Tuesday, April 17, 2007

One builder's response to housing sales slump

The Housing Bubble gives us an interesting piece of information:

“Home builder Lennar Corp. has sent letters to its subcontractors in Southern California, Nevada and other states, telling them to cut their prices by as much as 20% and resubmit invoices for work not yet paid for.

“The letters said the subcontractors have a choice of either cutting their invoice prices or being shut out of bidding on Lennar projects for the next six months. In some cases the work has already been completed.”

“‘Basically, they sent a letter out that said as the customers are paying us a lower price for our homes, we must pay you lower price for services,’ said an Orange County plumber with more than 200 employees.”

“‘So they gave us a choice of either reducing all unpaid invoices under current contracts by a percentage that varies from contractor to contractor, but it’s a range of 3% to 20%,’ the contractor said. ‘This is for work that we had already been lowest bidder on and it was ongoing like the fourth or fifth phases of the project. Lennar already demanded a 5% decrease from the previous phase, so this is the second time they’ve come to the well.’”

I would sue on the unpaid invoices from current contracts depending on how much Lennar owed me; it's likely they're going to be reducing their demand for work anyway across the board so it might not be such a big loss if they cut you off right away. That's the problem with being in the home-building business; when there's a massive inventory overhang and demand drops off the cliff, you've got few alternatives. Small builders could turn to repair work and possibly renovation; but I don't think that the business structure of large companies like Lennar could support such moves.

I think that the best course of action for Lennar shareholders at this point would be to liquidate the company. Their latest quarterly balance sheet found at Yahoo Finance shows assets of $12.4 billion and stockholder equity of $5.7 billion. On the asset side of the balance sheet, a good chunk of it consists of inventory and long term investments; if you give those numbers a 30% haircut and wipe out the line item for goodwill(ha!) you come up with revised assets of $9.1 billion approximately. You take those assets, liquidate them and pay off the liabilities of $6.7 billion and you are left with $2.7 billion of shareholder equity to divide up. This way you come out ahead, rather than plugging along until collapsing into bankruptcy. The main wildcard will be lawsuits for shoddy workmanship and possibly fraud.

Update: Morningstar has an analysis of homebuilders which suggests that Lennar is one that is best prepared to ride out the bust. Morningstar says that "
Lennar ... benefits from the fact that much of its inventory and debt is held off the balance sheet in joint ventures in which it shares risk with other parties."

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