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November 02, 2007

Ryland Homes
by Reggie Middleton

What does Reggie Middleton and Ryland's upper management have in common? They are both selling shares faster than no doc loans get approved!

Originally posted at Reggie Middleton's Boom, Bust & Bling Blog on October 16, 2007.

Okay. I admit, the title is pretty corny - but this blog post is really not that funny either, at least if you're long Ryland. The upper management of Ryland have sold more $33 million dollars of stock in the past year with at least $25 million of that dumped very recently in the last 3 months - right before the quarter reports. Here's another coincidence, despite the fact that the stock has been rapidly decreasing over the last year, none of the management have taken advantage of the opportunity to buy the stock a this cheap price - they have just sold. Hmmm! I wonder if there is something in this upcoming quarterly report that would make you want to dump your shares faster than the cannibal dumped his ex-girlfriend too??? For those of you who didn't laugh - there is this tasteless joke, "What did the cannibal do after he dumped his girlfriend? He wiped his @#$!" You should be laughing now. The reason I am telling corny jokes is to prepare you guys and gals who are long RYL for something that may not put a smile on your face.

Well, first let's take a look at who sold all of this Ryland stock (besides me, of course), then let's make our best guesstimate at why everybody decided to fund their kid's piano lessons right before quarter end (click the graph to enlarge).

Larger Image

Ryland's Bankruptcy Score - Coming out of 2006, it looks like Ryland's Z score fell off of a cliff!

All, or nearly all, of Rylands upper management & insiders have been selling heavily over the last calendar quarter, including senior VPs, directors, the chairman and CEO, and even (former) 10% owners of the company (Jeffrey Gendell has been replaced by Janus Corp. as a 10% owner). Apparently, Janus sees something that upper management and I do not see. To put this in perspective, insiders have (net) sold 2% of total shares outstanding in just 90 days. There is not one share that was purchased by management in this time period, but many were sold.

Other points of interest:

1. Ryland has an increasingly large (and involuntary) spec inventory due to cancellations
2. Seasonally, this should be one of the strongest quarters for RYL, yet the results look to be abysmal
3. In 2006, Ryland produced 11,744 loans totaling $3 billion - which significantly contributed to their bottom line. Look for mortgage financing to be a drag on earnings in the near future due to the credit crunch.
4. Has $85 million in cash, $2.5 billion in inventory and $1.5 billion in debt, accrued liabilities and accounts payable. This is a precarious situation, particularly since they are burning through cash; substantial negative cash flow rate.
5. Tapped credit facility for $75 million last quarter, apparently for the first time this much - nearly as much as they have cash on hand. Although they nominally have much more borrowing capacity, that capacity is dynamically restricted as their credit/cash flow/debt to asset situation worsens, which it currently has and probably will for the forseeable future.
6. In the 6 mos. ended 6/06 the company bought $175 million in stock driving cash flow negative. They did the same in the six months ended 6/07, despite producing a net loss and negative cash flow BEFORE the stock buy back. WHY IS MANAGEMENT AUTHORIZING THE COMPANY TO BUY BACK SHARES FROM NEGATIVE CASH FLOW AND EBITDA WHILE MIRED IN DEBT WITH SO LITTLE CASH ON HAND??? It could possibly be that management really thinks this current stock price is a steal, thus want to grab as much as possible for the company's own coffer??? Yeah, right! And Paris Hilton is a virgin! YET MANAGEMENT ITSELF IS RAPIDLY SELLING SHARES, directly into the company's share repurchase program! SHAREHOLDERS NEED TO TAKE NOTE. Stock based compensation is only 14% to 24% (max, giving them the benefit of the doubt) of the amount of shares purchased by the company. Management had the company buy back $60 million worth of shares and management sold $30 million of shares into the buy back program. It appears that management's interests are not totally aligned with that of the shareholders. If I were to subscribe to the conspiracy theories lurking around many of these blogs today, I would be led to believe that management is trying to prop up the price of the stock through Company's own resources via a share repurchase program. Naaaaahhh! Couldn't be. They wouldn't do that. Because of they did, it would benefit them over their own shareholders as they dump their stock. The buyback of stocks may prop up share price in the near term, but destroys value in the long term, reference my blog post on this topic.
7. At the rate RYL is burning cash, they will run out of money in 3.91 months, or just about the beginning of next quarter.
8. Cash burn should be increased significantly if and when RYL runs out of finished homes to sell and will have to start construction to monetize the land that they have in inventory to produce more salable homes. This is an industry wide problem, and not endemic to just RYL, but they will have no choice but to do so in order to continue as a going concern.
9. A potential sign of desperation: "In an effort to increase liquidity, (finished housing) models have been sold and leased back on a selective basis for generally 3 to 18 months. The Company owned 72.0 percent and 78.3 percent of its model homes at June 30, 2007 and 2006, respectively."

