Technical Olympic chief says company can weather Transeastern tumble

By Paul Deckelman

New York, Oct. 5 - Transeastern has its troubles - but Transeastern is not the totality of Technical Olympic.

That was the upshot of Technical Olympic USA Inc. chief executive officer Antonio B. Mon's presentation to investors Thursday at the Deutsche Bank Securities 2006 High Yield Conference in Scottsdale, Ariz.

Mon acknowledged right at the outset of his presentation that Transeastern "is the issue on everyone's minds."

The Sept. 27 revelations about the problems faced by the Hollywood, Fla.-based homebuilder's joint venture have roiled investors since then - Transeastern's bank debt has slid precipitously to levels in the mid-60s from near par previously, while Technical Olympic's own 7½% notes due 2015 at 75 are about 6 points off their pre-news levels and its 9% notes due 2010 at 95 are off 2½ points - while its New York Stock Exchange-traded shares fell have fallen about $2 from prior levels above $12.

But Mon pointed out that Transeastern is only one of a number of joint ventures Technical Olympic is involved in, accounts for only a relatively small portion of its business, would have only limited impact on its finances, even in a worst-case scenario, while Technical Olympic itself has a solid balance sheet and is prepared to wait out the current housing market downturn.

The Technical Olympic CEO said that the transaction between his company and its joint venture partner, The Falcone Group, acquiring Transeastern Properties Inc. for an undisclosed sum closed in August 2005, and, "with the benefit of hindsight, we all know ... Transeastern was acquired at the top of the [U.S. housing] cycle, at pretty high prices."

It had a "very leveraged financial structure," with a ratio of debt-to-capital exceeding 80%.

The joint venture was expected to deliver between 3,500 and 4,000 homes on an annual basis, but no sooner had the partners taken over than the previously booming Florida housing market began to correct from its overheated levels.

As interest rates rose and consumers became more cautious and less urgent about buying houses, demand weakened, causing an oversupply of both new and existing inventory homes, elevated cancellation rates - as prospective home buyers changing houses failed to sell their own homes - and downward pressure on homebuilder profit margins because builders had to also offer increased sales incentives and broker commissions and buy more ads to get houses sold in the softening market.

Although Technical Olympic anticipated a gradual slowdown in the Florida housing market, "these conditions have been more severe than anticipated and have negatively impacted the joint venture's ability to meet its projections," the company said in a recent statement.

Unsustainable capital structure

"The bottom line is very simple," Mon told the conference attendees. "The capital structure in place for the joint venture was $600 million in debt at annual carrying costs of roughly $60 million. [This] cannot be supported under current business conditions," which anticipate that Transeastern will only sell between 1,200 and 1,500 homes next year - translating to at least $40,000 of debt service for each home sold. "That doesn't work."

To remedy that, Mon said that Technical Olympic began dialogue with the joint venture's banking group "several weeks ago," and met with its entire bank group in person last week to update them on Transeastern's situation. It was news of this meeting, when it hit the markets, that caused the Technical Olympic bonds and stock and Transeastern's term loan debt to slide.

"We believe it will take several weeks to sort this out," he declared.

Mon said that the joint venture's debt is secured by its own assets, so that neither partner will be left holding the bag in the event of a default. The joint venture is currently exploring options to provide sufficient liquidity for itself, including requesting waivers from its lenders regarding potential defaults and permitting future advances under its revolving credit facility, and restructuring land bank obligations.

The CEO noted that neither JV partner plans to put any more equity capital into the company - a quick fix that could help it over the rough spots - until the capital structure problems are resolved.

Little impact on Technical Olympic

As has been previously announced, Mon said that Technical Olympic's Transeastern exposure amounts to $141 million - its $90 million equity investment at the time the company was acquired, a $30 million bridge loan, and the remainder in receivables and interest which it is owned.

He said his company has yet to make as much as a penny on Transeastern on a net basis and has "done everything we can" to help the joint venture along in this time of trouble, deferring collecting on interest and on fees as the managing partner, which it also owed. On an operating level, it integrated some of Transeastern's back-office functions with its own in order to allow the joint venture to use its capital more efficiently.

Transeastern was only expected to provide between $3.8 million and $5.7 million to the company's net income for the year, which is currently projected to be somewhere between $231 million and $262 million, so its underperformance, Mon said, "is not significant." In the event of a worst-case scenario that results in the joint venture's termination, Technical Olympic would take a charge, net of taxes, of $89 million, or $1.50 per share.

