Hovnanian CEO Comments on Homebuilding Market

From the fourth quarter earnings call,

"An amusing anecdote is that it's not uncommon for one of our operating associates to complain that the builder we lost a land opportunity to must be assuming home price increases, otherwise they wouldn't have been able to offer so much money for our land parcel. I'm sure that when we win a land parcel that the other builders bidding on it must say the same thing about us, but the reality is we all use different assumptions on what type of home to build, what finishes to include, the price versus velocity trade-off, the mix of different size homes, et cetera. It's part art and part science, leading to slightly different views on land value on any given parcel. At the end of the day, everyone loses more land deals than they win, but that was also true during the bull market run of 2002 to 2005."

Who would've thought?

Hovnanian Earnings Call ($HOV)

From the HOV earnings call,

Our land acquisition associates have been very busy, which has resulted in a full land committee calendar here at corporate. During the third quarter of 2012, we optioned 2,200 lots, bringing the total new land controls since January of '09 to 19,500 lots in 344 communities. During the third quarter, we spent $117.6 million on land and land development. To put this in perspective, we spent only $118 million of land and land development for the first 6 months of the year. We are not stretching or reaching in order to buy more land deals during the third quarter. The increased land spend was a function of finding more land deals that underwrote to a 25% plus IRR, based on the current sales pace and the current sales prices. The improvements we have seen in home prices and sales paces around the country are justifying higher land prices. This in turn causes more land sellers to consider selling, which creates more opportunities for us to buy land while maintaining our IRR underwriting criteria.

Now I will say overall, given the very low interest rates, we're definitely seeing a bias toward customers picking the larger houses. I think the logic is, with rates so low, the incremental monthly cost is not particularly great. So if they have good credit scores, recently we've seen a little bit more leaning toward the larger model homes than the average one that we had been experiencing.

Phoenix, I mean obviously, we're in the dead of summer or just finished the dead of summer, which is their slow season as they get up over 100 degrees all the time. Generally speaking, Phoenix is rock-solid, and we've been enjoying really good and steady price increasing in many of our communities there. So we haven't seen any slowing whatsoever there right now.

There is a housing bubble again in a number of states.

Latest and Greatest ($KV $AONE $GMXR $HOV)

KV said in its lawsuit that unless it is able to "immediately generate significantly higher market share and revenues from Makena than the current levels, the company will not be able to meet its cash obligations, and will run out of cash in less than three months from the date of this Complaint," which would be the first week of October. That even seems optimistic, and anyway they would be likely to file BK sometime before they literally ran out of cash. The FDA lawsuit that KV is banking on is not the clear winner that they need judging by the response by the FDA (e.g. "more time spent on pharmacies compounding 17-HPC means less time spent pursuing enforcement actions in other areas"). I would obviously expect the stock to collapse to ~0 in the event of a BK filing.

The AONE bonds are down to 20 cents (and they have issued new "debt" where the payments are made with stock), and the company had previously said that "as of May 31, 2012, the Company expects to have approximately four to five months of cash to support its ongoing operations." That suggests that sometime around August/September the company will need to do something dramatic, which would be good for the debt/equity trade. I continue to wonder how the $163 million of 2016 notes only be worth $35 million according to the bond market - yet the company has a market cap of over $100 million? Aren't both the notes worth significantly more and the stock worth significantly less? I think they should be looking at a debt/equity swap right now for all their existing unsecured debt. They would be in a much better position to survive with less leverage. Ultimately though, they are probably a goner no matter what as Vinod Khosla has said. The best outcome would be for the company to liquidate and distribute proceeds to bondholders, as ENER did.

