More Room Left for Consolidation Among Homebuilding Companies

Despite going through a wave of major deals in the last two years, the home construction industry still has a long way to go before potential dealmakers are slowed by antitrust concerns or a lack of targets, say industry analysts and experts. “My best guess is that there are 80,000 homebuilders in the U.S. with the top 20 companies accounting for only about 30% of the activity,” says Carl E. Riechardt, a construction industry analyst at Banc of America Securities. Riechardt says this means that there is a lot more room for consolidation among homebuilders. “I expect to see the business become more stratified, with the largest companies getting bigger and the smaller builders continuing to take advantage of their niche positions.” The Banc of America analyst adds that it will likely be the middle-tier players who will get squeezed by the increased concentration among the largest companies. “Mid-sized private builders will have increased difficulty competing with the larger publicly traded builders because they lack access to capital and the economies of scale that the giant companies have.” And increased scale is what the industry’s largest players have been reaching for in a spate of recent deals. One merger that has reshaped the leader board among the industry’s largest public companies was the May acquisition of Phoenix-based Del Webb Corp. by Pulte Homes Inc. for $1.8 billion. The merger gives Pulte increased access to the market segment that Del Webb has specialized in – active adult, or retirement, homes. Robert K. Burgess, chairman and CEO of Pulte Homes, said, “This combination raises Pulte Homes’ operations to an entirely new level and provides a vital piece in its strategy of serving home buyers throughout each stage of their lives. With our strong brand names and combined deliveries of 10,000-plus active adult homes annually, we now have a competitive advantage in serving the fastest-growing segment of the home-buying market.” Riechardt says that the combination of Pulte and Del Webb demonstrates the importance for homebuilders to appeal to a broad range of age-targeted consumers. “You can see a strategy emerging where the largest builders want to have their finger in every demographic sector of potential customers.” He adds that Pulte will be able to combine the strength of its homeowner-for-life marketing campaign with the increased exposure to the retirement category that is Del Webb’s specialty. Pulte’s marketing program, launched this year in a national television campaign, is an example of the kind of clout that the largest homebuilders can bring to bear on their sales efforts. The program encourages first-time home buyers to stay with the company for life as they upgrade to more expensive homes. Another strategic aspect of the Pulte/Del Webb deal, according to company officials, is the increased capacity to use each other’s land positions. Pulte has said that it will profit from improved land use efficiency and flexibility by gaining access to Del Webb’s existing land positions in fast-growing markets and being able to accelerate home sales and improve project returns. The combined company also will be able to expand Del Webb’s business into new markets and leverage Pulte Homes’ networks and infrastructure to create accelerated opportunities to further expand the newly combined company’s brand nationwide. Another megadeal among homebuilders occurred when Lennar Corp. snapped up U.S. Home Corp. in May for $1.2 billion. The transaction makes Lennar the fourth-largest homebuilder in terms of homes delivered in the U.S. At the time of the deal Lennar had been the fifth-largest builder, while U.S. Home had ranked eighth. The pact combines Lennar’s strength in entry-level and first- and second-purchase homes with U.S. Home’s might in the mid-priced and active adult segments. The merger also expands the geographic reach of Lennar – which operates in Florida, Texas, Arizona, Nevada, and California – to include U.S. Home’s operations in Colorado, Minnesota, Ohio, New Jersey, and Maryland. One aspect of the deal’s strategic rationale addresses a concern that Riechardt notes is a driving force for many recent mergers of homebuilding companies: access to land. “One of the most attractive assets that can be obtained by these deals is favorable land positions. It is growing increasingly hard to get lot entitlements from local jurisdictions.” At the time of the Lennar/U.S. Home pact, Lennar CEO Stuart Miller had said that a primary motivation for the deal was the opportunity to acquire excellent land positions in lucrative markets. But while the industry is fragmented enough to offset most antitrust concerns that doesn’t mean that homebuilders are free of regulatory constraints. The land use approval process can often be a major stumbling block for homebuilders. “You have to remember that land is the most local of assets. As environmental consciousness grows, the thing that makes many of the smaller homebuilders valuable is the land they own and the building permissions they have secured,” says Sheldon Grodsky, a principal at the South Orange, N.J., securities firm of Grodsky Associates Inc. A third merger that reshaped the landscape among the top tier of publicly held homebuilders was the $77 million purchase of Washington Homes Inc. by Hovnanian Enterprises Inc., which closed in January. The deal adds to Hovna-nian’s strength in East Coast markets and opens up opportunities elsewhere in the country. The combination of Hovnanian, the 16th ranked homebuilder, with Washington Homes, which was ranked 39th, may allow the combined company to break into the ranks of the top 10 U.S. homebuilders. For publicly traded builders like Hovnanian and Washington Homes a strong driver behind merger plans, according to Riechardt, is to reach a critical mass large enough to attract the attention of Wall Street. “Home-builders trade at repressed valuations, so one reason to merge can be to increase access to capital so as to unleverage balance sheets,” he says. But despite a cool reception among large investors, one industry analyst reports that homebuilders are delivering high rates of customer satisfaction to consumers. “In the deals we’ve followed, such as KB Homes’ acquisition of Lewis Homes in 1999, the deals have turned out to be a plus for customers,” says Paula Sorkin, who follows the homebuilding industry for J.D. Power & Associates. Sorkin notes that it is too early to evaluate the results of more recent mergers. One way the consolidation of homebuilders could help consumers is if the larger companies choose to take on more of the mortgage origination business themselves, says Doug Duncan, president of the Mortgage Bankers Association. “A number of the larger builders have mortgage operations, and we could see more going into this business as companies consolidate.” Duncan adds that the largest homebuilders will be able to profit from economies of scale if they choose to enter or expand this line of business. Still, like the homebuilding industry itself, Duncan says that the mortgage business is composed of perhaps as many as 9,000, lenders who will ensure that consumers have many options for purchasing homes. So whether it is activity in the mortgage-issuing end of the business or the actual construction of houses, the homebuilding industry will likely continue to offer opportunities for dealmakers.