Murray Stahl’s Horizon Kinetics Comments on TRI Pointe Homes
In 2010, real estate investor Barry Sternlicht capitalized TRI Pointe with $150 million of equity through his Starwood Capital private equity fund. Mr. Sternlicht became Chairman of TRI Pointe and received roughly 39% equity ownership of the company. Given his real estate experience, it is not surprising that he chose a vehicle that will ultimately benefit from a sustained recovery in the residential housing market.
TRI Pointe drew upon the entire $150 million infusion, using the proceeds to acquire lots in California and Colorado. As a result, it expanded rapidly, increasing its revenues from $14 million in 2011 to $247 million in 2013.
While seemingly on a rapid growth trajectory, Mr. Sternlicht chose to accelerate the company’s expansion through the just-completed merger with the homebuilding operations of Weyerhaeuser (Weyerhaeuser Real Estate Company, or WRECO), which closed July 8th. WRECO’s homebuilding operations were considerably larger than those of TRI Pointe, such that in terms of revenues and market capitalization, TRI Pointe has become one of the ten largest homebuilders in the U.S.
The transaction was structured as an equity offering by TRI Pointe for the assets of WRECO, increasing the company’s shares outstanding from 31.6 million to 162.9 million; thus, the market capitalization has just expanded from less than $500 million to $2.5 billion. This could be an important catalyst for the shares, although not fundamental in nature whatsoever. TRI Pointe was rather illiquid, as Starwood owned nearly 40% of the shares outstanding, leaving a float-adjusted market capitalization of under $300 million. The enhanced trading liquidity could eventually attract the interest of the ETF index engineers.
Nevertheless, TRI Pointe is currently priced in a manner reflective only of present earnings power, not of its substantial land bank. That is, investors are unwilling to pay a premium for the vast optionality that exists in the company’s largest market, California. To illustrate, the consensus revenue estimate in 2015, which incorporates the contribution of WRECO, is $2.77 billion. Based on an historical average for the industry, TRI Pointe should manage to earn a profit margin of perhaps 7.9% in a reasonably robust housing market. This would create $219 million of net income, and a $2.6 billion market capitalization using a 12x p/e multiple. This is only slightly higher than the current pro forma market capitalization of $2.5 billion.
However, homebuilding activity in California is still 74% below the normal average in that state. A return to a normal level would entail construction activity more than three times the current rate. As over half of TRI Pointe’s land lots are in California, an eventual recovery in this market would have a great impact on its earnings. Moreover, broad construction levels in the U.S. are still well below normal levels. The addition of WRECO exposes TRI Pointe to other markets as well, such as Washington D.C. and Texas. The company therefore is positioned to participate in a much broader recovery.
Yet, given the fact that this presumed expansion in the company’s earnings cannot be precisely estimated, this optionality is being discounted by investors at a very high rate. To evidence this, based on the company’s own projections, WRECO as a standalone entity could produce over $200 million of net income by 2016. If investors were willing to pay a multiple of 12x this estimate, the resulting market capitalization of over $2.4 billion would about equal the current implied market capitalization of TRI Pointe. In other words, at this price one is not paying for the entire TRI Pointe stub business, which should report nearly $500 million of revenues this year.
Importantly, TRI Pointe has the benefit of a key intangible asset that does not appear on its financial statements and thus cannot be traditionally valued. Mr. Sternlicht is an experienced, well known, and serially successful real estate investor. He therefore has access to strategic information within the industry that the average executive does not. It appears that he is using TRI Pointe as a new investment vehicle.
From Murray Stahl (Trades, Portfolio)’s Horizon Kinetics Second Quarter 2014 Commentary.