all adjustments.

Eric Landry

BxCapricorn said...

Adding you to my blog's links. My group has been watching (and shorting) the homebuilders lately (you're next restaurants) as the bubble deflates. Great job on the graphics, and I borrowed one for my blog (10 readers/day!). If you have a problem with it, just let me know.

CP said...


Thanks for your comment.

FASB Statement 109:
"The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized."

"A valuation allowance is needed when, based on the weight of the available evidence, it is more likely than not... that some portion or all of a deferred tax asset will not be realized.

Realization of a deferred tax asset is dependent on whether there will be sufficient future taxable income of the appropriate character... "

I just left the deferred tax assets alone in view of this uncertainty.

Worst case, they should be impaired in their entirety.

Best case, you seem to be conceding that $14 per share or 165% of book value is deferred tax assets.



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