Cracks In The Foundation

Beazer struggles coming from both the outside – and inside.

Jarred Schenke

December 1, 2007

It's nearly impossible to find an analyst out there who's bullish on Beazer Homes USA.  Most see a company that will have to struggle through a deepening housing recession that will likely crimp the company's financials through 2008. That's the view of many analysts.

And then there's Vicki Bryan. A senior high-yield analyst with Gimme Credit, an independent research firm, Bryan has become something of a gadfly to Beazer, and she's pulling no punches when it comes to her outlook on the Atlanta homebuilder's future prospects. In fact, Bryan likens Beazer's current situation to a lesson in physics. "A body in motion that falls off a cliff continues to fall off the cliff," Bryan says, adding a chuckle.

She cites a litany of reasons – quality cutbacks in their product; falling inventory values; huge jumps in sale cancellations; accounting errors and the firing of its CFO for shredding documents; federal probes and allegations of wrongdoing that are forcing the company into settlements; and declining market share. And perhaps the biggest obstacle right now: the ongoing fight, as of press time, with its senior creditors over $1.5 billion in debt.

While Bryan falls short of using the B-word as to Beazer's ultimate fate, she sees a very real possibility the company will have to recapitalize its entire balance sheet. "There's a possibility that if the market remains distressed through ‘08, Beazer will have to recapitalizing its balance sheet," she says. "And recapitalizing its balance sheet is failure."

Tightening the screws

Defining the future of Beazer Homes USA is like navigating through a fog. The company – once considered one of Atlanta's most valuable public companies with a share price at more than $60 during its high – has been caught in a near-perfect storm.

The credit crunch nationally has made it difficult for potential buyers to obtain mortgages as banks tightened the screws on lending standards. That has especially hurt buyers with poor to no credit – those who basically made up the sub-prime and Alt-A mortgage pools.  And many of those buyers were looking to purchase their first home, the bread-and-butter of Beazer's market, which are price points in the mid-$200,000 range.

As Business to Business went to press, Beazer was endeavoring to correct past earnings statements dating as far back as 1999. At press time, the company indicated those corrections would amount to less than $50 million.

And more recently, Beazer was among six homebuilders who settled with federal investigators for arranging title insurance companies to pay referral payments to them. The builders, including Pulte Homes Inc. and KB Home, have agreed to settle for $1.4 million, with Beazer anteing $261,000 for its share, according to reports.

Beazer also is negotiating settlement charges involving its mortgage origination unit, which allegedly helped buyers drum up some down payment dollars to meet Federal Housing Association requirements for FHA loans, according to reports. Beazer has guided analysts to expect charges to range from $8 million to $15 million.

Those factors most likely contributed to rumors this past summer that the company was nearing bankruptcy, a rumor executives denied as "scurrilous and unfounded."

In July, Beazer reported its unaudited earnings for that quarter while at the same time, filing papers with the U.S. Securities and Exchange Commission that said the company would be late in filing its actual quarterly report as it conducted investigations into accounting irregularities. Still, the unaudited report was telling: Beazer was reporting a net loss of $123 million on revenues of $761 million, down from revenues of $1.2 billion and net income of $102.6 million during the same period in 2006.

And while Beazer has yet to report year-end results (the company's fiscal year ended in September), it did report nearly two-thirds of all housing orders have been cancelled by customers. (Beazer officials, including CEO Ian McCarthy, declined to comment to Business to Business regarding this story.)

Who could be next?

For some analysts, though, the best that can be said about Beazer Homes USA is that the crystal ball remains murky. "We are not aware of anyone that is near those thresholds [of bankruptcy], including Beazer," says Robert Rulla, a director of ratings agency Fitch Ratings. Rulla believes that Beazer can struggle through 2008 with its working capital and borrowing capacity. And that's hoping that 2008 will be the trough in the housing market blahs.

"If this persists a lot longer and goes deeper, then yes, it will be a different story" for Beazer and other homebuilders, Rulla says.

Every other major homebuilder struggling to turn the tides on the shock of slipping sales and rising inventories, all of which are generating losses, are in a spiraling housing market. Through the second quarter of 2007, Beazer reported its inventory lost $269 million in value. And one analyst says the inventory write-offs may continue until the housing market itself finds a bottom and recovers.

"A lot of what happened at Beazer mirrored what happened in the national market," says Roger Tutterow, a professor of economics at Mercer University in Atlanta. "They are sharing the same pain most homebuilders have. But due to those events, it does raise the perception of risk for the stock."

Once Beazer stated it was going to forego filing quarterly earnings with the SEC, creditors – which have amassed more than $1 billion on the homebuilder – declared Beazer was in default of its loan obligations and threatened to accelerate the repayment schedule. Beazer was in real trouble of having to pay millions back while seeing income losses from the housing crash.

The company fought its creditors in Federal court in Atlanta, claiming it had no requirement under the Trust Indenture Act to file audited reports with the SEC for its secured debt and that the creditors were pushing for a "windfall." By the end of October, Beazer came to an agreement with its creditors, staving off repayment through May of 2008.

Bryan is most critical of Beazer's fight with its creditors, especially for refusing to file audited quarterly reports and an annual report. "They've alienated their only friends in their world, their bondholders," she says. "They have not cured this at all. They have waived accelerating the debt for six months. What kinds of companies pull this crap? It's the companies that are in trouble."

Tutterow was more optimistic, especially in light of recent Federal Reserve rate cuts, which could help the flow of liquidity back into the mortgage market.  And more directly, it could aid in easing Beazer's pain of devaluing inventories.

"With the Fed lowering rates, it's unlikely this alone will jump start the housing market. But what it does do is reduce the carry cost for inventory, which is not insignificant for big homebuilders like Beazer," Tutterow says.

But the value of Beazer's inventories are the foundation by which the company is able to borrow on its credit line, which in turn is its lifeblood in not only the fight against the housing crash, but also the competition among the other major homebuilders.

Despite an operating footprint that stretches from Atlanta all the way to the west coast, Beazer remains a minor player, with just 6 percent residential market share.  By comparison, Centex, D.R. Horton and Lennar have an average of 18 percent. And even KB Homes – another entry-level market builder – commands 12 percent.

That doesn't bode well for Beazer, which doesn't have the balance sheet or monetary cache to trudge against the competition, Bryan says. "Does the market care if Beazer goes away? No."