Description
Want a quality, growing homebuilder for free? Levitt Corporation ("LEV" or the "Company") is a recent spin-off from BankAtlantic Bancorp Inc. LEV is a real estate development company where the sum of its parts is far greater than the current equity value. At today’s price, you get the Company’s Florida homebuilding operations ("Levitt & Sons" or the "Homebuilding Group") for free. By the way, the Homebuilding Group is worth at least $14 per LEV share.
Cutting to the chase, here are the sum-of-the-parts components:
1) 34% stake in Bluegreen Corporation (NYSE: BXG), a publicly traded company – worth approximately $4.50 per share (after-tax).
2) 9,000 acres of land holdings in St. Lucie, Florida, known as Tradition-- worth almost $19 per share (after-tax) based on fairly conservative assumptions.
These two assets are worth $23.50 per LEV share which approximates the current stock price. The Homebuilding Group, which you get for free, is projected to earn $1.97 per LEV share next year.
Here is a link to a slide presentation on May 3, 2004 from LEV’s website which is helpful for getting the big picture:
http://www.levittcorporation.com/investor/presentations/pdf/2004-05-03_InvestorPresentation.pdf
Value of BXG Investment
LEV owns 9.5 million shares of Bluegreen Corporation, which is primarily engaged in the timeshare and land development business. BXG currently trades at approximately $11.50, implying that LEV’s stake is worth approximately $110 million, or $5.50 per share of LEV. This equates to an after tax value of approximately $4.50 (LEV’s basis is approximately $6.30 per BXG share owned). Because one can short out BXG if so inclined, we have attributed no illiquidity discount to these shares. I may add more detail on BXG in a subsequent post but given that you can short it out if you choose and it’s is a small part of the overall value inherent in LEV, I won’t discuss it in detail in this write-up.
During its recent road show, LEV management strongly hinted that the odds of them adding to the BXG investment were very low. The odds of them disposing of the investment or staying status quo they said were decent.
Value of Core Communities' Florida Land--St. Lucie (aka “Tradition”)
LEV’s primary land asset is approximately 9,000 acres of developable land in St. Lucie, Florida (along Interstate 95), known as Tradition. This land is held in a LEV subsidiary called Core Communities and is separate and distinct from the Homebuilding Group. Core Communities develops master-planned communities. Core Communities recently finished a 4,600 acre development known as St. Lucie West. It has been a major success and the Company has really built a name for itself in Florida.
During the first quarter, LEV sold 294 of the Tradition (the new development) acres for $19.3 million, implying an average selling price of $66,000. As of the end of the quarter, LEV had 1,268 acres of this land under contract to be sold at an average of $77,000 per acre. Substantially all of this land is raw, undeveloped residential land. Core Communities primarily sells land to third parties (e.g., Lennar, Pulte and Toll Brothers have purchased land from Core Communities) and also sells land to the Homebuilding Group. No profit is recognized on the sales to the Homebuilding Group until the ultimate home is sold.
Using a value of $65,000 per acre, the land is worth $18.80 (after-tax) per LEV share based on the following assumptions/inputs:
o Assumed value of land equal to $65,000 per acre (less than last quarter’s average sales price of $66,000 and significantly less than the land under contract to be sold at $77,000 per acre). Note: Management says there is nothing particular about the land that is currently under contract that would cause its value to differ materially from the remaining unsold land.
o LEV owns 4,574 acres of land with a cost basis of approximately $38.5 million. Two-thirds of this land has been improved (and the cost of such improvement is in the basis). For the remaining one-third, LEV estimates that it will cost $7,600 per acre to improve the land before it is sold, or a total of $11.6 million.
o LEV has an option to buy 4,456 acres of land for approximately $80.6 million, or approximately $18K per acre. None of this land has been improved and LEV estimates that it will cost $7,600 per acre to improve this land before it is sold, or a total of $33.9 million.
o We have assumed a tax rate of 40% and that LEV has 19.8 million shares outstanding (after the recent offering—see discussion below). Any SG&A incurred in liquidating the land is assumed to be nominal and offset by a conservative per acre valuation.
Note: The land utilized in the above analysis is “extra” land and does not include 7,000 lots of inventory currently controlled by the Homebuilding Group (about 3 years supply), nor does it include 144 acres of remaining land at St. Lucie West.
For a look at the sensitivity to the per acre value, using land values of $60K, $70K and $80K per acre results in after-tax values per LEV share of $17.43, $20.17 and $22.90, respectively.
