AV Homes (AVHI)

This company is a mess but it isn’t as overvalued as some of the other homebuilders.  So, I don’t think it’s a great short.

AV Homes develops retirement communities in Florida and Arizona.  It has many problems in Florida since foreclosures keep coming onto the market and depressing local real estate prices.  The 10-K states:

The significant number of home mortgage foreclosures has increased supply and driven down prices, making the purchase of a foreclosed home an attractive alternative to purchasing a new home, although this trend is moderating in the Arizona market. However, due to the judicial foreclosure process in Florida, we believe that foreclosed homes coming onto the market in Florida will be an issue for the near term. The judicial foreclosure process had delayed the initiation of actions in Florida generally and we have begun to experience an increase in foreclosure notifications on homes within our communities within the last several months. We believe this is a broader market trend. Homebuilders have responded to declining sales and increased cancellation rates with significant concessions, further adding to the price declines. The price declines, in some cases, may cause current homeowners, particularly those in our active adult demographic, to delay the resale of their current home, impacting potential purchases of our new homes. With the decline in the values of homes and the inability of many homeowners to make their mortgage payments, the credit markets have been significantly disrupted, putting strains on many households and businesses. In the face of these conditions, the overall economy has weakened significantly, with high unemployment levels and substantially reduced consumer spending and confidence. As a result, demand for new homes remains at historically low levels.

The company’s presentations talk about an impending housing recovery, yet the 10-K paints a different picture.  AV Homes’ existing Florida community has not been selling at a profit.  The local market there may be oversupplied as the company has to compete against existing residents in its community selling their home.  And in the future they will have to compete against the shadow inventory of homes in their community.  It may be a better idea for them to mothball the community until it is profitable to sell homes there again.

One of AV Homes’ key shareholders presumably believes in the company’s prospects in Florida (see press release):

Kelvin Davis, senior partner at TPG, said AV Homes has established a strong platform for future growth. “AV Homes has assembled a strong management team with deep industry experience. The Company is well-positioned to participate in the on-going recovery of the housing market, with real estate assets located in two healthy and growing Sunbelt markets,” Davis said.

I don’t know what they’re thinking.

The CEO

Roger Cregg used to be Pulte Group’s longtime CFO and is currently AV Homes’ CEO.  I don’t believe that he has ever been a CEO of a homebuilder before.  I suspect that he may do poorly as a CEO and may be leading the company down the wrong path.  The company may be wasting money on marketing consultants and unnecessary IT expenses.  These are areas where it is easy to waste money.  The latest 10-Q states:

General and administrative expenses increased $399 or 12% for the three months ended March 31, 2013 compared to the same period in 2012. The increase was primarily due to increased IT and marketing consulting fees, professional accounting services related to the year-end audit, and increased testing required as a result of our new accounting and operational software system in the three months ended March 31, 2013 as compared to the three months ended March 31, 2012.  These increases were offset in part by a decrease in legal fees in the first quarter of 2013 as compared to the same period in 2012.

The bottom line

This company has problems tied to its local real estate markets.  The CEO is unproven.  I question what TPG is doing- why get involved in homebuilders when valuations are high?

However, AV Homes is not extremely overvalued (mainly due to TPG’s investment in the company) so it’s not a great short.

*Disclosure:  No position.

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14 thoughts on “AV Homes (AVHI)

  1. Have you tried to get an idea of what the normalized earnings power for some of these homebuilders is? It’s possible the private equity firms are looking at what they think these companies can earn in a healthier environment and finding that they’re not particularly expensive at the moment.

    For example, AV Homes earned a little less than $20 million in 2003 and about $30 million in 2004. With simple inflation, that implies an earnings power of 30~35 million a year, assuming home construction rates return to what it was in those (somewhat bubbly, but not incredibly so) times.

    • What they will earn going forward will depend mostly on land prices and how well they operate their business. I don’t think that I am any good at predicting future land prices or future housing prices. You may be better at it than I am.

      If there is a housing recovery, AVHI may lag behind because their local market in Florida is oversupplied and because AVHI has been poorly run. The new CEO may do far better than his predecessors. However, it looks like he may be wasting money and making a mistake in not mothballing the Florida communities.

      As far as normalized earnings power go, I don’t believe that homebuilders are entitled to a particular normalized earnings power. There’s no rule in life or government law that entitles them to making money.

  2. Obviously, homebuilders aren’t entitled to any sort of return, nor are any other company (except for certain regulated utilities).

    That said, I don’t think that means that you can’t get an idea of the company’s earnings power in an average (non-bubbly, non-depressed) environment. Assuming that homebuilding is, on average, a profitable industry*, my belief is that you can just look at the most recent “average” environment, look at the company’s ROA**, and get an idea of what profits for the company might look like in the next average environment. For example, in 2003, the company made an operating profit of about $10 million on $362 million in assets, or a ROA of 2.76%. Assuming the company could do the same based on its current assets of $332 million, the company would be able to make a little over $9 million in EBIT, which would at least cover the company’s $8 million in interest expenses in 2012.