The big catalyst for GMXR is the bond maturity in February. That bond is trading at 69 and the 2015 unsecured is trading around 40. The well results in the Bakken have continued to come in poorly. They tend to be pretty opportunistic about debt/equity swaps and I'm sure they would rather spend money on drilling than on principal repayments to bondholders. The market cap is $60 million, which is more than the market value of the debt due in February. I would look for them to try to repay the February maturity in stock (via swaps) rather than cash. That will obviously be good for the long debt/short equity trade. Also, the company announced that they will release 2012 second quarter financial and operational results after the close of trading on the New York Stock Exchange on Wednesday, August 8, 2012.

Last is HOV, which has been trading stock for the bond that we own. It's nice to know that the company agrees that the bonds are a better value than the stock. I'm looking for continued swaps to put a ceiling on the share price while increasing the price/expected recovery of our bond. I've previously mentioned "impediments [which] will affect the home builders going forward (significantly higher-than-average vacancy rates, legacy land positions with subpar gross margins, competitive land market in attractive locations, rising labor/material costs, potential new home-builder entities with stronger balance sheets...)." Today I see a smart observation, that "the market may come to the realization that a sizeable portion of the land left on the balance sheet is: 1) Not in a desirable area despite the uptick in new-home demand; 2) Land that needs major improvement but does not yield an adequate gross margin at today's home prices after the necessary development spend."

Details of Hovnanian ($HOV) Debt for Equity Swap

Details of the previously announced transaction:

Pursuant to agreements with bondholders dated July 12, 2012, Hovnanian Enterprises, Inc. (the "Company") issued an aggregate of 3,862,671 shares of the Company's Class A common stock, par value $0.01 per share, in exchange for an aggregate of approximately $15.0 million of the Company's outstanding indebtedness, consisting of (i) $1,000,000 aggregate principal amount of the Company's outstanding 7.5% Senior Notes due 2016, (ii) $7,775,000 aggregate principal amount of the Company's 6.25% Senior Notes due 2016 and (iii) $6,205,000 aggregate principal amount of the Company's outstanding 8.625% Senior Notes due 2017 (the "exchanges").

The 2017 notes, which I like, traded up hugely after this exchange.

"Hovnanian Enterprises and GSO Capital Partners Announce $125 Million Land Banking Arrangement" ($HOV)

Today's press release:

• Funds managed by GSO will acquire a portfolio of land parcels from Hovnanian and option finished lots on a quarterly takedown basis back to Hovnanian. As of July 12, 2012, GSO has closed on six land parcels totaling 620 lots with total acquisition and committed future development costs of $65 million. In addition to the properties subject to the land banking agreement, during the next six months, GSO and Hovnanian anticipate identifying other land parcels totaling up to an additional $60 million in acquisition and development costs to complete the initial land banking portfolio.
• In addition to the land banking arrangement, GSO agreed to increase their equity stake in Hovnanian by exchanging $15 million of Hovnanian's 2016 and 2017 Senior Unsecured Notes for 3,862,671 shares of Hovnanian's Class A common stock.

The stock was up today, but I think this is mainly good for the bondholders.

With the "land banking" arrangement, HOV gives up land from their inventory in exchange for cash, and is able to buy it back under some undisclosed terms. This is conceptually pretty similar to just borrowing money, and it's notable that the disclosure does not give enough information to figure out an implied interest rate or cost of borrowing these funds. If anything, the intelligence of the party on the other side of the trade would imply that HOV is getting a bad deal or at least expensive money.

Then, the other part of the transaction is just another debt/equity swap. It is great for the long debt short equity trade that they are doing those. The stock was probably worth about $10 million, meaning that the bondholders received about 66 cents for their bonds.

WSJ: "Home Builders Beef Up on Cash to Gird for Next Wave"

Mentioned in today's WSJ:

"Hovnanian took advantage of the rising value of its common stock, which has nearly doubled in value since January, to reduce its debt load by issuing in the past two weeks 1.5 million class-A shares to bondholders in exchange for $6 million in debt.
[...]
By issuing stock now, builders are outrunning any potential weakness in the market that could result from rising unemployment, elections in November and problems in Europe.
[...]
For other builders, land plays a role, but there are other factors involved. Beazer and Hovnanian, for example, are saddled with heavy debt loads and are working to repair their balance sheets."