He termed this "not catastrophic, by any means." He said it would have only a small impact on Technical Olympic's debt-to-capital ratio.

A 'solid' balance sheet

Technical Olympic terms its balance sheet "solid," even pro-forma for the possible write-off of its whole Transeastern exposure.

As of June 30, its capital structure included outstanding debt of some $1.061 billion, consisting of $248.8 million of 8¼% senior notes due 2011, $297.2 million of the 9% senior notes due 2010, $125 million of 7½% senior subordinated notes due 2011, $184.7 million of 10 3/8% senior subordinated notes due 2012 and $204.8 million of the 7½% senior subordinated notes due 2015. The company's $800 million revolving credit facility was undrawn. Technical Olympic had $42.5 million of cash and equivalents - $39.6 million unrestricted and $2.9 million restricted. Including stockholder's equity of almost $1.099 billion, total capitalization was $2.159 billion, producing a 48.2% ratio of net debt to capitalization.

Transeastern unlike other ventures

Mon said that the Transeastern joint venture differed from the company's other, more established joint venture operations, and its own Florida operations, in significant ways that have exacerbated the problems the new joint venture company is having.

For one thing, he said, Transeastern "has a higher percentage of attached product" - several housing units in a row as part of one larger town house-style building, rather than the apparently more desirable unattached houses. For Transeastern, such units make up more than 50% of the housing it has built, versus about 20% to 25% in the older joint-venture communities.

On the financial end, while Transeastern was acquired at the top of the housing cycle - although nobody knew this at the time - and is heavily levered, the other operations were acquired over a longer period of time, not at a market top, are less levered (about 60% versus over 80% for Transeastern) and throw off more cash, particularly the company's active adult communities in the Phoenix area.

"So there are very significant differences between the Transeastern joint venture and the rest of the portfolio."

'Challenging' market conditions

That having been said, the fact remains that the housing industry overall is in the dumps, and Technical Olympic is no exception.

Its net sales have been running well below year-ago levels in three of the four regions where the company operates - Florida (down 9%), the Middle Atlantic states (down 30%) and the Western United States (down a whopping 72%). The only Technical Olympic market where sales are higher is Texas, up 12% year-over year. Meanwhile, cancellations are up in all four regions, as are the incentives the company must pay to encourage home sales.

A 'serious correction'

In toting up the cancellations, Mon said that "every month since June has gotten sequentially worse. We have yet to find a bottom."

He said that the downturn is a "serious correction" that will take "some months" for the industry to recover from.

He warned: "We expect '07 to be difficult. We expect sales rates not to improve until late next year, and some improvement in '08, and profits will recover in late '08, into '09."

Mon said that his company was being conservative in estimating when things might get better because "we've been around the longest, and we've survived very difficult conditions in the past." For the market to "normalize," cancellation rates must subside, interest rates have to stay low, and economy should stay solid.

Company seeks savings

To keep things moving along as best as possible, Mon said, Technical Olympic has moved to make more efficient use of its resources.

It has stopped buying land for new houses, except in Texas, where sales are still up year-over-year. It has redesigned its houses to better compete for a slice of the shrinking home-sales pie against existing home re-sales and other new-home builders by lowering their prices, taking from $5,000 to $15,000 of construction costs out of its homes. The process also involves better supply-chain management, pushing its suppliers for better prices. A key area is lumber, which is "going our way - lumber prices are significantly lower than they were in the past."

Mon said that Technical Olympic was also exercising balance-sheet discipline, keeping its revolver undrawn and available in the quarter ended June 30 and, "I would expect, ended 9/30," the results for which will be released within the next few weeks.

"We expect to end the year with a significant cash balance," he said, "as we begin to deliver a lot of homes that are scheduled for delivery in the fourth quarter." Meanwhile, cash will be conserved because, except for the Texas market, "we are not buying land to replace those lots."

He continued "we are using our cash flow to effectively deleverage the business and we really want to protect our borrowing capacity."

The company uses "a lot of structured financing" to acquire the land it buys for its housing developments, with 75% of the land controlled through options and joint ventures, to reduce risk.

Mon said that Technical Olympic is projecting a target net debt to capitalization ratio in the 45% to 55% range, and "we believe that the number will drift to the lower end of that range in 2007."

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