    I don’t think such a calculation of normalized earnings power is unreasonable–you don’t need exact home or land prices, you just need to assume that home and land prices will eventually rise high enough that homebuilders can make a profit. I suppose such an assumption does require some degree of housing/land price prediction, but do you really think that this is a difficult prediction to make? In my mind, it seems pretty clear that housing prices have bottomed; it’s a matter of timing to see when they’ll rise high enough to allow homebuilders to start making profits again.

    Along those lines, if you look at the terms of TPG’s investment, you see that most of it is in the form of convertible preferred stock with a dividend that escalates from 8 to 12 to 15% over about two years. TPG can make its 15% rate of return if the company starts to make a return on assets of about 4~5%. Such a rate of return would basically imply a return on future investments below the company’s cost of capital. Thus, given that even a capital-destroying rate of return for the company would still let TPG to make money, I don’t think their investment is as foolish as you make it out to be.

    Of course, the company isn’t making any returns on assets at the moment, but the TPG investment plus current cash minus current debt give the company liquidity for something like 6 years even after the dividend on the preferreds, assuming cash burn rates equal to those of 2010/2011 (2012 seems like an outliner, though I didn’t look into the details too closely; I could be wrong there). Wouldn’t the situation have to be fairly dire for housing prices to not rebound for another 6 years

    In short, I’d disagree with you on a few points:

    1/ I don’t think it makes sense to call homebuilders overvalued at least without trying to get an idea of their average earnings power.
    2/ I don’t think getting an idea of that earnings power requires detailed or difficult assumptions about the housing market.
    3/ Specific to AV Homes, I don’t think you need a high degree of CEO skill to assume a reasonable profit for shareholders; you just need to assume that he won’t actively destroy shareholder value. I don’t think there’s a record of homebuilders consistently doing that (recent bubble notwithstanding), though I could be wrong.
    4/ Along those lines, I think TPG’s investment makes sense under a conservative assessment of a housing rebound. If you assume the company can start making its cost of capital within 3 or 4 years (which is basically a bet that Florida/Arizona homebuilders in general can start making their cost of capital by then), it looks like there could be at least some value for shareholders.

    * As opposed to, say, airlines or something stereotypically unprofitable like that.
    ** Probably a better method than simply looking at net income for that year, given changes in the company’s debt load, etc.
    *** I would define this as 2~4 years

    • I guess we’ll see:
      1- How profitable the homebuilding industry will be. (I’m not good at predicting this.)
      2- How AV Homes will fare relative to its peers. I think that it will do poorly, but I’m not that certain about it and I’m not shorting AV Homes.

      Let’s see how the future turns out.

  3. What’s the deal with the class action lawsuit that’s been filed against AV Homes over the TPG transaction? Not being a lawyer, I don’t understand the nature of the wrongdoing that’s being investigated here. The lawsuit mentions possible violations of state and federal laws. I assume stockholders are getting short-changed here, but don’t understand how.

    • I presume that the lawsuit is suing AV Homes over the price that TPG paids for common stock and preferred shares. The lawsuit might also bring up a $4.7M fee that was supposedly paid to an affiliate of TPG.

      Sometimes law companies will file these lawsuits hoping that the defending company will reach a settlement out of court. Defending against the litigation and winning in court can be more expensive than settling out of court. Sometimes the law companies can win if the judge doesn’t understand that particular area very well. And also, different judges will come to different conclusions. That’s why there are court cases (ones with multiple judges) where the judges reach split decisions.

      • Thanks! But, I still don’t quite get it. I would assume the complaint against what TPG paid for stock is too low or a price not available to other investors? Is the payment of the $4.7 million fee illegal? If yes, wouldn’t this be of interest to the SEC?

      • They might be saying that because much of that $4.7 million fee may ultimately go to TPG, then it’s like a hidden discount on the stock+preferred stock.

  4. Looks like a second lawsuit has been filed against AV Homes, Inc. This one on August 7 by Levi & Korsinsky LLP.

      • I’m sure you’re right. But, can more than one law firm file a class action suit based on the same “complaint”? In other words, don’t these two law firms need to file their claims on different grounds or for different reasons?

  5. The “Google it” idea was a good one. Here’s an FAQ copied from a law firm specializing in class action…
    Q. What happens when more than one law firm filed a lawsuit against the same company for the same conduct?
    A. You should hire only one law firm to represent you for the same claim, and you cannot improve the amount you could recover by retaining more than one law firm. We generally work with other firms and where more than one case has been filed on behalf of a class, the cases will eventually be consolidated by the courts so that the attorneys will work together.

  6. Pingback: Homebuilders revisited | Glenn Chan's Random Notes on Investing

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