Description
This is a very simple idea so I will keep it short and to the point.
These are bona fide Senior Notes of Pulte Homes with guarantees from the operating subsidiaries. They are traded on the NYSE as preferreds with face value of $25 instead of $1000 per bond. At the current quote of $17.58 per $25 face, they are trading at 70.3% of face value. The current cash yield is 10.5%.
In contrast to actual preferred equity securities in which dividends can be halted, interest payments on these Notes are contractual and failure to pay them would lead to default. Moreover, these Notes are pari passu with all other Pulte bonds to the best of my knowledge. The Notes also enjoy the benefit of a negative pledge, though Permitted Liens are allowed up to 20% of Consolidated Net Tangible Assets.
Pulte’s upcoming homebuilding debt maturity schedule is quite manageable, with just $338mm of bonds due in 2009 and then nothing prior to 2011. The homebuilding revolver was recently pushed out till 2012.
The company, along with most of its competitors, is now clearly in debt paydown mode for the foreseeable future. This is a positive for bondholders. Meanwhile, bondholders have the opportunity to earn equity-like returns without taking equity risk.
Pulte’s balance sheet is in considerably better shape than many of its peers, especially those with bonds trading in the neighborhood of 70 cents on the dollar.
I believe these Notes make a compelling, though illiquid, investment (average weekly trading volume of less than $1.2mm over the past 6 months). Quite simply, while I expect to see several bankruptcies of publicly traded homebuilders, I think the odds of a Pulte bankruptcy are close to nil. Meanwhile, the distressed trading price of this issue implies the market is discounting a high probability of Pulte filing.
I expect it to take 2 or 3 years for Pulte’s spreads to tighten back to more normalized levels and these Notes to trade back closer to par ($25). Here is a matrix showing IRRs under varying assumptions for time frame and exit price.
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Ultimate exit price…. |
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Implied |
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$23.00 |
$23.50 |
$24.00 |
$24.50 |
$25.00 |
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Exit Date |
|
|
1 yr IRR |
39.7% |
42.0% |
44.2% |
46.4% |
48.5% |
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11/15/2008 |
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|
2 yr IRR |
24.3% |
25.3% |
26.3% |
27.3% |
28.3% |
|
11/15/2009 |
|
|
3 yr IRR |
19.3% |
19.9% |
20.5% |
21.2% |
21.8% |
|
11/15/2010 |
|
|
4 yr IRR |
16.8% |
17.2% |
17.7% |
18.1% |
18.6% |
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11/15/2011 |
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|
|
|
|
|
|
|
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Exit Price % of Face |
92.0% |
94.0% |
96.0% |
98.0% |
100.0% |
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Note that these bonds are callable at par beginning in 6/1/2011. So while it is theoretically possible they could trade above par prior to then, I am certainly not counting on it.
Risks:
Mark to market. While Sr Notes often appear to find a floor around 70 cents, there is no ironclad rule that prevents them from falling below such levels.
Weak covenants. These were issued when Pulte was investment grade.
Spike in long term Treasury yields. This would obviously limit upside, but could be hedged out pretty easily to isolate the credit spread.
Catalysts:
De-leveraging in the coming quarters / years as liquidation of homes and land inventory outpaces reinvestment in new inventory.
At some point in the coming years, the downturn will abate and an upturn will ensue, at which time a lower debt balance and improved prospects for future profits will enhance both investor sentiment and credit metrics. Note the projected IRRs in the high teens even if these Notes do not trade up for another 4 years (Nov 2011). By that time the market should be focused on 2012. Absent a massive depression, I simply cannot envision a homebuilding downturn that began in late 2005 lasting over 7 years (i.e. beyond late 2012) unabated before any signs of recovery are seen.
Catalyst
De-leveraging in the coming quarters / years as liquidation of homes and land inventory outpaces reinvestment in new inventory.
At some point in the coming years, the downturn will abate and an upturn will ensue, at which time a lower debt balance and improved prospects for future profits will enhance both investor sentiment and credit metrics. Note the projected IRRs in the high teens even if these Notes do not trade up for another 4 years (Nov 2011). By that time the market should be focused on 2012. Absent a massive depression, I simply cannot envision a homebuilding downturn that began in late 2005 lasting over 7 years (i.e. beyond late 2012) unabated before any signs of recovery are seen.