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

By: Reggie Middleton | Mon, Dec 3, 2007
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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 The assets that I used for that calculation have now been devalued by 50%, although some of it has been replaced by cash which Lennar is in desperate need of.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):



Reggie Middleton

Author: Reggie Middleton

Reggie Middleton

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