Midyear Update: Factors to consider for homebuilding finance
By MARGARET WHELAN
Though we are 10+ years into this recovery, and housing starts are still closer to trough levels than peak, it is clear that the market is slowing overall. House price appreciation has stalled while costs still rise, and the lack of availability of skilled labor has made it more difficult for private builders to compete. At the same time, national builders are leveraging their lower cost of capital to drive accelerated growth and take market share by buying smaller builders; other consolidators include the Japanese housing companies and Clayton Homes, which have also been active buyers of late. As rates start to rise, housing affordability will be even more constrained, further crimping sales growth and affordability. Together, all these factors have led to an increase in Mergers and Acquisitions (M&A) as the public builders look to supplement their organic growth with acquisitions of attractive private builders.
As a boutique advisory firm, we offer a highly-tailored, bespoke level of service to our private builder clients, representing their best interests as they look to de-risk, recapitalize, or sell out altogether. Given the length of this cycle, land positions at a low basis are hard to come by and, without home price appreciation, margins are squeezed and returns are falling. However, private builders are still highly regarded, especially if they have deep market knowledge and resources, access to attractive land positions, and employees who are engaged. One reason there has been so much M&A activity is that the competition among buyers is driving multiples higher, allowing sellers to realize higher valuations.
To prepare for a transaction, whether it be raising new capital or preparing a company for sale, we work with our clients through an efficient three-step process that is thorough, clear, and transparent with a goal to realize the lowest cost of capital or the highest valuation available:
1. Investment Positioning
Analyzing the seller’s competitive position and framing the value proposition is the most critical phase of the process; it is also the most controllable. Depending on the client, this phase can be time consuming, though it allows for the remaining steps to be accelerated by supporting a better and more predictable outcome. Most importantly, a thoughtful- ly laid out and well received value proposition should also garner a premium valuation and a lower cost of capital.
Key steps in this stage include reviewing the business model and competitive position to uncover a crisp value proposition, analyzing the historical financials which should be reviewed or audited by a recognized CPA firm, guiding the finance team to establish reliable cash flow forecasting tools, and partnering with management to create high-impact presentation materials to be shared with potential buyers who have signed a non-disclosure agreement.
2. Deal Preparation
In the second step, we leverage our experience and relationships to navigate the logistics of the upcoming transaction. We formulate the marketing timeline and distribution strategy, facilitate introductions to potential partners, and determine the optimal deal structure. To protect their intellectual property, we recommend that our clients set up and manage a multi-stage virtual data room to share information as the conversations progress with each party, and allow access removal once a dialogue concludes.
Based on follow-up conversations with these parties, we solicit feedback and interest levels, and then orchestrate company visits and due diligence. This stage of the process typically takes about 12 weeks as most parties will visit two to three times before presenting an offer; these meetings help the seller to get to know a potential partner and determine if the chemistry will be a good fit.
3. Pricing and Execution
Once the deal preparation phase is completed, we solicit letters of interest and term sheets from interested parties. As markets determine pricing, the best way to know the value of your company is to run a process and to secure a couple of offers at the same time, based on the same company fundamentals. By comparing and contrasting the most important deal terms, we’ll secure the best structure available.
Rather than engaging local real estate counsel, a strong M&A attorney is highly recommended to negotiate the legal documents. From operating agreements to employee agreements and purchase agreements, there are a lot of nuanced and industry related terms that must be accurately positioned. Timing is of the essence as values can shift over time, thus an experienced attorney will work efficiently to stay on schedule.