Description

With TARR, I believe you are buying a growing homebuilder for 6x earnings and getting a real-estate division worth $15+/share almost for free. Importantly, management (who owns almost 50% of the company) recognizes that the sum-of-parts is not valued appropriately by the markets and is looking at ways to unlock value. I believe the company could spin-off the homebuilder, and the stock is worth $35-45/share.

Background:

TARR is a homebuilder that specializes in the development and marketing of residential communities in high-density, urban locations. Additionally, the company has an investment division that owns and operates a portfolio of approximately 14,000 apartments and 1.3 million square feet of commercial space. Tarragon's operations are focused in Florida, Tennessee, the Northeast and Texas. Management is principally based in New York.

Historically, the focus of the company was its investment division. However, TARR has spent the last few years ramping up its development portfolio (both new development and condo conversion) of real estate projects and has invested in the people and corporate overhead necessary to do so. Today, the company has a highly profitable homebuilding business, with a backlog and pipeline of over $3 billion. The company believes that it has an expertise and reputation for working with local governments and independent specialty project developers.

A recent example of a company project is in Hoboken, New Jersey. TARR is the official redeveloper of the Hoboken Northwest Redevelopment Zone, which represents 5 residential projects in Hoboken currently selling or in process, comprising 700 apartment units with a selling value of approximately $250 million. Additionally, there are another 8 projects in the pipeline for completion in 2007 and beyond.

Management is strong and shareholder oriented. They have been in the real-estate industry for decades, and Bill Friedman (Chairman/CEO) has been at the helm since he took over the company in 1988. Since then, he has grown the share price from under $1 to today’s levels. Along the way, the company has consistently bought back stock when the market mispriced the company. Management owns almost 50% of the company (over 50% before adjusting for the convert).

Earnings & Valuation:

TARR's numbers are just starting to break-out with fully taxed projected results of $2.50 share expected for calendar 2004 and $4.00/share in 2005. This compares with $1.80 in 2003 and $0.32 in 2002. The dramatic rise in EPS is due to the acceleration/maturation of the homebuilding division, a strong real estate market as well as the company's ability to handle sales from multiple projects at once (for which the associated overhead was put on 12-18 months ahead of time).


Homebuilding 2001 2002 2003 2004 2005
Revenue 26.0 26.2 153.9 275 500
Gross profit 4.1 -2.7 30.0 65 124

Investment
Revenue 93.9 122.5 124.1 134 145
EBITDA 46.3 60.7 59.0 63 70

EPS $0.04 $0.32 $1.80 $2.50 $4.00


Calendar 2005 results are based on consolidated sales of approximately $500 million, which should be higher in 2006. Furthermore, this revenue level highlights the company's pipeline of projects at over six years, giving strong visibility for future years results.

What makes TARR particularly interesting as an investment opportunity is its less visible investment division, which should generate $63MM of EBITDA in 2004 and close to $70 MM in 2005. However, due to depreciation and interest charges the division does not generate meaningful GAAP income. In the current real estate market (mid-teens EBITDA multiples), the company believes the division is worth close to $350 mm (after subtracting associated debt and minority interests). Thus, with 21 mm fully diluted shares, the investment division alone could be worth almost $17. As another point of reference, appraisal value of the real-estate in the division (less debt/claims) was ~$15/shr in the 2003 10k.

While I do not expect the company to initially get more than a 5 to 7 multiple on its homebuilding division (it is smaller and younger than the majors), this would yield a value of $20 to $28; for a total combined potential value of $35 - $45. Over time, I believe this range can come up as the company’s homebuilding division executes and gets earnings growth and multiple expansion into 2006.

Lastly, I believe management (who are large shareholders) understands that the company is not getting credit for its investment division and is considering ways to highlight this value. I believe this includes the possibility of spinning off the homebuilding division, and converting the investment division to a REIT.

While the stock moved up sharply after the company provided 2005 guidance, I believe we’re still in the early innings here.

Catalyst

1. Demonstration of earnings acceleration in homebuilding division
2. Potential spin-off of homebuilding division and REIT-conversion of investment division
3. Potential acquisition target by a major homebuilder looking to increase its urban exposure