Description

Intro

The 9.75% MHO-A preferred trades at 50% of par, yields 20% and is well-covered by real estate inventory. A return to near-par in three years offers >40% CAGR. Like all homebuilders, MHO has shed inventory since the bubble popped. Unlike many, however, MHO's clearance sales generate positive cash flow and significant debt paydown. MHO-A does have one awful feature -- it's non-cumulative -- but recent insider buying which I detail later alleviates my concern in this area.

The Company

MHO started in Columbus Ohio in 1973, survived the rust belt depression in the late '70s and early '80s and eventually expanded into the Florida, North Carolina and Washington, DC markets. It's a conservative family company run by the founder's son, who has been with MHO since 1991. I encourage you to read Rosie918's March '07 MHO common write up for background information.

MHO has been more aggressive than most at selling down inventory and slashing debt. Perhaps the Ohio market's early crash (2003-04) gave them a head start, or perhaps they're just very risk-averse. Either way, these actions may harm common shareholder valuation but they virtually guarantee MHO's survival. Debt at the start of 2007 was primarily a 410m revolver and 200m of 6.875% bonds not due until 2012. They reduced the revolver to 255m by 9/30/07 and my current calculations put it at 70m (!!) pro forma for recent asset sales and anticipated 50m tax refund. I think they want this balance at or near zero as soon as possible so they can hunker down and ride through the trough without any untimely bank intervention.

Valuation

Real estate inventory dominates the 9/30/07 balance sheet:

Inventory 1111
Def Tax       73
PP&E          37
Other         134
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ASSETS  1354

Revolver    255
2012 bond 200
Payables    100
Misc debt    50
Other          97
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LIABS      702

On 10/30 management said Q4 sales would bring the revolver balance below 200m. At year end they announced:

1. They sold their entire West Palm Beach operation for 45m (50% writeoff)
2. They sold 3200 other Florida lots for 37m (50% writeoff)
3. They expect a 50m cash tax refund in Q2

These transactions reduce the revolver an additional 132m, to roughly 70m. That's a remarkable reduction from the 410m balance a year ago, demonstrating management's laser-like focus on survival. (Note that 93m of this reduction came from the savvy issue last spring of the very MHO-A preferred I now recommend). Here is my rough 12/31/07 balance sheet, pro-forma for the above transactions and tax refund:

Inventory  850
Def Tax      23
PP&E         37
Other        110
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ASSETS  1020

Revolver      70
2012 bond 200
Payables      80
Misc debt    50
Other          80
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LIABS      480

With management clearly focused on survival and debt paydown, I find this asset coverage sufficient for the 100m MHO-A paper.

Ugh Factor

I recoil from non-cumulative preferreds, have never owned one before and may never buy one again. I was only able to overcome my revulsion in this instance by noting that CEO Robert H. Schottenstein owns 62,000 shares in various trusts, including 2000 in each of three "skip" trusts which I presume to be for his grandkids. Most of these shares were bought in 2H07 at prices ranging from 16-20. Outside director Norman Traeger also owns 14,000 shares in various family entities, with recent buys at 14.50. The biggest risk with non-cumulative issues is bad intent, these insider purchases directly address that risk.

MHO-A has the best asset coverage of any distressed paper I've found in the current credit crunch. The company is positioning to survive a deep, multi-year housing slump and has reduced their covenant-carrying debt from 410m to 70m in little over a year. Insider purchases relieve my anxiety about any bad intent on management's part to exploit the repugnant non-cumulative feature. A return to near-par in three years offers better than 40% annual ROI.

Catalyst