Hovnanian Does Another Debt for Equity Swap

From an 8-K released after hours:

"Pursuant to agreements with bondholders dated June 28, 2012 and July 2, 2012, Hovnanian Enterprises, Inc. (the 'Company') issued an aggregate of 1,516,712 shares of the Company’s Class A common stock, par value $0.01 per share, in exchange for an aggregate of $6.0 million of the Company’s outstanding indebtedness, consisting of $3.0 million aggregate principal amount of the Company’s outstanding 7.5% Senior Unsecured Notes due 2016 and $3.0 million aggregate principal amount of the Company’s outstanding 8.625% Senior Notes due 2017 (the 'exchanges')."

Thanks, HOV! This is good for the HOV debt/equity trade. They previously mentioned that one of their "Potential Liquidity Management Levers" was going to be "issue equity for cash or debt".

This was $6 million face amount of debt, but both bonds were trading ~70, so the market value of the debt they received was more like $4.16 million. Trading 1,516,712 shares is equivalent to selling shares for $2.74 - a discount to the current market price of $2.74.

It's nice to know that the company agrees that the bonds are a better value than the stock. 

Barron's: "Home Builders Are 40% Overvalued"

A research note in Barron's:

"We believe the home builders have risen substantially above fair value with several home builders being 40% overvalued in our view. Many impediments will affect the home builders going forward (significantly higher-than-average vacancy rates, legacy land positions with subpar gross margins, competitive land market in attractive locations, rising labor/material costs, potential new home-builder entities with stronger balance sheets, trajectory of mortgage rates)."

Mentions TOL, MTH, HOV, and BZH as overpriced (underperform).

Barron's: "Home Builder Euphoria on Shaky Ground"

"[W]e think that even though home prices have stabilized, the rebound will be too modest and protracted to justify the current lofty valuations of Lennar and its peers. While the long, slow slog toward normalcy in the housing market continues, the data also indicate that the industry has a long way to go yet, making a bet on pricey homemakers likely premature.
[...]
Therefore, if Lennar, one of the sector's standouts, still seems like a pricey and uncertain bet, it doesn't seem that shakier home builders will be able to hang onto recent gains."

Although detractors believed that the word "normalcy" was a neologism as well as a malapropism coined by Harding (as opposed to the more accepted term normality), there was contemporary discussion and evidence found that normalcy had been listed in dictionaries as far back as 1857.

Looking at the Hovnanian Investor Presentation ($HOV)

Hovnanian gave a presentation at the JPMorgan Homebuilding and Building Products Conference last week. There was a fascinating section called "Potential Liquidity Management Levers":

• Enter into model sale leasebacks
• Sell excess land
• Issue equity for cash or debt 
• Enter into additional joint ventures
• Enter into land banking deals
• Limit started unsold homes
• Delay/reduce land purchases and takedowns
• Reduce land development spending

I thought this was pretty interesting. I think the odds-on favorite is that they will continue to restructure by way of the stock-for-debt exchanges. It's pretty cool that they've been able to do those transactions, and it's great for the short stock, long bonds trade.

Barron's Article on Hovnanian: "Hammered and Nailed" ($HOV)

This was a great Barron's article on Hovnanian that I meant to post earlier.

Vicki Bryan, an analyst at research outfit Gimme Credit, points out that the company hasn't generated enough cash to cover interest costs since 2006, the result of weak demand and stepped-up land acquisitions considered vital for its future.

[...]That's why Bryan thinks a bruising recapitalization is inevitable, perhaps within a few months. The maneuver could involve converting outstanding bonds into equity, heavily diluting existing shareholders. Bryan goes so far as to call Hovnanian's stock "worthless."

The article's "bottom line" has been prescient: "Hovnanian may have to ask bondholders to swap debt for equity, diluting stockholders."

