Reasons to be skeptical of the Pulte Homes-Centex merger

Well, say what you want about Pulte Homes (PHM) CEO Richard Dugas but don’t accuse him of buying high. Sure, offering $10.50 a share (in all-stock deal) for home building competitor Centex (CTX) is about $3 a share more than yesterday’s Centex price but it’s less than half what Centex shares fetched a year ago and more like 1/8 of what they traded for at the height of the housing bubble. Centex also has about $1.7 billion in cash – less than the total $1.3 billion initial purchase price. A steal? Not exactly. Centex also had $3.1 billion of debt and a balance sheet filled with cratering real estate and mortgage loans.

Dugas is betting that eliminating overhead in the combined companies to the tune of $350 million a year and a joint cash hoard of $3.4 billion will allow the newly-created entity to withstand the current tough times and flourish when real estate recovers. It’s a big bet that Centex will end up being worth more than the net $1.8 billion of debt Pulte is taking on (after subtracting the cash). And further write-offs could be ahead for Centex’s $3.3 billion of housing projects in development and almost $500 million of undeveloped land (as of Dec. 31).

There’s reason to be skeptical. After all, the homebuilding execs were blindsided by the end of the bubble after notoriously overbuilding particularly in some of the hardest hit states like Nevada and Arizona. Dugas today tells Bloomberg today that he’s “cautiously optimistic” after February’s upturn in home sales. He’s the same guy was seeing “encouraging signs” at Goldman Sachs’ housing conference in February, 2007, of course. Just two months ago, Pulte execs were saying they had too much inventory and now they’re adding everything Centex has, too. And our recent cover story not withstanding, no one thinks real estate prices and sales volumes will recover to the levels of a few years ago anytime soon.

Also, keep in mind that the “price” of an all-stock deal is subject to constant revaluation based on the price of the acquirer’s stock, in this case Pulte’s. At yesterday’s Pulte close of $10.77, the offered takeover ratio of 0.975 shares per share of Centex equals $10.50 a share. But Pulte’s shares are trading down in the premarket. We’ll have to wait for more details on whether the deal includes any adjustments in the ratio based on where Pulte trades (typically known as a collar or floor price).

So is Dugas making the right or is this more homebuilder management folly? Take at it in the comments and I’ll update the post later with more from around the web.

UPDATE1: Morningstar analyst Eric Landry really likes the deal, noting that Centex owns 68,000 lots, many in Texas and the Carolinas, away from the worst-hit bubble areas. He also see the combined companies preserving $1.2 billion of tax benefits Centex has that aren’t carried on its balance sheet. “As a result, Pulte is buying a company for a bit more than half of its adjusted undiscounted tangible book value of about $20 per share,” Landry writes this morning, before the companies’ conference call (and behind Morningstar’s paywall).

UPDATE2: Megan McGrath, an analyst who covers Pulte at Barlcays Capital, said she’s surprised since she didn’t think there would be much merger activity among homebuilders so soon. Broadly, the deal is consistent with Pulte’s goal “of gaining share throughout this downturn. The company expects to be able to generate significant cost savings and combined debt reduction of over $1bn,” she writes, though no change in her “equal weight” (aka “hold”) rating on the stock.