Historical Results and Commentary
May 11, 2007
Holdings
|
|
11-May |
|
1 |
F |
|
2 |
NBG |
|
3 |
AHL |
|
4 |
NKE |
|
5 |
SAFT |
|
6 |
VRSN |
|
7 |
SNP |
|
8 |
CAT |
|
9 |
INTC |
|
10 |
C |
|
11 |
TOA |
|
12 |
FNF |
|
13 |
MS |
|
14 |
TKC |
|
15 |
HMC |
|
16 |
CRYP |
|
17 |
X |
|
18 |
DOW |
|
19 |
COP |
|
20 |
ACH |
Performance of Individual Stocks For last 3 months
|
11-May |
|
|
FNF |
4.50% |
|
COP |
5.42% |
|
CAT |
16.06% |
|
NKE |
2.73% |
|
SAFT |
-11.28% |
|
VRSN |
2.29% |
|
SNP |
21.24% |
|
AHL |
6.14% |
|
INTC |
6.50% |
|
C |
0.45% |
|
TOA |
-60.60% |
|
F |
-4.12% |
|
MS |
4.48% |
|
TKC |
8.50% |
|
HMC |
-13.77% |
|
CRYP |
-14.06% |
|
X |
32.84% |
|
DOW |
9.86% |
|
NBG |
7.99% |
|
ACH |
27.47% |
Total Increase (Decrease) since last quarter: 2.63%
Additions: None
Subtractions: None
Commentary:
The most noticeable event in the past three months has been the implosion of TOA’s stock price. This was a case of me being half right (probably the most dangerous situation in investing!). I was correct in assuming that the home-building stocks had reached a low in the late summer of ’06, but I was very wrong about TOA. I am haunted by Ben Graham’s counsel to invest in leading and reputable companies. But, rather than going with a market leader like DHI, TOL, or KBH, I went with TOA because it seemed like the cheapest buy at the time. Then, in the fall of 2006, TOA disclosed that it was obliged to take over a failing joint venture and this would materially impact its results1. Basically, TOA had a major potential liability that it had not disclosed to shareholders. As a shareholder in the real world, I joined the class-action lawsuit against these crooks. It was extremely maddening and frustrating to see something like this happen. It is hard enough to win in the stockmarket if the rules are fair, but when companies cheat, it becomes nearly impossible.
Nonetheless, despite the dubious quality of its management, I decided to keep TOA as part of the 20. My rationale was that the stock was still trading at a reasonable discount to the book value of its equity, and even with its joint venture obligations, in time the P/E multiple of TOA and the homebuilding sector would have to rise. My judgment was probably poor at the time, as the discount to book value back in February 2007 was not all that great. However, the following notes show my logic for keeping TOA as part of the index right now. If you can improve on this logic, please email me, as I don’t feel I yet have a good grip on all the factors impacting the stock.
In summary, I believe TOA is currently at a discount to tangible book value of approximately 2.57 times. I think income will stagnate over the next few quarters, perhaps being slightly negative, but eventually the stock price is going to have to rise to correspond with the high discount to book value at which the stock is trading.
The following is a slightly more complicated explanation. As a starting point, the following table show’s some of the relevant statistics for TOA.
TOA’s vital statistics as of May 11th 2007 are as follows:
|
Stock Price |
3.92 |
|
Market Cap |
$233.6 million |
|
Tangible Equity in worse case scenario2 |
$602.4 million |
|
Current Discount to tangible equity |
2.578x |
|
Stock price at book value parity |
10.1 |
So, in the static case, I feel TOA should see its price rise to 10.1 to trade a ratio of 1 of market capitalization to tangible book. However, TOA does not exist in a static bubble, and the dynamic decline of the current housing market is something very important to consider. What is interesting and important to note, is that much of the earnings losses in the past thee quarters have been due to provisioning for the expected settlement of the Transeastern Joint Venture. In other words, TOA’s core homebuilding business, though in decline, is still a viable business in my opinion. For the quarter ending March 31st 2007, operating losses excluding the provisioning for the Transeastern JV were only $14.3 million.