Insider Sales

The following table summarizes the Company's purchases of its own equity securities during the six months ended June 30, 2007:

(in thousands, except share data)
PERIOD	TOTAL NUMBER OF SHARES PURCHASED	AVERAGE PRICE PAID PER SHARE	TOTAL NUMBER OF SHARES PURCHASED AS PART OF PUBLICLY ANNOUNCED PLANS OR PROGRAMS	APPROXIMATE DOLLAR VALUE OF SHARES THAT MAY YET BE PURCHASED UNDER THE PLANS OR PROGRAMS
January 1-31	45,000	$ 54.42	45,000	$ 199,139
February 1-28	270,000	54.64	270,000	184,386
March 1-31	580,000	45.19	580,000	158,175
April 1 - 30	-	-	-	158,175
May 1 - 31	160,000	44.92	160,000	150,988
June 1 - 30	210,000	41.34	210,000	142,307
Total	1,265,000	$ 46.86	1,265,000

On December 12, 2005, the Company announced that it had received authorization from its Board of Directors to purchase shares totaling $250.0 million. During the six-month period ended June 30, 2007, approximately 518,000 shares were repurchased in accordance with this authorization. At June 30, 2007, there were no remaining shares available for purchase in accordance with this authorization.

On December 6, 2006, the Company announced that it had received authorization from its Board of Directors to purchase shares totaling $175.0 million, or approximately 3.1 million shares, based on the Company's stock price on that date. During the six-month period ended June 30, 2007, approximately 747,000 shares were repurchased in accordance with this authorization. At June 30, 2007, there were approximately 3.8 million shares available for purchase in accordance with this authorization, based on the Company's stock price on that date. This authorization does not have an expiration date.

I foresee things turning around for Ryland in the second half of 2009 (using proprietary methods) & the company as stable by 2012, assuming the real property markets do not veer significantly off of my projected track. This is also assuming Ryland is around for the next 8 quarters. If one didn't know any better, one would assume that the insiders have their doubts. Here are some visualizations of Ryland's metrics as I have calculated them.

Revenue Growth: Except for Texas, negative till 2nd quarter of '08. Despite the fact Texas is performing better from a revenue perspective, it may be hard to actually make money in TX. We shall see.

Gross Margins: Single digits till 2011

Gross margins (excluding impairment and write-downs), % - still in the single digits till 2011

Cancellation rates are going to get worse before it gets better, so we might as well get use to it.

Not only will profit from mortgage origination drop, it might actually drag the company further into the negative if they get stuck with some bad loans on the books.

Debt to capital looks to increase for several quarters. I think the company is playing a dangerous game with the share buyback program. Hey, management! Instead of trying to make the shares look more valuable, why don't you plow the funds back into the operation to actually make the shares... well, more valuable!

Hence, the z score bankruptcy analysis. As you can see, it looks like Ryland fell off of a cliff here. While they are not in the guaranteed bankruptcy area, they are definitely well entrenched in the "at risk" portion, and hoveing right above the high risk of bankruptcy. I forecast them getting out of it in 8 quarters if they right the boat by acting prudently, ex. aligning management and shareholder interests, halt share buybacks, etc. Then there is the unknown of the market. My estimations may very well be too conservative if the banks get more aggressive than I forecast in dumping their REOs.

Reggie Middleton
http://boombustblog.com/

Reggie Middleton is the personification of the freethinking maverick--the penultimate nonconformist as it applies to macro strategies, investment, and analysis. He uses his background and knowledge in new media, distributed computing, risk management, insurance, financial engineering, real estate, corporate valuation, and financial analysis to pursue, analyze, and capitalize on global macroeconomic opportunities.

Finding most available research lacking, both in quality and quantity, Mr. Middleton assembled his own talented research staff. As forensic research is a lynchpin for his own investing, "to actually put food on the table," he stands behind it as doing what it is supposed to do - illustrate, elucidate and educate.

He does not sell advice or research. He is an entrepreneur who exists outside of mainstream corporate America and Wall Street. This allows him the freedom to do things that many cannot--perform without conflicts of interest and corporate politics. He prides himself on developing some of the highest quality, actionable research available - regardless of price. He welcomes any and all to peruse his blog of freely available analysis, opinion and participatory social media; use his custom tools, download files, interact with the community and make critical comparisons from a results orientated perspective. Reggie believes ideas and implementations are improved and fine-tuned when bounced off of the collective intellect of the many, in lieu of that of the few - in essence, a form of collaborative open source financial analysis.

Visit his blog Boom Bust Blog.

Copyright © 2007-2008 Reggie Middleton

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