September 18, 2011 - 10:40pm EST by
2011 2012
Price: 10.31 EPS $0.00 $0.00
Shares Out. (in M): 187 P/E 0.0x 0.0x
Market Cap (in $M): 1,928 P/FCF 0.0x 0.0x
Net Debt (in $M): 2,151 EBIT 0 0
TEV ($): 4,078 TEV/EBIT 0.0x 0.0x

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This write-up builds on cmn3d's detailed piece on US housing generally.  For those interested in betting on a housing recovery, I believe LEN/B is a particularly attractive, albeit not terribly liquid, way to do so.


Lennar is the 3rd largest homebuilder in America.  There are two classes of common stock - Class A (ticker LEN) and Class B (ticker LEN/B).  This write-up is focused on the Class B shares.  LEN/B shares are currently trading at a 25% discount to LEN. 


According to page 111 of the 10-K, "The only significant difference between the Class A common stock and Class B common stock is that Class A common stock entitles holders to one vote per share and the Class B common stock entitles holders to ten votes per share."  CEO Stuart Miller controls ~68% of the Class B stock according to the proxy statement.  Because of the super-voting status of the Class B shares, Miller controlled ~46% of the total votes for Class A and Class B combined.  Given that the vast majority of Miller's holdings are in LEN/B and not LEN, and given the super-voting status of LEN/B shares, one could argue that LEN/B ought to trade at a premium to LEN, not a discount.


However, some discount is warranted as LEN is quite liquid while LEN/B is not.  Over the past year, LEN has traded on average 4.5 million shares per day to LEN/B's 30,000.   The current 25% discount to LEN is just about the widest it's been in the last 12 months.  Since LEN/B shares started trading publicly in April 2003, the discount has averaged only 12%.  That average shrinks to just 7% if we exclude the last 36 months. 


If the current discount were to shrink back to 7%, that alone would provide a 24% lift, holding the price of LEN constant.  To the extent that both LEN and LEN/B increase as housing rebounds, the 24% lift would be multiplicative.


LEN/B shares are trading at just 74% of tangible BV.  Note that another $3.20 / share of deferred tax assets do not show up in BV.  While the PV is worth less than $3.20, it is clearly worth far more than 0.  This is particularly true for Lennar relative to many of its peers.  Lennar's DTA is now far smaller on a relative basis and will therefore be utilized and monetized far sooner, especially since Lennar is currently profitable.  If we were to conservatively value that DTA at $2.00 per share, then LEN/B is trading at just 64% of adjusted TBV / share. 


LEN/B's valuation of 74% of TBV (before DTA) represents a sizeable discount to the comps.  For instance, DHI is at 1.21x; PHM is at 1.05x; KBH is at 1.10x; TOL is at 1.04x; RYL is at 1.02x; MDC is at 0.93x; SPF is at 1.38x; and MTH is at 1.14x.  Some discount to the comps was reasonable a few years ago at the time of maximum pessimism for Lennar.  At that point, the extent of Lennar's potential liability related to the insolvent LandSource JV was still unclear at the time and Barry Minkow's Fraud Discovery Institute had just issued a report in January 2009 in the wake of Madoff suggesting that Lennar was a Ponzi scheme.


While many of the homebuilders are very similar to each other, I think there are 2 main aspects to the company that set it apart from most of the other publicly traded builders - JV/deal structuring prowess and Rialto.


Obviously, Lennar would be a cleaner story if it never had any JVs to begin with.  But given the presence of them, I certainly would prefer to have Miller and company negotiating them than just about anyone else.  The team has made substantial progress to date.  The total number of homebuilding and land JVs has been reduced from 261 at November 2006 to 36 at May 2011.  Similarly, the number of JVs with recourse debt has been reduced from 94 at November 2006 to 13 at May 2011.  The amount of gross recourse JV debt has been reduced from $1,764mm at Nov 2006 to $162mm at May 2011.  Pages 62-63 of the 10-Q shows that the JVs with the $162mm of gross recourse debt have $2,189mm of total assets at May 2011.  They also have $57mm of reimbursement agreements from JV partners on those JVs.  The remaining JVs have been substantially deleveraged, as well.  JV debt to total capital is now down to 32% on average.


And several of the largest and most material JVs for Lennar seem to have been resolved particularly favorably.  In July 2009, LandSource emerged from bankruptcy, freed of the crushing load of bank debt that had been used to finance a huge $707mm cash distribution to Lennar in Feb 2007.  Lennar had to invest $140mm of new equity as part of the resolution, giving Lennar 15% of the new equity in the now deleveraged entity called Newhall.  But more importantly, while Lennar did have to "invest" that $140mm, I viewed this outcome as a tremendous win considering the $708mm cash distribution in Feb 2007 did not get nullified, reversed, etc.  Then in early 2011, Lennar's large Heritage Fields El Toro JV extended the maturity of its debt until 2018.  Lennar even recognized a gain as part of the debt was extinguished in connection with the extension.  Given this track record in restructuring troubled JVs, perhaps the company should trade at a premium to the comps on account of its JVs, not a discount!


