Wednesday, April 15, 2009

Lennar prepares an 8K spread for investors - but is it enough to quiet critics or whet the wallets of insiders?

Lennar (NYSE:LEN) has been a mover, a shaker, an innovator in the home-building industry, but with the industry in trouble, they have found themselves under scrutiny. They are concerned about their future.

But perhaps they should also be concerned about the future of a share owner-putting a human face on a shareholder.

What if that share owner owned one share of stock, exactly one share of LEN?

What if that person was an orphan in a desolate, drought and plague-ridden village in Africa, whose next drink might be contaminated water, whose next meal was a few days from the last, who was last visited and given a hug several weeks ago? What if?

Every quarter, would (or could) LEN’s managers make a personal report and look that tiny, 100% dependent child and his little sister squarely in the eye and honestly tell them, “We’ve done our best to operate the company and because it’s within our span of control, we’ve done all that we could to disclose because we recognize that you have relied upon our financial statements and disclosures, and out of all the other stocks from which you could have chosen the world over, you have entrusted us with your only, most precious and last bit of capital".

All shareholders’ dependence, hopes, dreams and cash flow expectations over a lifetime depend on the information companies provide. Each share of stock purchased is based on the 100% trust and reliance the shareholder places in the company. Stocks are called “securities” for a reason.

Or is the fiduciary duty of undivided loyalty different for an owner of one share as opposed to a million shares of LEN? How does LEN know that one share is not a test? What if the test share were owned by Warren Buffet?

What if the “$474 Million of recourse debt” fear could be recognized as the opposite, the financial windfall?
What if, hypothetically, all the recourse debt came due and it fell upon LEN? It seems to me, that they would have over $600 Million left from the $1.1 Billion in cash reported. Reported book value would decline by about $3 from $16.34 to still over $13.00. That the assets (ex $1.7B in Landsource Communities Development LLC (LCD)) of roughly $6B from the joint ventures would add, even with $1.9B (ex $1.3B of LCD) of additional debt, rather enhance LEN’s balance sheet. The ex-LCD JV’s sport an estimated 45% debt to equity ratio, a bit more than LEN’s on balance sheet 37.4% net debt to net equity ratio as reported by Morningstar, that’s if the 8K asset valuations are as anchored in reality as the indebtedness surely is.

The above, however, is subject to some potential breaking news on LCD.
Since LCD is a trophy property, now as before commanding premium value, will it stand as a proxy post the reported bankruptcy workout in progress in valuing LEN’s other holdings at least in Southern California? Big Builder Online reports “would indicate based upon LEN’s own bid, a value of $550 million for a land venture that was purchased (from Newhall Land and Farming) for $1 billion in 2005, had a book value of $1.3 billion in 2006, and was valued at $2.6 billion in 2007, when Lennar sold 68% interest in the company to MW Partners, a partnership of CalPERs, CalPERs advisor MacFarlane Partners, and Weyerhaeuser Real Estate Co. A $300 million valuation for the land in the venture would be a figure that executives familiar with current land trends estimate would be closer to market realities.

Allow me to catch my breath. What was once in early 2007 sold to the peerless, astute CalPERs-backed group for $2.6B scarcely two years later may be worth $300MM? That’s a cool $2.3B haircut-minus 88% or if valued at the $550MM, a $2.05 B or 78% dent.

Disclosing more, hiding less

The management team at Lennar decided to be more proactive. They will disclose more and hide less. Seemingly detailed disclosures appear in a recent supplemental 8K filing dated March 31, 2009. A 20-page PowerPoint-like document, action packed with new Joint Venture information is positioned, intended and distinguished by LEN as better way to understand and assign value to shares and attempts to be something of a standard setter in the universe of home building industry financial statement disclosures.

Clues and cues
Board and management can only control what happens within the organization and communicate the same to investors. Management clearly cannot control securities markets. In some respects, though, markets do take important cues from management. Management must recognize at least two forms of investor communication: 1) Information that may positively stimulate a stock price, e.g., good news-- new developments, new sales, and other indications the company is performing well and 2) The opposite--removing or addressing concerns, obstacles, hurdles and impediments to enhance investors’ comfort levels and collective understanding of the company. Kudos are deserved by LEN’s board and management for listening, for recognizing that it alone controls and decides whether to increase the flow of information to respond to analysts’ and investors’ concerns.

