Reasons to be skeptical of the Pulte Homes-Centex merger

Posted by: Aaron Pressman on April 8, 2009

Well, say what you want about Pulte Homes (PHM) CEO Richard Dugas but don’t accuse him of buying high. Sure, offering $10.50 a share (in all-stock deal) for home building competitor Centex (CTX) is about $3 a share more than yesterday’s Centex price but it’s less than half what Centex shares fetched a year ago and more like 1/8 of what they traded for at the height of the housing bubble. Centex also has about $1.7 billion in cash – less than the total $1.3 billion initial purchase price. A steal? Not exactly. Centex also had $3.1 billion of debt and a balance sheet filled with cratering real estate and mortgage loans.

Dugas is betting that eliminating overhead in the combined companies to the tune of $350 million a year and a joint cash hoard of $3.4 billion will allow the newly-created entity to withstand the current tough times and flourish when real estate recovers. It’s a big bet that Centex will end up being worth more than the net $1.8 billion of debt Pulte is taking on (after subtracting the cash). And further write-offs could be ahead for Centex’s $3.3 billion of housing projects in development and almost $500 million of undeveloped land (as of Dec. 31).

There’s reason to be skeptical. After all, the homebuilding execs were blindsided by the end of the bubble after notoriously overbuilding particularly in some of the hardest hit states like Nevada and Arizona. Dugas today tells Bloomberg today that he’s “cautiously optimistic” after February’s upturn in home sales. He’s the same guy was seeing “encouraging signs” at Goldman Sachs’ housing conference in February, 2007, of course. Just two months ago, Pulte execs were saying they had too much inventory and now they’re adding everything Centex has, too. And our recent cover story not withstanding, no one thinks real estate prices and sales volumes will recover to the levels of a few years ago anytime soon.

Also, keep in mind that the “price” of an all-stock deal is subject to constant revaluation based on the price of the acquirer’s stock, in this case Pulte’s. At yesterday’s Pulte close of $10.77, the offered takeover ratio of 0.975 shares per share of Centex equals $10.50 a share. But Pulte’s shares are trading down in the premarket. We’ll have to wait for more details on whether the deal includes any adjustments in the ratio based on where Pulte trades (typically known as a collar or floor price).

So is Dugas making the right or is this more homebuilder management folly? Take at it in the comments and I’ll update the post later with more from around the web.

UPDATE1: Morningstar analyst Eric Landry really likes the deal, noting that Centex owns 68,000 lots, many in Texas and the Carolinas, away from the worst-hit bubble areas. He also see the combined companies preserving $1.2 billion of tax benefits Centex has that aren’t carried on its balance sheet. “As a result, Pulte is buying a company for a bit more than half of its adjusted undiscounted tangible book value of about $20 per share,” Landry writes this morning, before the companies’ conference call (and behind Morningstar’s paywall).

UPDATE2: Megan McGrath, an analyst who covers Pulte at Barlcays Capital, said she’s surprised since she didn’t think there would be much merger activity among homebuilders so soon. Broadly, the deal is consistent with Pulte’s goal “of gaining share throughout this downturn. The company expects to be able to generate significant cost savings and combined debt reduction of over $1bn,” she writes, though no change in her “equal weight” (aka “hold”) rating on the stock.

Reader Comments

mlimberg

April 8, 2009 10:24 PM

The only reason to buy Centex is to have a place to hide and blame for the existance of all the bad assests both have hidden for the past 5 years.

Alone or together, both will or would have failed.

This housing thing is far from hitting a bottom. Only "fools" rush in, and the investors that are snapping up the foreclosures are way too early. It will lead to a second wave of foreclosures and drag the housing industry down for the next 5 years... and take the next 10 years to begin to gain, ever so slowly upward again.

Mark

April 9, 2009 1:07 PM

no comment. no one care...
getting the feeling this is just like one of those bank mergers we have been seeing, they haven't end well. 1 big company losing money is better than 2 companies losing money. this is going to be about cost cutting, not first sign of recovery. the construction/sale activity is not going to increase, so there is nothing to gain here for investors.

leslie

April 14, 2009 3:42 PM

Even those called timely when quoted in articles pertaining to the market are not too big to mis-step...Why not do a check on Aubrey Ferrao; Gulf Bay Development, Fiddler's Creek, Naples Florida now. See the Fiddler's Creek Homeowners Blogspot on the internet. There you can discover what has happened to the shining developer. The residents are asking for fees and monies back as the promised amenities and conditions were never fulfilled. The golfers never even got a clubhouse. Their course marketed and sold to buyers as exclusive, private, gold membership has been turned into a public course. There has been near mutiny with talk of hiring attorneys by disgruntled purchasers. The existing residents speak openly about the arrogance, greed, and lack of concern for the residents’ welfare exhibited by Gulf Bay. Their lack of faith and trust in anything Gulf Bay says, does, or say they will do, has continued to be substantiated time and time again in every interaction or attempt to resolve issues. The members and residents feel lied to, cheated and threatened by Gulf Bay Management, CEO and CFO. Times have changed since the interview with Aubrey Ferrao preceding the blog comments in earlier publication. The fiddler's creek homeowner's blogspot is filled with intelligent, comprehensive comments. Fine depiction of smoke and mirrors, bait and switch per their comments. So, who knows the future for Pulte and Centex. Pass or Fail? and where is safe?

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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