Pulte Homes & Centex Merging

Pulte/Centex to Create Largest U.S Homebuilder

The boards of directors at Pulte Homes Inc. (PHM - Snapshot Report) and Centex Corp. (CTX) have approved a merger agreement that will combine the companies in a stock transaction valued at a current equity market capitalization of $3.8 billion. This merger would create the largest U.S homebuilder based on more than 39,000 homes closed in calendar year 2008, which easily exceeds the 23,915 homes closed by former leader, D.R. Horton, Inc. (DHI - Analyst Report).

Terms of the Deal

Centex shareholders will receive 0.975 shares of Pulte common stock for each share of Centex they own. Based on the current share price, Centex shareholders will be receiving more than a 20% premium for its shares relative to yesterday’s closing price. When the transaction closes, Pulte shares holders will own approximately 68% of the combined company and Centex shareholders will own 32%.

Rationale

Pulte Homes believes that combining the two companies will help it navigate through the downturn and accelerate its profitability. By purchasing Centex, Pulte will have greater exposure to the first-time homebuyer market, which it plans to complement with its strength in the active adult and move-up markets. Pulte expects efficiency gains and other savings should generate cost reductions of approximately $350 million within 3 years of the transaction closing, with $250 million coming from overhead and $100 million from debt expense relief.

Industry Impact

Let’s try to put it all in perspective. The homebuilding industry has been going through a vicious downturn. Housing starts have fallen from almost 2.273 million units to the current level of 583,000 units, which represents a decline of 74%. Housing prices remain under pressure, especially in the previously overbuilt markets, such as Las Vegas and Miami. Heavy incentive use is still necessary to move volume.

Home inventories remain too high relative to sales. In our view, over the next 12 months, tighter lending standards and the weak U.S labor market decreases the pool of available buyers more than low mortgage rates and improved home affordability draw in new applicants.

In a market environment rewarding companies with a strong balance sheet, we believe an industry transaction adding leverage without significant cash flow generation potential appears unlikely. Generally speaking, there is the major risk of adding too much debt and land to an acquirer’s balance sheet, especially if homebuilding demand conditions turn progressively weaker for a longer-than-expected period of time.

Given our continued negative view on the housing market, we are not confident that today’s merger news sets off an immediate wave of acquisition activity. We believe consolidation is more likely after the cycle turns up. The potential cost savings synergies and greater bargaining power with suppliers and sub-contractors will still be there for potential partners.