Summary of LEN’s recent 8K disclosures

·Based upon LEN’s new information, it appears in the past they initiated substantive actions to protect its balance sheet and shareholders.
·It also makes commendable disclosure of the manner in which it conducts its interests with unconsolidated joint ventures, including a mention that LEN’s internal audit unit monitors its compliance with fiduciary duties to them.
·The financial tables are a step in the right direction although disclosures are not sufficient regarding their off balance sheet, unconsolidated joint ventures.
·For example, the document breaks out the top ten JVs per LEN’s investment; shows 7 of 10 are “land” deals, 6 of 10 are located in Southern California, 7 of 10 are 2004/5 vintage deals, only 4 of 10 reveal recourse debt data, the total JV Equity column is a mystery number and the source of near 70% of LEN’s $474 Million in potential exposure to recourse debt remains uncertain.
·A related issue still waiting to be addressed relates to the nature, timing, consistency, extent, and method of valuation adjustments, if any, and the future compared to the past.

LEN’s share price and some additional investors’ concerns

·LEN has a reported $6.80 per share in cash, yet the stock is only at $8.18 – a slight premium.
·LEN’s is second from bottom in an eight-company* industry survey – whose average share price is 145% of cash per share which would make LEN’s share price $9.86.
·LEN’s reported book value per share is $16.34, yet the stock reflects a 50% discount to same, the lowest in the industry by a wide margin; the above industry average calculated equals 115% of book – which would make LEN’s share price $18.79.
·At the above seemingly attractive entry points, LEN’s insiders have shown a pattern not of acquisition, but rather disposition; there have been scant open market acquisitions, absent three directors and one officer, since 2008.

Smoke signals from Pulte/Centex deal?

Pulte Homes (NYSE:PHM) recent proposed takeover of Centex (NYSE:CTX) is valued at $1.3B – yet Centex has $1.4B in cash on the books.

Control, consolidation and disclosure

LEN’s 30% interest may be inching along, closer to “control” in certain off balance sheet entities by virtue of its managing JV member status in 70% of the JVs or in its role slashing exposure to recourse debt requiring consolidation onto its balance sheet and disclosure. Note - the bankrupt LCD deal above in which Lennar and arms length former unit LNR own a combined 32%, yet combined, have 50% of the vote.

LEN was an innovator in the off balance sheet, joint venture “Land Bank”
LEN appears to have effectively implemented industry-leading advantages from the “land bank” concept. It became a significant driver of LEN’s profits, though with some hedge fund-like characteristics: shielded from competitors’, regulators’ and investors’ eyes, valued to proprietary models with custom-engineered risk, reward, exposure and leveraged protected with unknown hedges and counter parties.

A modest proposal: show investors the bronze, silver and gold linings.
LEN’s 8K filing lists the top 10 joint ventures based on LEN’s investment. A more responsive and reasonable approach might include the top ten recourse debt exposure deals with names redacted. LEN has an exceptional opportunity and challenge to lead the industry and indeed set the standard for public companies disclosure, consistent with its home selling tag line: “Everything’s Included”. It can become the brightest beacon of light in the industry by offering total disclosure of its off balance sheet operations and potential risks, rewards during an unprecedented, historic storm in the industry and economy. Investors are clearly yearning for decisive, tough, transparent decisions at the helm of our leading corporations.

LEN's innovative home purchase incentives $50K; reach record high at LEN
In the first quarter of 2009 fiscal year, LEN reported increasingly generous incentives, averaging over $50,000 per home. With the same mirror focused on management’s actions with respect to its share price, although LEN shines brightly on its home sales incentives concept, it fades in comparison with similarly creative ways to incentivize existing and potential shareholders. Perhaps LEN may consider a principal-protected or stop-loss securitization for some of these ventures, parsing out the slices of potential risk and reward or simply implement a corporate share repurchase program using a below market price put writing strategy.

Here’s how it looks to me: LEN has responded, with welcome and improved disclosures, but has not yet quenched investors thirst for more. This is something that applies not just to LEN but all public companies. All public companies should begin to address these questions: “What can management and boards do? What are all the tools and ways in which they can help investors feel more informed and comfortable about the stock?” For the ultimate benefit of all the constituencies that LEN’s board and management serve, recognize and deliver a fiduciary duty: individual and institutional shareholders alike, LEN employees in their 401k plan, joint venture partners, creditors and beneficiaries of family investments and related trusts and their regulators, LEN can set a high bar, new standard for disclosure that will help restore consumer and investor confidence. They can begin to lead by example.

* Eight company industry survey company components include DR Horton (NYSE:DHI), Toll Brothers (NYSE:TOL), Pulte Homes (NYSE:PHM), Centex (NYSE: CTX), Lennar (NYSE:LEN), KB Homes (NYSE:KBH), NVR Inc. (NYSE:NVR), MDC Holdings (NYSE:MDC).

The source of the financial statistics provided is Yahoo finance 4/9/2009

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