Today’s announced merger between Standard Pacific (SPF) and Ryland Group (RYL) will create the nation’s fourth-largest homebuilder, with revenues and market capitalization exceeding $5 billion.
It’s a huge deal for the two companies, as well as investors who are in the market for homebuilders’ stocks. So should investors buy into the new company?
Probably not.
A Look at the SPF-RYL Merger
The two management teams believe they have similar values and ideas, which should make for an easy merger which is planned to close sometime this coming fall.
Shareholders of Standard Pacific will own 59% of the new company while Ryland shareholders will hold 41%. The new firm will have a new name and stock symbol — neither have been announced yet.
The merger would give the new company more exposure to top markets and make it a stronger player. Based on figures provided by Standard Pacific and Ryland, the new company will operate in 41 major metropolitan areas and 20 of the top 25 markets. It would hold a top five market share in 15 of those markets, to boot.
Additionally the new company should have more power at the negotiating table with contractors, banks and landowners. Management also believes the merger will allow for cost savings of over $70 million.
From a number, standpoint the new firm will have more than 74,000 total property, trailing 12 months revenues of more than $5.1 billion, and $2.5 billion in backlog value from the first quarter of 2015.
Lastly, the new company will operate in multiple levels of the housing industry. Currently Ryland sells entry-level home buyers. Standard Pacific sells a more high-end product to those looking to move up the ladder of real estate.
Combining the two companies gives the new firm the ability to make lifelong customers who upsize a few years after buying their starter homes. Brand loyalty is not something we have seen in the past when it comes to homebuilders, but the SPF-RYL merger may be the start of it.
But as rosy a picture as Standard Pacific and Ryland paint, homebuilding stocks aren’t where investors want to be today. I have three reasons why:
- Margins in the space are falling. Both RYL and SPF reported shrinking margins in their last quarterly reports. RYL saw gross margins of 19.7%, down 260 basis points the previous quarter and off by 140 basis points compared to the first quarter of 2014. Standard also had gross margins fall by 240 basis points from the previous quarter. And Hovnanian Enterprises (HOV) had the same issue in the first quarter and actually posted a loss due to discounting and incentives it was forced to offer.
- The new company will be as unattractive as RYL and SPF. If you weren’t going to buy RYL or SPF before, a larger version of them is not going to make that much of a difference. The major problems hurting homebuilders are still present regardless of size: low homeownership rate, low new household formation rates, the memories of those who went through foreclosures, not to mention the millions with trashed credit reports. Furthermore, many homeowners who were underwater during the housing bust are just coming up for air — and flooding the market with their houses newly up for sale. There’s too much competition for builders right now.
- Interest rates are going up. Many believe the Federal Reserve could announce higher rates this week, or at the latest in the fall. Not only are the builders hurting now, but when rates begin to rise, and they certainly will eventually begin, the total price of owning a new home will rise. Those increasing costs will certainly push some potential buyers out of the market. Either fewer homes will be sold, more incentives and upgrades will be given, hurting margins further, or and most likely both will happen.
The Bottom Line
All and all, the RYL-SPF merger is not one investors should be buying. While both companies are rather healthy, the industry as a whole appears to be heading south. My recommendation is don’t buy today, but keep the new firm on your watchlist as it may be a good investment in the future.
As of this writing, Matt Thalman did not hold a position in any of the aforementioned securities. Follow him on Twitter at @mthalman5513.
