Homebuilders Hammered. Time for M&A?

Home sales in 2006 suffered their steepest decline in 17 years. Is the battered sector headed for consolidation?

by Maya Roney

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Wall Street analysts and housing experts keep calling the bottom in the real estate market, but once again the bottom is falling away beneath them. On Jan. 25, the National Association of Realtors reported that existing home sales dropped 8.4% to 6.48 million in 2006, the largest annual decline in 17 years. Sales for the month of December fell to a 6.22 million annual rate, down 7.9% from December, 2005, and below expectations. Beazer Homes (BZH) added to the gloom when it reported quarterly earnings the same day. Beazer Chief Executive Ian McCarthy said, "we have yet to see any meaningful evidence of a sustainable recovery in the housing market."

Top homebuilders saw their stocks tumble on the news. Toll Brothers (TOL), Ryland (RYL), Meritage Homes (MTH), and Hovnanian Enterprises (HOV) all dropped about 4% for the day. As their profits have been hammered with the housing downturn, homebuilders have seen their stocks fall as much as 40% from their peaks.

Now, experts are wondering whether homebuilders are headed for a wave of consolidation. It's not only because homebuilders have gotten so much cheaper in recent months. It's also because of the structure of the industry. The sector has lots of little players—the top 15 companies build only about a quarter of all the new homes in the country. That suggests that consolidation could lead to more efficiency. "I think you're going to see consolidation overall," says analyst Rob Stevenson of Morgan Stanley (MS). "It's still a very fragmented market."

Deal Time?

What's more, industry after industry has been peppered with deals over the past year, from health care to media to technology. Mergers and acquisitions soared to a record $4.06 trillion in 2006, up 36% from the year before, according to financial information provider Dealogic. A key reason has been the rising power of private equity firms, which doubled their buyouts to $737.4 million in 2006 and accounted for 18% of all deals during the year, vs. 12% in 2005. Deal activity looks likely to heat up even more in 2007 (see BusinessWeek.com, 12/19/06, "Deals of the Year, in a Year of Deals").

Buyout specialists have begun to show interest in the homebuilding sector. Billionaire investor Carl Icahn recently increased his stake in WCI Communities (WCI) to 14.6% of the company's outstanding shares. Icahn, who made a run at Time Warner (TWX) a year ago, says he plans to talk with the builder about how to revive its stock. The Florida luxury homebuilder, which concentrates its efforts in one of the markets hit hardest by the housing slowdown, has seen its stock drop more than 25% over the past year.

The most likely buyers within the industry are the largest homebuilders. Companies with revenues over $13 billion include D. R. Horton (DHI), Pulte Homes (PHM), Lennar (LEN), and Centex (CTX). The next tier of companies consists of Beazer Homes, Hovnanian Enterprises, and Ryland Homes. Over the past decade or so, these companies have made a number of relatively small acquisitions. The top 10 builders by revenue held 23% of the market in 2005, up from 9% in 1992.