The following table shows what happens to TOA’s operating profit when we take out all the weird BS that has been going on over the last 3 quarters.
|
|
3/31/2006 |
6/30/2006 |
9/30/2006 |
12/31/2006 |
3/31/2007 |
|
Gross
Profit |
154.9 |
171 |
89.6 |
41.2 |
84.2 |
|
SG&A
Expenses |
97.4 |
104.4 |
85.3 |
89.1 |
95.8 |
|
Net Profit (Loss) From Operations,
Excluding Extraordinary Items |
57.5 |
66.6 |
4.3 |
-47.9 |
-11.6 |
From this perspective, the company looks OK. Yes, it is losing money, but if they can work on margins just a little bit, the bleeding can be put under control. However, there are three factors that make me nervous. First, the company’s credit rating is falling, and combined with the new debt it must take on as part of its obligations surrounding the Transeastern JV, interest payments could get nasty. In addition, I have no confidence in the transparency or competence of the management of this company, and it would be very surprising if there were no additional ‘extrordinary’ items that pop up in the company’s balance sheet in coming quarters. Third, I am expecting that TOA will have to make slight write-downs in the value of its inventory, as I fear home prices are going to fall in many of the markets where TOA is active.
Well,
perhaps the final conclusion is that I am stubborn. I have written before that I fear the housing
market in the
1The following is copied from the 1st quarter press release that came out on May 10th, 2007. I have tried to highlight the major factors impacting TOA regarding its obligations surrounding the Transeastern JV in yellow and my commentary is followed in red:
Transeastern
TOUSA acquired its 50% interest in the Transeastern JV on August 1, 2005, when the Transeastern JV acquired substantially all of the homebuilding assets and operations of Transeastern Properties, Inc., including work in process, finished lots and certain land option rights. The Transeastern joint venture paid approximately $826.2 million for these assets and operations (which included the assumption of $127.1 million of liabilities and certain transaction costs, net of $30.1 million of cash). (TOA acquired 50 percent of a doomed joint venture, and acquired some or all of its liabilities in the process) The other member of the joint venture is an entity controlled by the former majority owners of Transeastern Properties. TOUSA continues to function as the managing member of the Transeastern JV through the Company's wholly owned subsidiary, TOUSA Homes L.P.
Upon formation of the Transeastern JV, for the benefit of the senior and mezzanine lenders to the joint venture, TOUSA entered into completion guarantees in which they guaranteed the payment of costs, the payment or bonding of mechanics' liens, and the completion of development activities associated with the completion of real estate projects started as of August 1, 2005, in the event that the borrowers defaulted on such obligations (TOA has ultimate responsibility for any financial problems that the joint venture runs into) (the ``Completion Guarantees''). TOUSA and TOUSA Homes L.P. also entered into Carve-Out Guarantees to indemnify the lenders for any liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, charges, expenses and disbursements arising out of fraud or material misrepresentation by any of the borrowing entities, the misappropriation by the borrowing entities of certain payments, improper use of insurance proceeds, intentional misconduct or waste with respect to the collateral and failure to maintain insurance (the ``Carve-Out Guarantees''). The other member of the joint venture also executed carve-out guarantees, however, if it is determined that the lenders' losses are a result of TOUSA's acts or omissions, TOUSA must indemnify the other member for any damages it suffers under the guarantees. In addition, under the Carve-Out Guarantees if TOUSA, the joint venture or any of its subsidiaries files for bankruptcy protection, TOUSA may be responsible for payment of the full amount of the outstanding loans. As of December 31, 2006, the Transeastern JV had approximately $625.0 million of bank debt outstanding of which $400.0 million was senior debt. The borrowers under the credit agreements are subsidiaries of the Transeastern JV. The senior loans were extended by EH/T Transeastern LLC and the two mezzanine loans were extended by TE/TOUSA Mezzanine LLC and TE TOUSA Mezzanine Two, LLC. Deutsche Bank Trust Company Americas (``DBTCA''), as administrative agent for the lenders claims that it is entitled to exercise its rights under pledge agreements that would allow it to direct the voting of or acquire the membership, equity or ownership, and/or other interests in the borrowers, thus acquiring control of those borrowers. DBTCA has further asserted that if it does so, a voluntary bankruptcy filing or commencement of insolvency proceedings by any of the borrowers, at the ultimate direction of the lenders, would trigger the Company's obligations to repay all amounts due under the credit agreements governing the loans. The Company disputes that a voluntary bankruptcy filed at the direction of the lenders, either directly or indirectly, would trigger such obligations. Copies of the Completion Guaranties and Carve-Out Guaranties were filed as exhibits to TOUSA's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2006.
