A Sneak Peek at the Next Lennar Analysis

I know I said I would have the Lennar report by last weekend, but it has been a monumental task to sift through the mish-mash that was passing as disclosure. I will probably post it tomorrow, or the day after. Here is a sneak peak of what I will focus on.

I have been a little critical of the ratings agencies, and I don't think I have been unfair. Look below to see what I think this formerly investment grade company should have been rated since '05, after consolidating JV's and off balance sheet debt. I know many will say non-recourse this, minority ownership that, blah, blah, blah. Listen, if you are going to book the profits from a vehicle, you should book the liability from said vehicle too. It's real simple. If you can take loss from investment in, or debt towards, a vehicle, it should be reported. I guess those smartest guys in the room at Enron taught the rating agency guys and sell side analyst community very little. Hey, what do I know, I am just a lone, unknown Internet blogger.

Fully Consolidated Bankruptcy Scoring, Including Off Balance Sheet Vehicles
	2005	2006	2007E	2008E
Z-score ( Including JV's )	2.50	2.18	1.59	1.48
Reggie's Debt rating	CCC	CCC	CC	CC

Remember, a score of 1.8 or lower indicates a 72% probability of bankruptcy in 8 quarters.

Now, even as an unconsolidated, standalone entity, Lennar does not look like a good credit risk. Fully consolidated, it is time to pull debt our of Lennar before its too late. Remember, nearly a billion dollars of off balance sheet debt is full recourse, a quarter billion of off balance sheet debt is recourse through reimbursement agreements, $676 million in joint and several recourse off balance sheet debt, plus of course $3.7 billion in non-recourse debt, odd balance sheet. Then there is $2.5 billion in on balance sheet long term debt. Keep in mind that this company's revenues are forecast to be about $6.7 billion (with nearly a billion dollars in annual losses) and its equity market is only $2.7 billion. Despite that, momentum traders have turned this into a commoditized trading vehicle that ignores the fundamentals - pushing the stock up significantly over the last two days, if fundamentals ever came into play to begin with. These guys are trading about $2 worth of debt for every $1 of stock they buy and sell.

Much, much more to follow. See also Lennar Comes Clean! $5.5 billion of off balance sheet debt

Comments

[mike]

Reggie, I am short LEN and I think this will be a disaster but I don't get some of the things you say. (1) Earlier in your blog you once said that LEN will run out of closings in 2 Q's by taking their backlog and dividing. Huh? I don't get it. I mean yes we are seeing an atomic disaster in housing, but you are wrong if you think NO ONE is buying houses. Plus, LEN can discount the homes the way Mr. Hovnanian is doing it. It's gonna be hard and this is a reason that they are in danger of bk, but let's realize that there is a business here after all. (2) The second thing is I don't get how you can refer to reader comments as "non recourse this, non recourse that". I mean, it is NON RECOURSE. Period. In my view, a company has to disclose the JVs it invests in, and the balance sheet of this JV, and the earnings from it, this way we can start to assess whether or not it's likely to go bankrupt, which would cause a loss of the earnings stream (and possibly a writedown of the stake in the JV, which is probably worthless anyway). However, having said all that, if the debt is non recourse, that's what it is. You can't say LEN has 5.5B off-BS debt. It has 2B. That's how I see it.

[mike]

Let me just make an additional point, reggie. Here is where your point might be right: if it is in LEN's interest to prop up JV's, then you can say that it has 5.5B. For example, let's say an investment bank has a hedge fund that it is ashamed to admit is failing, they will finance it to prop it up and keep up appearances. Another example: a restaurant invests in one its franchisees and one of them falters. This is a JV. They will funnel money to the entity to make things look good. So the question you need to answer is: does LEN care if these JV's go bankrupt. My guess is they don't give a S***

[Reggie]

The backlog is the amount of potential money they have in their pipeline. Cancellations are what they lose from their backlog. Quarterly closing are how fast they can actually monetize their backlog. When the backlog drops to a fraction of their quarterly closings, they are in trouble. Suppose you sell five widgets a day (1 person each widget), and you only have 4 people left willing to buy a widget. What are you going to do tomorrow to make money?

If Len discounted homes like Mr. Hovnanian, they would have a $9 share price like Mr. Hovnanian as well. Did you go over the last set of quarterly results for Hov? Their much ballyhooed sales event didn't move that many homes, given their situation.

As for non-recourse, the exclamation should be "Its debt, period!". Like I said earlier, recourse or not only makes a difference when you consider not paying your debt. The fact that it is non-recourse doesn't mean the problems just disappear. If they renege on the debt, they lose the equity or portions thereof, the assets, or portions thereof, the related profit streams - which they book as profit in terms of equity interests on balance sheet but choose to leave the assets (weighs down financial performance metric) and liabilities (just weighs down). This just the $3.5 billion of non-recourse. The also recourse and debt that is effectively recourse, which is about 40% of the debt that they report on balance sheet. That is a lot!

I will post the numbers on Lennar soon, but I believe they are effectively insolvent in a matter of quarters. Think of financial statements in terms of reality, and not GAAP guidelines or annual reports.

Glad to have you here reading my blog!