I've already written a few posts about Hovnanian. I view the debt as cheap relative to the stock, and you'll notice that they are undergoing a slow motion restructuring.

Hovnanian (HOV) Using Proceeds From Share Issuance to Repurchase Notes

Hovnanian had recently announced that they would be issuing and selling up to 28,750,000 shares - which is almost a 30 percent increase in shares outstanding. Today they announced that the

"net proceeds from the issuance of the Shares, along with cash on hand, will be used to fund the purchase of approximately $15.3 million principal amount of 6 1/4% Senior Notes due 2016, approximately $22.8 million principal amount of 7 1/2% Senior Notes due 2016 and approximately $37.4 million principal amount of 8 5/8% Senior Notes due 2017 in a private transaction."

The 6.25s trade at 72, the 7.5s trade at about 60, and the 8.625s trade at 60 as well. There's actually only about $175 million of the 8.625s remaining, so they are buying back more than 20 percent of that issue. Another slow motion restructuring. The stock appears to be roughly half owned by retail; and most of the institutional holders are index funds.

Hovnanian (HOV) Prices Share Offering at $2

"Hovnanian Enterprises announced today that it priced its previously announced offering of 25,000,000 shares of its Class A Common Stock at $2.00 per share..."

That was priced 7 percent below today's close. Great for the bonds/stock trade.

"Hovnanian Enterprises, Inc. Announces Proposed Public Offering of Class A Common Stock"

"Hovnanian Enterprises, Inc. announced today the commencement of a registered underwritten public offering of Class A Common Stock. The offering is anticipated to consist of the issuance of 25,000,000 shares of the Company's Class A Common Stock. [...] The Company intends to use the net proceeds of the offering to purchase certain of the Company's senior unsecured notes in a private transaction and for general corporate purposes, including the refinancing, repurchase or repayment of indebtedness, working capital needs, capital expenditures and expansion of the business."

Good for the long bonds short stock trade...

Hovnanian (HOV) Swaps Shares for Debt

Pursuant to agreements with bondholders, each dated March 26, 2012, Hovnanian Enterprises, Inc. issued an aggregate of 981,302 shares of the Company's Class A common stock, par value $0.01 per share, in exchange for an aggregate of approximately $4.1 million aggregate principal amount of the Company's outstanding 8.625% Senior Notes due 2017.

This bond has recently been trading at around 60.

Saturday

• Barron's: the cash held by its top ten firms equals close to ten percent of the market capitalization of the Nasdaq 100.
• Also in Barron's: Hovnanian is still a total dog; "there has been no information from Hovnanian to support the price rise".
• Tyler Cowen on the elderly: "The real question about our fiscal future is not Republicans vs. Democrats but rather whether any coalition can limit benefits to older people."
• Atlantic on MBAs: "[E]ven 20 years later, the average salary of a class that graduated into a bear market was still lower than those of classes that had graduated into an equity boom..."

Capital Structure Arbitrage Idea (HOV, HOVNP)

I can't believe that basically all the homebuilders survived the crash without having to file for bankruptcy or completely wipe out the equity. Granted, they had to restructure by raising massive amounts of equity and exchanging debt for new equity.

Anyway, realization is dawning once again that residential real estate is still troubled due to massive inventory overhang, especially all the houses that are the wrong type (too big) or built in the wrong places. The SPDR homebuilder ETF (XHB) is down 17 percent year to date.

I notice that the more troubled homebuilders are developing mispricings in their capital structures. For example, the Hovnanian preferred stock (HOVNP) trades at 12 cents on the dollar. That's a market value of 15 million for the 125 million in face value of preferred, which is a deficit of 110 million. Yet the company has a market capitalization of 140 million. That is a pretty glaring inconsistency.

