M/I HOMES INC MHO.PA
October 21, 2012 - 10:15pm EST by
rosie918
2012 2013
Price: 21.50 EPS $0.00 $0.00
Shares Out. (in M): 4 P/E 0.0x 0.0x
Market Cap (in $M): 86 P/FCF 0.0x 0.0x
Net Debt (in $M): 142 EBIT 0 0
TEV ($): 228 TEV/EBIT 0.0x 0.0x

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  • Homebuilder
  • Preferred stock

Description

I am recommending a long position in the MHO Series A Preferred Shares.  This security is a $100mm issue of 9.75% non-cumulative non-convertible preferred stock.  doggy835 wrote it up back in January 2008, but a whole lot has changed since then.

 

MHO announced that it was discontinuing the dividend when it reported Q2'08 earnings on July 31, 2008.  The last dividend payment was June 16, 2008.  However, I expect the dividend to begin getting paid again in the not too distant future.  When that happens, these preferreds should quickly trade up to $25 or slightly higher.

 

While it wasn't immediately clear from the earnings release at that time, MHO was forced to discontinue all dividend payments because the losses reported with Q2'08 earnings drove the restricted payments basket under its bond indenture into negative territory.  The restricted payments basket has remained in negative territory since that time.

 

However, MHO raised common equity on May 19, 2009 and again on Sept 5, 2012.  This latest common equity raise last month will drive the RP basket back into positive territory as of the end of Q3'2012.  That is why I believe this is a timely idea now despite the rise in the price of MHO preferreds.  This will be the first time since the dividend was discontinued that the bond indenture no longer prohibits such dividends.

 

That said, MHO in the registration statement for the Sept 2012 common equity offering notes that "we have no immediate plans to pay any cash dividends on our common shares or 9.75% Series A Preferred Shares."  Generally the lawyers are very particular about the precise wording used in such documents and I believe that to be the case here too.  Rather than stating that MHO has "no plans", or "no plans in the short term", or "no plans in the foreseeable future", they state that they have no "immediate plans" (emphasis added). 

 

While the plans are not "immediate", I believe that MHO does indeed have plans to start paying the dividend again soon enough.  There are many reasons why.  First, in contrast to others, such as HOV who never paid a common dividend in history, MHO paid a quarterly common dividend until both the common and preferred dividends were suspended in 2008.  (Note that I mention HOV not to pick on them unduly, but because they are another homebuilder that issued a similar preferred at a similar time).

 

Also in contrast to companies to many private equity sponsored portfolio companies across different sectors and even to HOV, companies in which coercive debt exchanges and purchases of deeply distressed debt at tremendous discounts have generated massive "gains on debt extinguishment" ($501million so far in the case of HOV in less than the last 4 years alone), with such income often far exceeding the core businesses' cumulative profitability or retained earnings (negative $1.1 billion in the case of HOV), MHO has never demonstrated such a prior history.  So while the same cannot be said for such other companies, for MHO it would be completely out of character to "take advantage" of its preferred holders to benefit its common shareholders.

 

Moreover, MHO is not in a position of deep distress to the point where there can be any real doubt about whether the preferreds would ultimately have value in a liquidation, wind up, etc.  Ultimately, if the company is ever to be wound down, liquidated, etc, or if these preferreds are ever redeemed or refinanced, the $25 liquidation preference per share will first have to be paid.  That being the case, the only doubt around these preferreds is if and when the dividends start flowing again, not whether the company is in a position to pay them or whether there is enough value beyond the debt to fully support the liquidation preference of the preferreds.

 

While sustained profitability will ultimately provide the best form of "coverage" for the MHO preferreds, the asset coverage today looks strong.  Pro forma for the latest common equity offering, MHO tangible shareholders equity represents 3.18x the preferreds current market value, or a "theoretical P/TBV" for these preferreds of 0.31x, as shown in the following table.  Assuming future conversion of the $57.5 million of convertible bonds only enhances such "coverage".

 

Tangible equity "coverage"

 

 

 

Total tangible shareholders equity

             317.5

Preferreds at Current Market Price

 

               86.0

 

Implied Tangible Equity Coverage of Prefs

3.18x

 

Theoretical "P/TBV" for Prefs

0.31x

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assuming Future Conversion of Converts

 

Converts Face Amount

 

 

               57.5

Plus: tangible shareholders equity

             317.5

 

Tangible Equity PF for future conversion

             375.0

Preferreds at Current Market Price

 

               86.0

 

Implied Tangible Equity Coverage of Prefs

4.36x

 

Theoretical "P/TBV" for Prefs

0.23x

 

Perhaps the best reason to expect that the dividend gets turned back on is that Chairman and CEO Bob Schottenstein owns/controls 74,050 shares of the preferreds via several family trusts -- $1,851,250 of liquidation preference (1.85% of the issue).  This would correspond to $180,497 of annual dividend payments on his preferreds, not to mention additional common dividends on his common stock that could be reinstated once the preferred dividends are.  So it should be in his own best interest to see the dividend reinstated.