TOUSA has disputed and continues to dispute these allegations. However, the Company continues to engage in settlement discussions with representatives of the current lenders to the Transeastern JV and with the other member of the joint venture. As part of these discussions, TOUSA has proposed a structure in which either the joint venture or the successor to some or all of its assets would become TOUSA's wholly or majority owned subsidiary. The proposal also contemplates paying the joint venture's $400.0 million of senior debt in full through the incurrence of additional indebtedness. (TOA got screwed to the tune of at least $400 million) In connection with these negotiations TOUSA is evaluating various financing alternatives. TOUSA would require third party financing to facilitate this transaction as well as an amendment to its secured credit facility permitting this to occur. Although TOUSA is in discussions with its banks relative to this financing, there is no assurance that it will be successful or that this financing would be on terms acceptable to TOUSA.
A settlement with the joint venture's mezzanine lenders, if one is reached, could result in, among other things, the issuance of equity and/or debt securities by TOUSA or one of its subsidiaries, including the joint venture. TOUSA is also in discussions regarding the joint venture's obligations with respect to terminating the joint venture's rights under option contracts and any obligations under its completion guarantees and construction obligations. In connection with making the joint venture the Company's wholly or majority owned subsidiary, TOUSA is in discussions with the other member of the joint venture which consider, among other things, releasing potential claims, terminating the joint venture's rights under land bank arrangements to purchase certain properties in which the member's affiliates have interests, and releasing the joint venture from its obligations with respect to certain properties including land bank arrangements. Although to date the interested parties have agreed to extend the rights under the agreements through payment of fees, to preserve the joint venture's rights under the land bank arrangements, or for other reasons, the lenders to the joint venture could cause their respective joint venture borrower to file for bankruptcy at any time.
There is no assurance
that TOUSA will be able to reach satisfactory settlements in these
negotiations. Any settlements are likely to involve the Company having to incur
more indebtedness which could, among other things, increase its debt servicing
obligations and reduce its ability to incur indebtedness in the future (TOA could very well not be able to settle its disputes,
meaning it might have to take the full hit of its joint venture’s liabilities)
While TOUSA remains committed to working with all interested parties to
achieve a consensual global resolution, settlement discussions are ongoing and
the Company may be unable to agree to a settlement with the lenders or other
parties, including obtaining necessary consents and financings. Even if a settlement is reached,
TOUSA cannot predict the outcome of any such settlement, including the cash or
other contributions the Company may have to make in order to effectuate any
such settlement if there is one at all. Additionally, TOUSA may choose to
pursue other strategies and alternatives with respect to the joint venture. If
the Company is unable to reach a settlement and become liable under some or all
of the guarantees, it may have a material adverse affect on the Company's
business and liquidity and defaults under documents governing its existing
indebtedness could occur which may require the Company to consider all of its
alternatives in restructuring its business and its capital structure. (TOA does not know how it will pay off its new liabilities)
During the year ended December
31, 2006, TOUSA evaluated the recoverability of its investment in the
Transeastern JV, under APB 18, The Equity Method of Accounting for Investments
in Common Stock, and determined its investment to be fully impaired. As of December 31, 2006, the Company
wrote-off $145.1 million related to its investment in the Transeastern JV,
which included $31.3 million of member loans receivable and $21.4 million of
receivables for management fees, advances and interest due to TOUSA from the
Transeastern JV. (The joint venture is worthless)
In accordance with SFAS No. 5, Accounting for Contingencies (``SFAS 5''), TOUSA has evaluated whether any amount should be accrued in connection with a potential restructuring of the Transeastern JV as discussed above. Accordingly, as of December 31, 2006, the Company accrued $275.0 million (reflecting its estimate of the low end of the range of the estimated loss as determined by computing the difference between the estimated fair market value of the consideration the Company expects to pay in connection with the global settlement less the estimated fair market value of the business it would acquire pursuant to its proposal).
