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December 03, 2007

Lennar's 50% Haircut Does Not Make Them Look Any Better
by Reggie Middleton

Now that I have had a chance to actually go through what Lennar's transaction is about, I have a lot more to say. Here goes...

From WSJ.com:

Lennar Corp. has sold about 11,000 home sites to a venture mostly owned by the real-estate arm of Morgan Stanley for $525 million, a large land sale that signals that investors have begun to pounce on bargain deals.

The sites -- in 32 communities in areas hit hard by the housing downturn -- were valued on Lennar's books at $1.3 billion as of Sept. 30. The low price the venture paid is a vivid sign of how land values have plummeted with the downturn, precipitated by defaults on subprime mortgages and tightening credit that have led to a broader slowdown in sales.

I could have sworn Lennar's CEO was just in the news saying they were going to mothball properties (sit on them) until the market turns. Maybe I was imagining it. My Voodoo post alleged Lennar was borderline insolvent. This recent news item simply reinforces that, and brings them closer to that insolvency. The assets that I used for that calculation have now been devalued by 50%, although some of it has been replaced by cash which Lennar is in desperate need of. Hence, they have now just about arrived at full balance sheet insolvency, yet have pushed cash flow insolvency back another $525 million. I got the 50% number in lieu of the 60% number published in the media because Lennar recieved 20% equity ownership in the venture that they sold the company to, and retained 50% voting rights and rights of first refusal for reacquisition at market prices, which should have an optionality value of about 3%.

BUTTTTT!!! This is the kicker, now we can mark their current inventory holdings to market, at about 50% of what was reported in their financial statements (see the links below for detail on how to see through this). Not to pick on Lennar, the other builders are holding the same inventory, depending on geograpic location, of course. Running this through my fully consolidated Lennar model (the one built for the Voodoo post that consolidated a lot of the hidden off balance sheet debt and assets), let's see what we get...

First off, we apply our market mark of 50% to raw land, work in process, an investment in unconsolidated entities (we'll put a much smaller mark on the finished sites, but valuation looks bearish in many areas). We also put the mark on goodwill (which in this situation is really Bull@#$@), and we'll leave the other assets category alone for the most part to give them the benefit of the doubt. Financial assets (mortgages, Lennar did $10.5 billion last year) in the categories of "held for sale", "held for investment" and "held to maturity" (notice how this number increased, denoting a problem selling them) will get the same haircut E-trade got, which admittedely is a gross generalization, but if anything is conservative since the E-trade MBS assets were likely far superior to Lennar's (who assuredely got quite aggressive pushing mortgages to move their difficult inventory) with an average FICO of 720 and 50% of them rated AA or higher.

The result??? For Q307 we have $6,277,501,000 in total assets and $5,315,821,000 in total liabilities. The net equity divided by total shares outstanding gives us a book value per share of $6 (hint: the builders have been trading at a deep discount to book value - Shhh! Keep this on the down low). For the next fiscal quarter, using the model's projections, you get negative equity, or insolvency as I predicted in the voodoo post. The good (okay, the better) news is that Lennar has pushed off cash flow insolvency for a year and marginally improved their Z scores with this deal. According to the new cash infused Z scores, they have bought themselves an extra year before bankruptcy. Since it appears many home builder investors either don't know about Lennar's off balance sheet shenanigan's and inventory valuation games or don't care, they may actually get away with trading at $15 to $20 per share while actually being insolvent. Hey, Enron got away with it at $90 per share, at least for a while.

For those who haven't been following Lennar in my blog, here is a quick update on their situation in full and explicit detail (for those that thought the Voodoo post was too bearish, recent events bring much more to light):

• Voodoo, Zombies, Lennar's Off Balance Sheet Accounting and Other Things of Mystery & Myth
• Straight Talk From the ex-Homebuilder CFO: Yes.. straight from the Lennar CEOs mouth... land has zero value...
• Straight Talk From the Homebuilder CFO: The tricks builders use to disguise the true losses on their book value
• Straight Talk From the Homebuilder CFO: The Coming Land Recession, Pt I
• Straight Talk From the Homebuilder CFO: The Coming Land Recession, Pt II
• Straight Talk From the Homebuilder CFO: How independent are the independent auditors?

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

Who am I?

Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I am definitively outside the box - not your typical or stereotypical Wall Street investor. I work out of my home, not a Manhattan office. I build my own technology and perform my own research - in lieu of buying it or following the crowd. I create and follow my own macro strategies and am by definition, a contrarian to the nth degree.

Since I use my research as a tool for my own investing to actually put food on my table, I can stand behind it as doing what it is supposed too - educate, illustrate and elucidate. I do not sell advice, I am not a reporter hence do not sell stories, and I do not sell research. I am an entrepreneur who exists just outside of mainstream corporate America and Wall Street. This allows me freedom to do things that many can not. For instance, I pride myself on developing some of the highest quality research available, regardless of price. No conflicts of interest, no corporate politics, no special favors. Just the hard truth as I have found it - and believe me, my team and I do find it! I welcome any and all to peruse my blog, use my custom hacked collaborative social tools, read the articles, download the files, and make a critical comparison of the opinion referencing the situation at hand and the time stamp on the blog post to the reality both at the time of the post and the present. Hopefully, you will be as impressed with the Boom Bust as I am and our constituency.

I pay for significant information and data, and am well aware of the value of quality research. I find most currently available research lacking, in both quality and quantity. The reason why I had to create my own research staff was due to my dissatisfaction with what was currently available - to both individuals and institutions.

So here I am, creating my own research for my own investment activity. What really sets my actions apart is that I offer much of what I produce to the public without charge - free to distribute and redistribute, as long as it is left unaltered and full attribution is given to the author and owner. Why would I do such a thing when others easily charge 5 and 6 digits annually for what some may consider a lesser product? It is akin to open source analysis! My ideas and implementations are actually improved and fine tuned when bounced off of the collective intellect of the many, in lieu of that of the few - no matter how smart those few may believe themselves to be.

Very recently, I have started charging for the forensics portion of my work, which has freed up the resources to develop the site to deliver even more research for free, particularly on the global macro and opinion front. This move has allowed me to serve an more diverse constituency, which now includes the institutional consumer (ie., investment turned consumer banks, hedge funds, pensions, etc,) as well as the newbie individual investor who is just getting started - basically the two polar opposites of the investing spectrum. I am proud to announce major banks as paying clients, and brand new investors who take my book recommendations and opinions on true wealth and success to heart.

So, this is how I use my 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. I have included a more in depth bio at the bottom of the page for those who really, really need to know more about me.

Visit his blog Boom Bust Blog.

Copyright © 2007-2008 Reggie Middleton

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