To the earlier point about Lennar's prowess in structuring and resolving JVs, simply compare the advantageous resolutions of LandSource and El Toro to some of the competitors.  Transeastern brought down Technical Olympic and South Edge / Inspirada has really ravaged KBH.


Minkow has also been largely discredited at this point.  A July 21 sentence handed down from a federal court in Miami granted Lennar recently a $583mm judgment against Minkow.  He was also sentenced to 5 years in prison for his role in a stock manipulation scheme.


While Lennar clearly binged on too much land in the bubble days, it was also among the first to read the writing on the wall.  As the downturn began, they slashed home prices farther and faster than the comps to offload as much as possible.  While they were criticized for this early on as it hurt their margins, Miller suggested that the industry was in for a long downturn and that the first sale is the best sale in such a case.  Lennar was also among the earliest and most aggressive in selling off land earlier on in the downturn, not only to remove the future impairment risk but also in order to harvest tax losses and bring in cash tax refund $ as soon as possible.  In fact, this was the genesis of LandSource, which was recapitalized in Feb 2007, delivering a cash distribution to Lennar of over $700 million.  Similarly, Lennar sold a large portfolio of land to Morgan Stanley Real Estate at the very end of its fiscal year in 2007, netting Lennar $445mm of cash.


Lennar has been pragmatic, not only via the land sales.  Lennar issued $276.5mm of 2% converts struck at $27.64 per A share on April 27, 2010 as the nearing expiration of the tax credit pulled forward demand and got investors excited about the industry.  Lennar also issued $446mm of 2.75% converts struck at $22.13 per A share in November 2010 (versus $13.80 current share price on the class A shares). 


Rialto makes Lennar somewhat unique among the homebuilders.  (TOL's Gibraltar business is much smaller.)  This is Lennar's distressed real estate investing arm, headed up by Jeff Krasnoff, who previously led LNR.  LNR was founded in 1990 to buy distressed real estate out of the S&L crisis.  LNR was also an early and big player in CMBS.  It was spun out of Lennar on Oct 31,1997, by which time it was producing over half of Lennar's earnings.  LNR was then sold Feb 3, 2005 near the top of the market to Cerberus.   Needless to say, LNR was a massive homerun for Lennar. 


Lennar's 8-K filing on Feb 11, 2010 has a detailed slide presentation, the last 1/3 of which is focused on Rialto.  It also summarizes the history of LNR, providing some fodder for those bulls who want to "dream the dream" on Rialto.  I also recommend Wells Fargo's May 2, 2011 note for a more conservative deep dive on Rialto.  While the quality of current earnings from Rialto is admittedly lower in the early years, I think the optionality and potential ultimate value creation is quite attractive.  While I certainly wouldn't expect Rialto to be a homerun on the scale of LNR (the S&L crisis produced some truly unique fire sales of assets), it has the potential to be spun out over time like LNR was as the platform continues to be built up.  And one can make that argument that a fund management business should get a higher multiple of earnings than a homebuilder.


Despite all the progress made in offloading land, Lennar is still very long on land.  On the basis of LTM closings, Lennar still owns 8.7 years worth of land, and controls another 0.9 years via JVs.  Though in fairness, this calculation quickly comes way down when closings start to rise again. 


I think that Stuart Miller is appropriately focused on increasing shareholder value at Lennar given his 12% economic interest in the total company (both share classes combined).  Bob Toll at TOL and Larry Mizel at MDC have large stakes in their companies, but I think Lennar wins out on this point as well.  Bob Toll appears closer to retirement than Miller, which is understandable given he is 70 years old while Miller is 54.  Larry Mizel is 68, and while he seems intimately involved today at MDC, he doesn't appear to have as impressive and deep a "bench" as at Lennar.


In summary, I believe LEN/B is an attractive way to play for those wanting to get long housing.  It's trading at a discount to the comps today, and also boasts the optionality of and potential future "sizzle factor" of Rialto.  Whereas, historically, Lennar traded at a premium to the comps as the management team was considered to be one of the savviest in the business.




Homebuilding debt leverage levels are on the higher end of the non-distressed comps.


Long land position; impairment risk to the extent the market worsens from here.


Overweighted to Florida.


Rialto has been converting distressed loans to REO at a faster pace than I had expected.  While these are theoretically marked to market when converted to REO, there hasn't been too much REO monetized as of yet to give greater comfort in the conservatism of such marks.




Housing market sustains improvement.


Housing market sustains improvement.
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