 

 

 

 

 

 

 

 

Annual

Preferreds

 

 

Shares

$ Liq Pref

Divvy

Owned by Bob Schottenstein

 

           74,050

      1,851,250

     180,497

Total Outstanding

 

      4,000,000

  100,000,000

  9,750,000

 

% of Total

 

 

1.85%

1.85%

1.85%

 

It seems to me that if he did not expect the preferred dividends to be returning, then he would not be continuing to hold onto them, especially as the price has risen.

 

In summary, I believe it is largely just a matter of time before this paper trades up to or gets refinanced at par / liquidation preference ($25 per share).  What makes the idea timely today is that for the first time in years, the company is no longer restricted from paying the preferred dividends.  So after discussing in every 10-Q and 10-K since Q2'08 the temporary prohibition on dividend payments under the bond indenture due to the negative restricted payments basket balance, this language should no longer be present in the upcoming 10-Q to be filed in early November.  Similarly, I would not be surprised if this gets discussed on the quarterly earnings call scheduled for Thursday of this week.

 

While such dividends may not be restarted immediately, I believe the preponderance of the evidence suggests a restart in the relatively near future.  Now that the housing recovery looks increasingly sustainable and real and MHO is profitable again, and barring a massive increase in interest rates, then once the dividends restart, the MHO preferreds should immediately trade north of $25 and yield somewhere between ~9.5% on a current basis per the table below.  (I think it is unrealistic to expect them to trade significantly over $25 because they are callable at $25).

 

Capital Appreciation Potential

 

 

 

 

 

 

Future Share Price

 

 

$25.00

$25.50

$26.00

$26.50

$27.00

$27.50

 

% of Par

 

 

100%

102%

104%

106%

108%

110%

 

Implied Dividend Yield

 

9.75%

9.56%

9.38%

9.20%

9.03%

8.86%

 

 

 

 

 

 

 

 

 

 

 

Current Price

 

 

$21.50

$21.50

$21.50

$21.50

$21.50

$21.50

 

Implied Appreciation

 

16.3%

18.6%

20.9%

23.3%

25.6%

27.9%

                     

 

At that point, I believe this will be some of the most attractive ~9.5% paper out there, and holders will have also enjoyed some nice capital appreciation to boot.

 

doggy835's January 2008 write up made a convincing case to expect the dividends to be paid, barring the unlikely event of "bad intent" on the part of management to exploit the non-cumulative feature.  While the dividend has been suspended, there has been absolutely no evidence of "bad intent" -- rather, the suspension has been completely out of management's and the board's hands due to the bond indenture.  Given no evidence of "bad intent" to date, nothing in management's or the company's historical behavior to suggest we ought to assume "bad intent", and the CEO's significant ownership in the preferreds, I expect to see the dividend reinstated inside of a year.

 

Meanwhile, I cannot point to a catalyst on the horizon to knock down the preferred shares' price from current levels.  In fact, contrast them to HOV's straight preferreds which have traded up from $0.40 to $10.50 so far despite its extensive past history of taking advantage of its bondholders, its massively negative shareholders equity (negative $482mm of Pro Forma total shareholders equity as of its latest capital raise) and complete lack of asset coverage, it's significantly lower "coupon" at 7.625% vs MHO's 9.75%, and a lack of insider ownership of its preferreds.  Not to mention that MHO has clawed its way back to profitability (with help from common equity offerings to deleverage) and a positive restricted payments basket while HOV is still burning cash and losing money, and its restricted payments basket looks hopelessly negative. 

 

From a relative value perspective, with the market willing to pay $10.50 for the HOV preferreds today, it would be very hard to understand why it should be willing to pay less than the current $21.50 for the MHO preferreds.

 

Thus, while I believe the probability of  the MHO preferreds trading up to $25 inside of a year and then representing some safe but juicy paper in this interest rate environment is high, I also think the downside from here seems pretty limited.

 

 

Risks

"Bad intent" on the part of management and the board, such that the dividend is not restored despite the ability to begin paying it again.  As noted above, this behavior would be both out of character for MHO and contrary to the Chairman and CEO's own best interest.

 

 

Catalysts

 

Quarterly earnings call and upcoming 10-Q note that the restricted payments basket which had been negative since mid 2008 is now positive, so there is no longer a prohibition on dividend payments.  Even if not immediately reinstated, this "tips off" the market that the dividend should be reinstated in relatively short order.

 

 

 

Dividend is reinstated.


I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

Quarterly earnings call and upcoming 10-Q note that the restricted payments basket which had been negative since mid 2008 is now positive, so there is no longer a prohibition on dividend payments.  Even if not immediately reinstated, this "tips off" the market that the dividend should be reinstated in relatively short order.

 

Dividend is reinstated.

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