LEV anticipates working through this land inventory over the next five to seven years, or 1,200 to 1,700 acres per year. It is difficult to do a DCF valuation because of the value per acre assumptions you have to make out in year six or seven. I am more comfortable looking at the valuation based on a conservative per value based on today’s values. It seems like the assumed appreciation in the land will offset the time the value of money. In fact, LEV’s management has publicly said that they feel that they could sell all of the land at Core Communities at today’s prices if they so desired. However, as Tradition becomes more developed and desirable, the land prices should increase. Having said that, if you assume that the land is sold evenly over the next six years for an average of $80K per acre (i.e., just $3K higher than the land currently under contract for sale) and use an 11% discount rate, you get an after-tax value of approximately $16 per LEV share.
The gross margin on the land sales has gradually improved. Based on a detailed analysis of the land inventory at Core Communities, it appears that the Company is very conservative and front loads a lot of the costs to the initial acreage sold. As a result, the gross margin should improve over time. In fact, the gross margin in 1Q04 was 59% versus 43% for FY2003. The earnings estimates from Core Communities are simply too low—and maybe by a very wide margin. The consensus estimates (consensus being derived from FBR and Raymond James estimates; BB&T is excluded because the report is way off the mark in many respects) for this segment are approximately $20 million for 2004E and $29 million for 2005E. For 1Q04, Core Communities earned $8.7 million and only sold 294 acres. They should sell at least 1,250 acres this year (as of the end of 1Q04, 1,268 acres were under contract to be sold). As noted above, the average sales price per acre in 1Q04 was $66,000. The average sales price for the acreage under contract to be sold is $77,000. I don’t think you need a calculator to do this math.
Secondary Offering and Pro-Forma Balance Sheet
The Company recently completed a secondary offering, raising approximately $110 million of net proceeds, most of which will be used to exercise its option on the 4,456 acres. The remainder of the proceeds was used to pay down debt. Here is a look at pro-forma balance sheet items at 3/31/04:
Net Debt (before offering) $126 million
Plus: Purchase of land under contract $82 million
Pro-Forma Net Debt (before offering) $208 million
Less: Cash from offering $110 million
Pro-Forma Net Debt (after offering) $98 million
Book Value (before offering) $138 million
Plus: Proceeds from offering $110 million
Less: BV of Core Communities $74 million
Less: BV of BXG Investment $72 million
Pro-Forma Book Value of Homebuilding Group $102 million
Note that substantially all of the debt is at the Homebuilding Group level. As noted, the offering proceeds are being used to exercise the land option and to pay down debt. I have not factored in any interest savings from the debt pay down in my analysis.
Value of Homebuilding Group (Levitt & Sons)
Levitt & Sons (the Homebuilding Group) is a homebuilder that was founded in 1929 by William Levitt who is also known as the “Father of suburbia”. Levitt developed "Levittowns" in NY, NJ and PA and has built over 200,000 homes. Today, the homebuilder has a concentration of business in Florida with a focus on the active-adult market (i.e., it is geared towards the 55 year and older demographic). Many of the retirees moving to Florida from the East Coast are familiar with the Levitt brand from the Levittowns. This strong demographic trend of the active-adult market is a wind at Levitt & Sons’ back and it has developed a strong reputation for building these communities.
A high level of visibility exists in the Homebuilding Group’s 2004 earnings due to the existence of a backlog of signed contracts for new home. Levitt & Sons ended the year with backlog of $459 million. Substantially all of these homes will be delivered to the customer, as the Homebuilding Group has historically closed 99%+ of its backlog within 7 to 12 months. This is a result of a high non-refundable deposit required for each home purchase; Levitt & Sons’ typical customer deposits approximately $30,000 on a $231,000 home, making it prohibitively expensive for them to pull out of the deal.
The year-end backlog of $459 million would be an appropriate estimate for 2004 sales if the Homebuilding Group delivered these homes in no less than 12 months. Because most homes are delivered in less time, and because additional homes that are sold early in the year are delivered by year end, the backlog understates expected home sales for 2004.
Historically, the Homebuilding Group’s sales total on average 122% of the prior year end’s backlog. This would imply 2004E home sales of $560 million. The consensus estimate for 2004E home sales is $544 million.
In 2003, the Homebuilding Group operated at a net income margin of approximately 6%. Applying this rate to our 2004 sales estimate of $560 million, we get approximately $34 million of after-tax income from the homebuilding business, or approximately $1.72 per share. It is important to note that Levitt & Sons’ peers operate at a 7% to 9% net income margin, so we should see some improvement in this ratio as management eliminates unnecessary SG&A and leverages expenses over a much larger revenue base. Every 1% improvement in the homebuilding net margin translates to $5.6 million of after-tax earnings (backlog of $560 million times 1%).
