Description

Lennar Class B shares provide an opportunity for a) investors who want to participate in the homebuilding sector at a discount, or b) those who want to speculate that an activist will be able to close the discount in the next 12 -18 months.

Lennar is one the nation’s largest homebuilders, with sales of $11 billion in fiscal 2016. The company operates in four major segments: Homebuilding is 89% of revenue and Financial Services (6% of sales) which primarily originates and resells mortgage related to Lennar built homes derives most of its sales from Lennar’s new home customers.  Lennar’s other two segments are Rialto an investment manager specializing in foreclosed homes, distressed debt and mortgages, and a multifamily construction operation, which primarily operates through joint ventures.

Lennar Corp. has two classes of stock – the Class A shares  (LEN) are actively traded and the Class B Shares (LEN-B) which have identical economic rights, but have 10 votes per share.  Due to the low trading volumes of the Class B shares (approximately 25,000 shares per day) the Class A shares trade at a significant premium to the B shares – currently around 20%.  For investors who are willing to sacrifice liquidity, LEN-B offers an opportunity either as a straight long position or hedged with the Class A shares.

Prior to the great financial crisis, Lennar’s Class B shares sold at a single digit discount to the Class A shares.  The discount widened dramatically in October of 2008 and remained in the mid 20 percent range until recently, when Mario Gabelli’s GAMCO indicated that it had acquired a significant position in the B shares and intends to discuss making the B shares freely convertible into A Shares.

                        Lennar Class A Premium

                                Over Class B

Lennar’s homebuilding segment operates in 17 states and represents 89% of revenues and roughly 80% of operating profits before corporate G&A. The product mix is primarily focused on entry-level buyers and move-up buyers. Prices range from the $300,000s to the $500,000s.  The average price of a Lennar home delivered in 2016 was $362,000 up from $345,000 in 2015.

New home sales in the United States have been in a slow recovery mode since the 2008-2009 financial crisis, but are currently well blow the levels seen in the 1970s, ‘80, or ‘90s, let alone the early 2000s.  Lennar, with its strong presence in Florida was particularly hard hit, but has managed to grow revenues and profits as the economy has recovered.  Low interest rates have helped as well.

Risks 

Lennar faces two obvious macro risks.  Homebuilding has always been a cyclical industry.  A decline in the economy and lower employment hurts demand for housing more than most other sectors.  Housing is also particularly sensitive to interest rates as many first time buyers compare the cost of renting versus ownership. 

Another macro factor that has emerged since the GFC is the reduced level of home ownership in general.  Homeownership peaked at 69.2% of households in 2004 and is currently under 64%.  This is close to the levels seen in the early 1960s, just before the Baby Boomers came into the housing market.  Millenials seem less interested in owning homes than previous generations.  Whether this trend will continue or is just a reaction to the excesses of the previous housing bubble, high levels of student loans and a weak job market is hard to say.  On the positive side, new home purchases have been steadily increasing since the 2011 trough and remain 25 to 30% below the 1 million plus average seen in the 1970 to 2000 period.

Since the Miller family controls 40% of the votes, it is unlikely that the Class B shares will become convertible into Class A shares without their support.  The only real benefit I can see for maintaining the discount is the reduction in future gift/estate taxes it provides for the family.  This may not be an issue if Trump’s proposed tax plan goes through, but I have no basis to handicap the likelihood of tax law changes.  If Gabelli’s proposal fails, I think it is likely that the premium would go back to the mid 20s, an increase of about 5 percentage points.

Capital Structure

Lennar has 203 million Class A shares outstanding and 31 million Class B shares.  The Miller family holds 21 million of the Class B shares, giving them roughly 40% of the votes.  Stuart Miller, age 59 is the chairman and CEO. 

The Class B shares have been in existence since the company went public in 1971. Initially the Class B shares received 90% of any dividends paid to the Class A shares and could only be transferred within the Miller family.  These rights were modified when the company listed on the NYSE in 2003 and class B shares now receive the same dividends as the Class A shares and are freely tradable. The Class B shares are not convertible into Class A shares except that if the Class B shares become less than 10% of total shares outstanding, they will automatically convert to Class A sha  

Summary 

Lennar is a reasonably priced homebuilder selling at approximately 12 times earnings.  Because of the liquidity discount, the Class B shares effectively sell for less than 10 times earnings.  If there is no change in the conversion rights of the B shares, they should provide a reasonable return.  A successful campaign by Gabelli would provide a nice 

Catalyst

There is a shareholder proposal in the current proxy statement to eliminate the preferential voting enjoyed by the Class B shares.  While this proposal will clearly not succeed, it has elicited a filing by Mario Gabelli’s GAMCO which owns 3.5 million Class B shares (11%) indicating the Gabelli intends to discuss making the Class B shares convertible into Class A shares and that Gabelli may put this proposal in the 2018 proxy.  This would allow the Millers to retain control, but would close the gap between the Class A and Class B share prices.