Hovnanian Not Too Big to Fail

It s looks like Ara Hovnanian is attempting to tear a page out of Lehman’s (LEHMQ.PK) pre-bankruptcy playbook. In its final weeks, as documented in “Too Big to Fail” by Andrew Ross Sorkin, Lehman attempted to spin off its “toxic” assets into a new entity (referred to in the book as “Shitco” by some Wall Street Execs) and finance it via third party investors, namely other Wall Street Banks. The idea never saw the light of day as apparently no investment banker with any knowledge of the proposed transaction would touch it with a ten foot pole.

In a striking resemblance to Lehman’s failed attempt, it has recently been reported that Hovnanian (HOV) is circulating a private-placement memorandum to the investor community seeking financing for a land venture being dubbed “LandStock”. The new venture appears to be a vehicle that would allow Hovnanian to offload land from their balance sheet as well as acquire and develop new land parcels and finished lots from third parties in major markets. The venture would then look to sell this land to builders at a profit, including Hovnanian. Further, Hovnanian indicated that it is considering investing about $40 million for a 10% non-controlling stake in the new company.

Unfortunately, it appears that Hovnanian has only finished about half of Sorkin’s book and hasn’t figured out how it ends. Unless Hovnanian can find a “sucker” to finance this transaction, it should not and will not get done. While Hovnanian’s assets are physically different than those of Lehman, they are susceptible to the same issues that made a potential investment incomprehensible.

Despite much of the assets already being impaired by significant writedowns over the last 2 years, its inventory is not recorded at the fair value in a way a 3rd party investor would value it. In other words, the Hovnanian assets are susceptible to additional “mark to market” exposure and therefore, upon the execution of such a transaction, it would further deteriorate Hovnanian’s already negative book equity.

The idea behind “Landstock” is nothing more than an attempt to “sell” its already marked down, “toxic” land to generate cash. It appears to be an act of desperation analogous to Lehman’s failed efforts. I suggest that Mr. Hovnanian call Richard Fuld before he gets his hopes up about “Land-Crock” and ask him how his not so dissimilar transaction worked out.

Disclosure: No positions