For 2005, the consensus EPS for Homebuilding Group is $1.97 per LEV share. This is derived from a consensus 2005E sales estimate of $686 million (up 26% y-o-y) and a net income margin of 5.7%. Similar to the Core Communities analysis, I think the Street estimates for the Homebuilding Group are simply too low. The anticipated upside surprises will likely (hopefully!) attract earnings momentum investors.
So what is the right multiple to pay for the Homebuilding Group? We think that it should command a premium to the homebuilder peer group’s multiple of 8x 2005E EPS for several reasons:
1) Levitt & Sons is growing much faster than its peer homebuilder group, as evidenced by its “book to bill”, or ratio of homes sold in a calendar year to homes delivered in that year. Other regional homebuilders exhibit ratios of about 1.09, whereas LEV’s ratio is currently 2.22. This means that for every one home delivered in 2003, the Company sold 2.22.
2) The Homebuilding Group’s earnings are highly visible as the company closes 99%+ of its backlog and does not build homes on spec. For the typical homebuilder, backlog as a % of forward EPS is 45% indicating a high degree of earnings visibility. For LEV, the backlog as a % of forward EPS is 85% indicating an even higher earnings visibility.
3) The demographics and population trends of Florida clearly indicate that people are moving to the state in massive numbers. According to the U.S. Census Bureau, 330,000 people were expected to move to Florida in 2003, up from 260,000 in 2001. Florida was second to only Texas in number of housing unit additions from July 1, 2001 to July 1, 2002. LEV will also benefit from the location of its land due to the rapid development of South Florida.
4) Levitt & Sons’ customers are not nearly as interest rate sensitive as a typical homebuilder’s customers, as substantially all the company’s customers are retirees. In fact, 40% of the company’s customers pay 100% cash for their homes, making them indifferent to rate movements.
One source of potential upside is the possibility that, as recently reported by the local press, a Fortune 50 company is considering relocating to St. Lucie. The local press also reports that a one other major employer is considering Tradition.
The homebuilding peer group is trading at approximately 8x 2005E EPS. Using the same multiples, the Homebuilding Group is worth $15.74 per LEV share. At 7x, 9x and 10x 2005E EPS, the Homebuilding Group is worth $13.77, $17.71, and $19.67, respectively, per LEV share.
Why the Valuation Gap?
Other than limited coverage and the usual spin-off trading dynamics, the market is misunderstanding LEV. Here’s how: The typical analyst is looking at LEV and saying, “OK, BXG is worth $5 per share so the implied value of the Homebuilding Group is $17.50 per share which is about 7x earnings of $2.50 per share which seems reasonable but not overly cheap compared to the group.” The flaw in that analysis is that the analysts are adding the Homebuilding Group and Core Communities (i.e., Florida land) earnings together and viewing it all as a homebuilding operation. Even the Wall Street analysts seem to miss the distinction. Raymond James arrives at its price target of $25 by applying a 8x multiple to its $2.50 2004E EPS from the combined “homebuilding operations” and adding $5 a share for BXG.
The FBR analyst attempted a sum-of-the-parts analysis but used a price per acre of $50K for the owned land and $70K per acre for the option land. When asked why there was a difference between the values, he didn’t have an explanation and agreed that there should not be much of a difference. In fact, his value for the land per LEV share is $7.67. The owned land alone is worth $9.40 per share after-tax at $65K per acre and then you have another 4,500 optioned acres on top of that worth the same! For what it’s worth, FBR assigns a value of $14 to the Homebuilding Group.
BB&T totally whiffs the analysis and uses a range of $18K to $22K per acre to value the land. I think the analyst must have gotten basis and fair market value confused.
I normally wouldn’t focus so much on sell-side research but it shows how much LEV is being mis-analyzed. Therein lies the opportunity.
Alternate Valuation Approach
Another way of looking at the valuation opportunity is to assign a $15 valuation to the Homebuilding Group (7-8x 2005E EPS) and $4.50 for the BXG stake. At the current stock price of $23.50, this gives a valuation to the Florida land holdings at Core Communities a value of $4 per LEV share. This valuation implies that the land is worth $8,800 per acre ($4 x 19.8 million shares outstanding divided by 9,000 acres). I’ll buy that.
Catalyst
--Market understanding how to value LEV
--Earnings growth well above group average
--Earnings surprises
--Realization of land value
--Fortune 50 company moving to area
--Improving margins in line with group average
--Distribution or disposition of BXG