Bargain homes

The homebuilding industry has been the unlikely winner since the coronavirus pandemic selloff in March. In such an environment, underperformers are likely to undergo scrutiny from activists. One such underperformer is Taylor Morrison Home.

According to Activist Insight Vulnerability, Taylor Morrison is the second most vulnerable company in the home building industry, after Select Interior Concepts, which last year was targeted by ADW Capital Management and B. Riley. Taylor Morrison is in the 95th percentile of companies most likely to be targeted by an activist over the next nine months.

Taylor Morrison’s management might come across as more concerned with empire-building than shareholder returns. In a recent presentation, management included a slide that showed “the making of the fifth-largest homebuilder” via acquisitions. But shareholder returns have suffered while most of its peers benefitted from the strong tailwinds stemming from low-interest rates, rising demand for suburban housing, and consumers’ preference for larger homes amid the “work from home” trend spurred by the coronavirus pandemic.

Activist thesis

As Taylor Morrison is the only company in the homebuilding universe trading below book value, an activist could ask the company to explore all avenues to plug the valuation gap.

This could include asset sales to bring down debt, a more aggressive share repurchase program, or a sale of the entire company. More specifically, an activist could ask Taylor Morrison to pause its acquisition binge and focus on integrating its current purchases. Activists don’t like empire-building managements that put shareholder returns on the back seat, so a management change could also be on the cards.

Taylor Morrison might also be spreading itself too thinly by expanding its geographic reach and venturing into the build-to-rent market. An activist could ask the company to become more focused. With a net margin half of its peer median group, another avenue could be to improve profitability via cost cuts.

Business and structure

Taylor Morrison Homes is a $3-billion market-capitalization home builder active in eastern, central, and western U.S. states. A large part of its business is in the East, in states like Florida and Georgia, although it recently expanded in California through acquisitions. The company also has a small financial services segment, which includes title and mortgage services.

Taylor Morrison has been growing its revenues through an aggressive acquisition-led strategy. In 2020, Taylor Morrison completed the acquisition of William Lyon Homes for $2.5 billion in cash and stock, marking its entry in Washington, Oregon, and Nevada markets, and increasing its entry-level homes penetration. This was the company’s sixth acquisition in the last seven years.

The homebuilder had been classified as a controlled company until about 2017, when private equity firm TPG Advisors sold its control stake in the open market.

Peers and industry

The housing market has been very strong in recent years. The COVID-19 pandemic, the ensuing “work from home” economy, and low interest rates sparked demand for larger homes in suburban areas. Indeed, demand has been so strong that the S&P Homebuilders Select Index, a basket of homebuilders, outperformed the S&P 500 Index so far this year by 16 percentage points.

Yet Taylor Morrison shareholders have not benefitted from this industry outperformance. Its shares are up just 2.7% this year, largely in line with the performance of the S&P 500.

Taylor Morrison’s homebuilding peers include Pulte Group, which was targeted by Elliott Management in 2016, Meritage Homes, M/I Homes, and large peers like Lennar and D.R. Horton.

Homebuilders have not been historically attractive for activists but this might change. In recent years, activists have targeted companies in adjacent markets such as home improvement companies, which arguably have a simpler business model. Among them are Lumber Liquidators, Lowe’s, and just recently Tile Shop Holdings.

Financials

Taylor Morrison’s revenues have grown steadily, largely due to acquisitions and a strong home market. With the 2020 closing of the William Lyon acquisition, revenues for the trailing 12 months rose to $6 billion compared with $4.8 billion in 2019. Yet the acquisition has added to the debt, which increased from $2.6 billion in 2019 to $4.2 billion, and increased leverage from around 2 to 2.3, according to Activist Insight Vulnerability.

The company’s profitability could be improved. Its gross margins of around 16% trail those of the median peer group by 14 percentage points.

Valuation and performance

Taylor Homes’ performance and valuation is by far its biggest vulnerability. The stock underperformed its peer group median over one-, three-, and five-year periods on a total shareholder return (TSR) basis. Its five-year TSR is 43% versus 120% for the peer median, according to Activist Insight Vulnerability. The S&P Homebuilders Select Index is up 57% over the past five years.

Taylor Homes underperformed despite its revenues quadrupling during the period. Its price-to-book ratio, analysts’ preferred valuation method, stands at just around 0.90, according to Activist Insight Vulnerability. Its median peer trades at 1.7 price-to-book. Smaller rival M/I Homes has a price-to-book ratio of 2.1, while Meritage Homes trades at 1.5. Large rivals like Lennar and D.R. Horton change hands at a price-to-book of 1.4 and 2.4, respectively.

Corporate governance and management

Taylor Morrison has been led by Sheryl Palmer since August 2007, after previously serving as executive vice president for the West Region of Morrison Homes. Previously, Palmer worked in various leadership roles at Pulte Group.

Morrison has been serving as chair as well since 2007, which could raise concerns with an activist. Lead independent director Peter Lane has served for around eight years, which is at the limit of what’s allowed under good corporate governance practices.

Overall, Taylor Morrison’s board seems relatively refreshed with a high proportion of female board members. The company does not have a majority vote in uncontested elections, which makes a potential withhold campaign harder to run.

Shareholder register

BlackRock is the largest shareholder with nearly 14% of the shares, followed by Vanguard with 9.2%. According to Proxy Insight Online, BlackRock voted in favor of activists in 29% of times in the U.S. over the past five years, versus Vanguard’s 26%.

Fidelity Management & Research is the third-largest shareholder with more than 7%, and more likely to back dissidents; it voted in favor of activists in nearly 40% of proxy contests in the U.S. Oaktree Capital and Donald Smith are also large shareholders, two funds that are inclined to support activists. U.K.-based Parkmead Group is believed to have strong oil and gas assets, but an erratic development strategy, serious corporate governance concerns, and simmering shareholder discontent have made its stock extremely undervalued. After speaking with a shareholder, Activist Insight Vulnerability reporters believe the company is vulnerable to an activist incursion.