Safehaven | Again, I say, Credibility is the key, Mr. Hovnanian

December 27, 2007

Again, I say, Credibility is the key, Mr. Hovnanian
by Reggie Middleton

Don't think that this is just my quarterly carping and caviling of the CEO of a succcessful 3rd generation family business that has fallen on the ropes. I have a lot of respect for hard won, multi-generational wealth. I really mean that, lot of respect. It is very difficult to become a centi-millionaire while finding the time to instill within your children the principles and drive to continue what you have built. What I am doing quarterly though, is taking note of the significant mishaps of this latest in the generational success story. Ara Hovnanian has fallen on some relatively rough times, like practically everyone in the residential real estate industry. I know the feeling, and I defintiely sympathize. In this particular case though, I truly doubt the CEO's ability to weather through the storm - a storm which he is responsible for turning his ship straight into. As a recap, Hovnanian was one of the first builders to really market their sharp cost cutting through the national press, which I simply thought was laughable in its simplistic attempt to conceal the true results of the effort. Then, I browsed through their financials and the usual due diligence stuff, to see that they have a whole host of problems, most of which are not mentioned in the press, such as:{readmore}

a lot of bad mortgages on the books (I warned of this risk in detail in the first post on my blog),
a CEO that purchased personally at the top of the market with a 100% LTV loan (yeah, that's right) now trying to flip it very shortly thereafter in a down market,
legal issues stemming from overly aggressive loan underwriting, etc.

I glanced at the results the following quarter, and more of the same. I attempt to provide a useful contrarian perspective, one that would have come in handy during the heady, debt driven, purchase boom peak of 2005.

A quick tutorial list that may have guided Mr. Hovnanian elsewhere?

Basically, the gist is that the large scale, capital markets driven, public company home builder model is an accident waiting to happen in a real asset bubble - that is unless you are very, very careful. By human nature, who is very careful in a bubble??? It all looks good going up, but we see how ugly it can get coming down.

And it has a lot farther to go according to my housing value projections (see Okay, I have just recharged the batteries in).

I say all of this because management's credibility is the key to maintaining a relatively stable share price in a turbulent market and adverse macro conditions. Nothing personal, but every time I get the opportunity to gauge this firm's current management, credibility is found lacking and the 70%+ drop in share price seems to concur. Excessive debt and poor performance contribute, of course. We all makes mistakes, but if it happens repetitively, it is a habit and not a mistake. Case in point, the following transcript excerpt from Hovnanian's last conference call. All the man had to to was give a direct answer to the analyst's question. An "I don't know" would have been acceptable to me, particularly because it is most likely the truth. After reading the links above, zero seems like a likely answer as well. Save Lennar's unusually honest (at least at that time) CEO, not many bosses would admit such a thing in public, though.

HOV's most recent conference call transcript excerpt, courtesy of seekingalpha.com:

Ara K. Hovnanian, President and CEO, Hovnanian Enterprises Inc.

Our current plan is not to shrink our footprint, but shrink the size of the foot that's in that footprint, if you will. We just plan to pare down our inventories in virtually all of our markets.

Carl Reichardt - Wachovia Securities

Okay.

Later on in the call:

Wayne Cooperman - Cobalt Capital

You wrote off a lot of stuff this quarter and you still have a $19 book value. I was wondering if you could actually opine what I should take that to mean. I mean, does that imply that you should earn some kind of return on that $19 book value, or you could sell all the rest of your assets and we could get $19? Because your stock's at $7 and something doesn't make sense.

J. Larry Sorsby, Executive VP, CFO of Hovnanian Enterprises

The stock is too cheap.

Wayne Cooperman - Cobalt Capital

Seriously, though, what does $19 mean to me? I mean, are we going to earn a 15% return on that $19 book value? Are we going to keep selling assets that are now at the same price we've written them down to?

Ara K. Hovnanian

Well, as I am sure you are well aware, Wall Street has not been kind to homebuilders. Many are selling below book value and --

Wayne Cooperman - Cobalt Capital

[They believe] in the book value. You guys just wrote off a lot of stuff. The $19 is now your kind of -- what you would think accurate book value, or at least that's part of the question.

J. Larry Sorsby

What you are really asking us to do is make a projection and as I think we've made it pretty clear, we are just not in a position that we are going to make a projection.

Wayne Cooperman - Cobalt Capital

I don't even want a projection. I just wonder if you could just talk about what you guys see as the -- what's embedded in that? Do you think you could sell your assets for what you've written them down to or do you think they are written to a level where you actually earn a return on them?

Ara K. Hovnanian

If you are planning on a 15% return on $20 of book value, I wouldn't bank on that at this moment. Fifteen-percent ROE is for normal times. We are not in normal times, so I say if that's your benchmark, I wouldn't count on that for the short term.

J. Larry Sorsby

Yeah, when the market recovers, which it ultimately will do, we'll get back to earning those kinds of returns. But when we are still in a cyclical correction or downturn, it's difficult to approach a 15% return and that's about all we can say at this point.

Ara K. Hovnanian

Yeah, I mean obviously when the markets were better, we were earning in excess of 40% returns on our after tax, on our beginning equity. Fifteen-percent we kind of consider a more normalized part of the market. And then when you are in a trough of the market, you'd expect to earn below that for sure.

Wayne Cooperman - Cobalt Capital

The other -- I mean, would you guys expect to sell off more raw land or assets and get close to your book value and pay down debt that way?

Ara K. Hovnanian

No. I think generally speaking, the most logical course right now is to continue building and selling homes. We think that maximizes value and cash flow. As opportunities arise on land sales or potential joint ventures, we are certainly going to explore those as well. The main focus and certainly the main thrust is continuing to build through the housing and we think that maximizes the recoverable dollars that we've got invested.

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

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