Equity investors are wildly optimistic (as we saw with the worthless stock inefficiency) and therefore a company's common stock price is usually not as realistic a reflection of enterprise value as the prices of more senior securities. I think the most likely outcome with HOV is that both the common stock and the preferred go to zero. That is certainly what the preferred stock and bond prices suggest.

The one downside to a long HOVNP short HOV trade is that the preferred dividend is not only suspended, but also is not cumulative. That means that the dividends are not accruing, although the common stock cannot receive distributions until the preferred dividends are reinstated.

K. Hovnanian Enterprises (HOV) Issuing Stock to Deleverage

After hours, Hovnanian (HOV) announced they are issuing sommon Stock, tangible equity units and senior unsecured notes. Supposedly, the offer will consist of $50 million of common stock; 3,000,000 tangible equity units (each with a stated amount of $25 and comprised of a prepaid stock purchase contract and a senior subordinated amortizing note due 2014), and $150 million aggregate principal amount of senior unsecured notes due 2015.

The company intends to use the proceeds to fund the purchase of their 8% Senior Notes due 2012, 8⅞% Senior Subordinated Notes due 2012 and 7 3/4% Senior Subordinated Notes due 2013 pursuant to tender offers which are being commenced today.

Selling equity securities to fund debt repurchases is a way of deleveraging the balance sheet - increasing equity and reducing debt. The market cap of the company is only ~$350 million, and they are looking to sell quite a bit of equity. This is a pretty clear signal that the company sees the stock as overpriced relative to its debt.

Also, this transaction is a way for the company to batten down the hatches. Missing an interest payment or bond maturity is an easy way to lose your job, and I don't think the market is very good for homebuilder CEOs/CFOs.

Looking at USG Corp (USG)

USG Corp (USG) manufactures gypsum products: wallboard ("drywall"), joint compounds, and so forth. A wallboard panel consists of an inner core made of gypsum (calcium sulfate) plus various binders and additives, wrapped in paper.

Who else makes this stuff? Georgia Pacific, National Gypsum, Temple-Inland, CertainTeed (subsidiary of Saint-Gobain SA), PABCO Gypsum, Lafarge, and American Gypsum (once a subsidiary of Centex, now owned by Eagle Materials).

Also, there is imported Chinese wallboard. Is there anything too heavy and low-value to be imported from China? I guess not.

Anyway, it is sort of a crowded industry, selling a commodity product to customers that are desperate (homebuilders and other construction), and who themselves face weak demand.

For almost two decades, the United States has build far more houses than the levels of household formation would suggest are needed. [If you are a Credit Bubble Stocks reader, I will assume that I don't need to belabor the bearish housing argument.]

I think this is relevant not only to homebuilding but also building products. Think of the wallboard manufacturers. Over two decades they have expanded capacity, adapting to a market that was building hundreds of thousands of extra houses (and other types of unneeded buildings), every year.

USG announced second quarter earnings today and I still like my USG short.

Their trailing 12 months EBITDDAR is only $47 million, versus the enterprise value of $2.8 billion. Interest expense for same period was $175 million.

I question whether USG cash flow can support its $1.95 billion in long term debt (witness the interest coverage shortfall). I don't see how the market can ascribe any serious value to the equity.

Is the market expecting a big homebuilding boom? I don't get it. Buffett owns a big slug of USG but he is notorious for holding on to positions for too long.

One of my investing themes is that the current TTM is going to be a high-water mark for economically sensitive businesses, assuming a double dip where things start getting worse again.

Backlog and Market Cap to Debt Ratios for Major Homebuilders

Following up on posts One and Two about homebuilder ratios.

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

Debt-to-market cap. A measure of the amount of financial leverage.


One thing to keep in mind is that the data not consider off-balance sheet debt, so the amount of debt is understated. The understatement is not necessarily equal - certain builders use more joint ventures to control land. Also, certain builders have more contingent liability for their off-balance sheet debt.

Also, significant numbers of orders in the backlogs will probably cancel. Some builders are better than others at converting the backlog into cash.