Is Builder Merger Mania Returning?

Since Lennar’s deal to acquire U.S. Home last spring, there has been a long void in home builder acquisition activity. But the cork just popped out of that bottle.

Recently, K. Hovnanian Enterprises, a public company headquartered in Red Bank, N.J., and Washington Homes, another public home builder headquartered in Landover, Md., announced an agreement to merge. And that came on top of the announcement that The Drees Co., a private Giant from the Kentucky suburbs of Cincinnati, is negotiating to acquire Zaring National Corp., a public builder headquartered in Cincinnati.

Does this mean that merger mania is back? Should we look for a new onslaught of consolidation, especially among the biggest of the big in home building?

"I wouldn’t necessarily read that much into these deals," says home builder stock analyst John Stanley of UBS Warburg. "Zaring has been on the market for a long time (since February 2000). Hovnanian and Washington are just trying to develop enough critical mass to get on the radar screen of investors. The recent rally in home builder share prices probably helped the Hovnanian-Washington deal come together, but I don’t think it had much to do with Drees and Zaring."

In fact, the Drees deal for Zaring is complex enough that it might not come together at all. "I’d say the chances are somewhat north of 50% that we’ll actually get it done," says Drees president David Drees. The two companies have agreed to negotiate exclusively with each other until Sept. 30 in an effort to agree on definitive terms.

They are close in size, but not in financial health. Drees ranks 40th on PB’s Giants list with $377.8 million in 1999 revenue on 1,734 closings. The firm is thriving in the long business expansion of the past decade. Zaring ranks 48th with $314.3 million in 1999 revenue on 1,251 closings, but is far less robust, thanks to Wall Street’s ill treatment of small-cap builder stocks. Zaring also has faced some money-losing operations, especially a manufactured housing company, Homemax.

Under terms of the proposed transaction, Drees would acquire all outstanding shares of Zaring at a price per share equal to 1.2 times adjusted book value on Sept. 30. Adjustments to book value would include deductions for operations that Drees does not intend to acquire, losses incurred in connection with the disposition of Zaring markets and expenses incurred by Zaring in consummating the transaction.

The sticky property in the whole deal is bound to be Homemax, the North Carolina manufactured housing operation Zaring acquired several years ago. "Homemax has never made money, ever, and we want no part of it," says David Drees. "We have the option to sell it to Allen Zaring personally, and we’ll exercise that right the day we close on Zaring National Corp."

Industry insiders say Zaring is an extremely weak company in desperate need of a strong suitor, and many attribute the weakness primarily to Homemax. "Zaring’s banks recently curtailed the firm’s credit lines, severely," says one industry analyst who refused to be quoted by name. "The manufactured housing operation is the primary reason. They never should have hung on to it as long as they have."

Drees’ acquisition proposal involves a two-step process. First, Drees would acquire Zaring’s assets in the Raleigh, N.C., market for $12 million in cash on or before Sept. 30. Thereafter, Drees would acquire the rest of Zaring in a merger transaction in which Zaring’s public shareholders would receive cash in an amount equal to 1.2 times adjusted book value.

Drees has home building operations in Cincinnati, Cleveland and Dayton, Ohio; Washington, D.C.; Raleigh; and Dallas and Austin, Texas. Zaring has operations in Cincinnati and Dayton; Indianapolis; Louisville, Ky.; Nashville, Tenn.; and Raleigh and Charlotte, N.C.

"We still have not made a final decision on which of those divisions we want," says Drees chairman Ralph Drees. "Zaring is making money in Cincinnati, and they operate at a higher price point in that market than we do, so their Cincinnati operations are attractive to us. We also think the Indianapolis market is strong. We’d like to be there."

Meanwhile, K. Hovnanian’s acquisition of Geaton DeCesaris Jr.-led Washington Homes will further entrench Hovnanian in East Coast markets where the firm is already strong. After the merger, Hovnanian will add to its dominance of the New Jersey market, where it is already No. 1, and become the largest builder in North Carolina as well as the second-largest in the metro Washington, D.C., market. Hovnanian has less dominant positions in Southern California; Dallas; Nashville; Huntsville, Ala.; and the Gulf Coast of Mississippi.

In the fiscal year ended July 31, 2000, Washington delivered 2,517 homes for $470 million in revenue. Hovnanian projects record deliveries of 4,400 homes and revenue of $1.2 billion in the fiscal year ending Oct. 31, 2000. The combined companies have a backlog of 3,332 homes, valued at $800 million, and expect to deliver 8,000 homes in fiscal 2001. Last year, Hovnanian ranked 16th on PB’s Giants list, and Washington was 39th. The combined company now has a shot at breaking into the top 10, which Hovnanian hopes will open a few eyes on Wall Street.

"Our two companies are an exceptional cultural and strategic fit," says president and CEO Ara Hovnanian. "... Together we will become a more diverse and substantial company, with shareholders’ equity exceeding $300 million and total assets approaching $1 billion."

Under terms of the merger agreement, Washington Homes shareholders will receive the equivalent of 1.39 Hovnanian class A common shares or $10.08 in cash for each share of Washington Homes. That brings the total purchase price to about $77.4 million, based on Hovnanian’s closing share price of $7.16 on Aug. 25, 2000. Up to 50% will be paid in cash, with the balance remaining (not to exceed 60%) to be paid in Hovnanian common shares.

The merger has been unanimously approved by the boards of directors of both firms.