During the three months
ended March 31, 2007, the Company accrued an additional $78.9 million, calculated
under the same basis, due to changes in the proposed settlement and in the
estimated fair market value of the business it would acquire. The decrease in
the estimated fair market value was primarily attributable to decisions to
abandon the joint venture's rights under certain option arrangements, the joint
venture's delivery of homes during its quarter ended February 28, 2007, and the
continued decline in value due to current market conditions. The $78.9 million
is presented as a separate line item in the Company's consolidated statement of
operations for the three months ended March 31, 2007, and the accrual of $353.9
million and $275.0 million is included in accounts payable and other
liabilities in our consolidated statement of financial condition as of March
31, 2007 and December 31, 2006, respectively. Our estimate of the high end of
the range is $456.8 million, assuming full repayment of the outstanding
indebtedness. Our estimated loss could change as a result of changes in
settlement offers and a change in the estimated fair value of the business to
be acquired. We will continue to evaluate the adequacy of this loss contingency
on an ongoing basis. No assurance can be given as to what amounts would have to
be ultimately paid in any settlement if one can be reached at all. (TOA has provisioned a total of $353.9 million to cover
expected losses from the settlement of this joint venture fiasco. The maximum it would have to provision for
would be $456.8 million, assuming full repayment of the joint venture’s
debt. This represents an increase in
necessary provisioning of $102.9 million)
2Balance Sheet data as of 31 March 2007. My notes below show how I arrived at tangible book value:
|
CONSOLIDATED STATEMENTS OF
FINANCIAL CONDITION |
|
|
|
|
|
|
(Dollars in millions, except par
value) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
31-Mar-07 |
|
With my
additions, looking only at tangible assets |
|
|
|
|
(Unaudited) |
|
|
|
|
ASSETS |
|
|
|
|
|
|
HOMEBUILDING: |
|
|
|
|
|
|
Cash and cash equivalents: |
|
|
|
|
|
|
Unrestricted |
|
$ |
23 |
|
23 |
|
Restricted |
|
|
3.8 |
|
3.8 |
|
Inventory: |
|
|
|
|
|
|
Deposits |
|
|
236.5 |
|
236.5 |
|
Homesites and land under
development |
|
|
853 |
|
853 |
|
Residences completed and under
construction |
|
|
762.1 |
|
762.1 |
|
Inventory not owned |
|
|
296.1 |
|
296.1 |
|
|
|
|
|
|
|
|
|
|
|
2,147.70 |
|
2174.5 |
|
Property and equipment, net |
|
|
29.9 |
|
29.9 |
|
Investments in unconsolidated
joint ventures |
|
|
140.4 |
|
140.4 |
|
Receivables from unconsolidated
joint ventures, net of allowance of $54.6 million and $54.8 million at
March 31, 2007 and December 31, 2006, respectively |
|
|
42.8 |
|
42.8 |
|
Other assets |
|
|
287.8 |
|
287.8 |
|
Goodwill |
|
|
100.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,776.30 |
|
2675.4 |
|
|
|
|
|
|
|
|
FINANCIAL SERVICES: |
|
|
|
|
|
|
Cash and cash equivalents: |
|
|
|
|
|
|
Unrestricted |
|
|
7.2 |
|
7.2 |
|
Restricted |
|
|
3.9 |
|
3.9 |
|
Mortgage loans held for sale |
|
|
37.8 |
|
37.8 |
|
Other assets |
|
|
12.8 |
|
12.8 |
|
|
|
|
|
|
|
|
|
|
|
61.7 |
|
61.7 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
2,838.00 |
|
2798.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY |
|
|
|
|
|
|
HOMEBUILDING: |
|
|
|
|
|
|
Accounts payable and other
liabilities |
|
$ |
627.3 |
|
627.3 |
|
Customer deposits |
|
|
59.3 |
|
59.3 |
|
Obligations for inventory not
owned |
|
|
296.1 |
|
296.1 |
|
Notes payable |
|
|
1,060.80 |
|
1060.8 |
|
Bank borrowings |
|
|
50 |
|
50 |
|
Unprovisioned
Liabilities from the Transeastern joint venture mess in worst case scenario |
|
|
|
102.9 |
|
|
|
|
|
2,093.50 |
|
2196.4 |
|
3 |
|
|
|
|
|
|
Tangible
Shareholder's Equity |
|
|
|
|
602.4 |
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Historical Results and Commentary