The Entire Brookfield Homes (BHS) Short Thesis
Quick Take on BHS
Positives for short:
1. Brookfield's specific market focus exacerbates an already bad situation
- BHS homes had an average selling price of $655k
- A buyer would need a non-agency backed Jumbo Loan / ~250k in equity to
secure agency backed financing.
2. The sales trends are awful (Volumes fell 25% yoy)
3. The margin pressure is awful (Margins shrank ~50% yoy)
4. Backlog shrunk dramatically (50%) yoy to 22% of target volume or 240 of 1050 home target for 2007. Historically backlogs have been 30-40% of the next years revenue (trailing 5 years).
ASSUMPTIONS THAT MAY ACT AS A TAILWIND:
1. The liquidity crisis in the Jumbo Mortgage market could cost BHS quite a bit of it's backlog... and make it very difficult to backfill that backlog
2. The liquidity crisis in the Jumbo Mortgage market will likely reduce sales for Q3 and Q4.
3. Higher Jumbo Loan interest rates will likely put further pressure on home prices. A buyer only has so much money and if more money goes to interest expenses than less money can go towards the principal price of the home. It's a simple equation...
Negatives for short:
1. Brookfield homes is an affiliate of Brookfield Asset Management and Brookfield properties. B.A.M. owns 53% of BHS. Brookfield's revolving credit facility comes from Brookfield Asset Management and therefore
they have a VERY friendly lender... this is perhaps the most problematic part of developing a short thesis for these guys. Three of BHS directors serve as executive officers and/or directors of Brookfield's affiliates (BAM, B-Properties).
THIS SUPPORTIVE GROUP OF AFFILIATES AND FINANCIERS IS PROBLEMATIC TO A SHORT THESIS. - but the rest of the story could support significantly lower prices over the near term.
2. Interest Rate Cuts of 1% increase their FCF (reduce interest expense)
by $4M... so a quarter point cut creates 1M in FCF.
Profile / Markets
62% of BHS sales are booked in the State of California with about 38%
split between Washington DC (32%) or for Other / corporate property
(6%).. The company has 59 spec homes built and manages 33 communtiies.
This is down from 153 spec homes in 2006 and at their target.
Sales & Cancellations Trends:
1.) Revenues / Profits - Last quarter had 155M in rev / 10M in profit vs
~193M in rev / 40M in profits (30M excluding land sales) in Q2 2006.
2.) Average Selling Price for a BHS home was $655,000 in Q2 2007.
This is a 11% decrease from the $739,000 average selling price in Q2 2006.
3.) Volume fell 25% from 1582 closed homes in 2006 to 1159 in 2007
4.) Cancellations: were at 22% in Q2 - consistent with Q1 2007... I'd
expect this number to spike again in Q3.
Gross Profit Margins:
H1 2007 Gross Margins fell to 18% down from 30% in 2006. Given that the
average selling price was $655k I presume the average gross profit
margin per home is $117k.
BHS is financed by Brookfield Asset Management - that is where they're
credit line comes from. THEY HAVE NO INTEREST COVERAGE COVENANTS and
they paid back 40M of their 60M balance in Q2... that should mean they
have a 20M balance on the credit line.
Too bad about the interest coverage covenants - WOULD HAVE BEEN NICE TO
HAVE A TRIP WIRE.
LINKS BHS 10K FILING:
*** Two Price Decline Scenarios ***
A.) If home prices fall 5% - gross margins would be about $85k per house
or 13% gross margins (a 500bp or 30% decline).
B.) If home prices fall 10% - gross margins would be about $55k per
house or 8% (a 1,000bp or 60% decline).
The company believed it would have have FCF of 50-75M ($2-$3 per share)
in 2007. They may buy land or they may buyback stock depending on
whether or not land prices fall substantially / opportunistically.
I think this FCF picture could help lay a case for the stocks trading
range of $20 - $30 per share or 10x FCF (at the cyclical trough... if
you think this is the cyclical trough). If we see BHS lower there FCF
guidance substantially to $1.50 to $2 per share then I think there is a
decent a lower trading range.
BHS Accounting Assumptions
Related to Impairments
They are assuming markets normalize at H1 2007 sell rates & prices for
2007-2008... with a return to 2004 level of sells (1 sell per week) in
2009 at 2004 profit margins... all this seems a bit high.
Brookfield also manages a JV with Standard Pacific (SPF)
Standard Pacific has taken some write downs on that JV but Brookfield
doesn't fell that they need to at this time. They may need to add
capital into the JV because they believe it's value has a LPV of 101% -
so they may need to add 1% more equity to the JV. Not big money.
RIGHT NOW THESE ASSUMPTIONS LOOK A BIT OPTIMISTIC
"Requirements imposed BHS project specific financings require Brookfield
Homes Holdings Inc., to maintain:
- a tangible net worth of at least $250 million
- a net debt to tangible net worth ratio of 2.50 to 1 and a
- net debt to capitalization ratio of no greater than 65% "
Requirements of BHS revolving credit facility with Brookfield Asset
Management Inc. that require BHS to maintain minimum:
- Stockholders’ equity of $200 million [CURRENTLY AT and a consolidated
net debt to book capitalization ratio of no greater than 70%. Refer to
“Management’s Discussion and Analysis of Financial Condition and Results
of Operations — Contractual Obligations and Other Commitments” for