Okay. I admit, the title is pretty corny - but this blog post is really not that funny either, at least if you're long Ryland. The upper management of Ryland have sold more $33 million dollars of stock in the past year with at least $25 million of that dumped very recently in the last 3 months - right before the quarter reports. Here's another coincidence, despite the fact that the stock has been rapidly decreasing over the last year, none of the management have taken advantage of the opportunity to buy the stock a this cheap price - they have just sold. Hmmm! I wonder if there is something in this upcoming quarterly report that would make you want to dump your shares faster than the cannibal dumped his ex-girlfriend too??? For those of you who didn't laugh - there is this tasteless joke, "What did the cannibal do after he dumped his girlfriend? He wiped his @#$!" You should be laughing now. The reason I am telling corny jokes is to prepare you guys and gals who are long RYL for something that may not put a smile on your face.

Well, first let's take a look at who sold all of this Ryland stock (besides me, of course), then let's make our best guesstimate at why everybody decided to fund their kid's piano lessons right before quarter end (click the graph to enlarge).

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Ryland's Bankruptcy Score - Coming out of 2006, it looks like Ryland's Z score fell off of a cliff!

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All, or nearly all, of Rylands upper management & insiders have been selling heavily over the last calendar quarter, including senior VPs, directors, the chairman and CEO, and even (former) 10% owners of the company (Jeffrey Gendell has been replaced by Janus Corp. as a 10% owner). Apparently, Janus sees something that upper management and I do not see. To put this in perspective, insiders have (net) sold 2% of total shares outstanding in just 90 days. There is not one share that was purchased by management in this time period, but many were sold.

Other points of interest:

1. Ryland has an increasingly large (and involuntary) spec inventory due to cancellations

2. Seasonally, this should be one of the strongest quarters for RYL, yet the results look to be abysmal

3. In 2006, Ryland produced 11,744 loans totaling $3 billion - which significantly contributed to their bottom line. Look for mortgage financing to be a drag on earnings in the near future due to the credit crunch.

4. Has $85 million in cash, $2.5 billion in inventory and $1.5 billion in debt, accrued liabilities and accounts payable. This is a precarious situation, particularly since they are burning through cash; substantial negative cash flow rate.

5. Tapped credit facility for $75 million last quarter, apparently for the first time this much - nearly as much as they have cash on hand. Although they nominally have much more borrowing capacity, that capacity is dynamically restricted as their credit/cash flow/debt to asset situation worsens, which it currently has and probably will for the forseeable future.

6. In the 6 mos. ended 6/06 the company bought $175 million in stock driving cash flow negative. They did the same in the six months ended 6/07, despite producing a net loss and negative cash flow BEFORE the stock buy back. WHY IS MANAGEMENT AUTHORIZING THE COMPANY TO BUY BACK SHARES FROM NEGATIVE CASH FLOW AND EBITDA WHILE MIRED IN DEBT WITH SO LITTLE CASH ON HAND??? It could possibly be that management really thinks this current stock price is a steal, thus want to grab as much as possible for the company's own coffer??? Yeah, right! And Paris Hilton is a virgin! YET MANAGEMENT ITSELF IS RAPIDLY SELLING SHARES, directly into the company's share repurchase program! SHAREHOLDERS NEED TO TAKE NOTE. Stock based compensation is only 14% to 24% (max, giving them the benefit of the doubt) of the amount of shares purchased by the company. Management had the company buy back $60 million worth of shares and management sold $30 million of shares into the buy back program. It appears that management's interests are not totally aligned with that of the shareholders. If I were to subscribe to the conspiracy theories lurking around many of these blogs today, I would be led to believe that management is trying to prop up the price of the stock through Company's own resources via a share repurchase program. Naaaaahhh! Couldn't be. They wouldn't do that. Because of they did, it would benefit them over their own shareholders as they dump their stock. The buyback of stocks may prop up share price in the near term, but destroys value in the long term, reference my blog post on this topic.

7. At the rate RYL is burning cash, they will run out of money in 3.91 months, or just about the beginning of next quarter.

8. Cash burn should be increased significantly if and when RYL runs out of finished homes to sell and will have to start construction to monetize the land that they have in inventory to produce more salable homes. This is an industry wide problem, and not endemic to just RYL, but they will have no choice but to do so in order to continue as a going concern.

9. A potential sign of desperation: "In an effort to increase liquidity, (finished housing) models have been sold and leased back on a selective basis for generally 3 to 18 months. The Company owned 72.0 percent and 78.3 percent of its model homes at June 30, 2007 and 2006, respectively."

Insider Sales

Transaction

Insider

Shares

Average

Total

Shares

& Date

Relationship

Traded

Price

Amount

Owned

2007-08-29-

GENDELL JEFFREY L

307,000

$28.60

$8,778,960

4,194,292

(Former 10% Owner)

(Direct

Sale

Indirect)

8/8/2007

GENDELL JEFFREY L

173,162

$38.93

$6,741,214

4,501,292

(10% owner)

(Direct

Sale

Indirect)

8/9/2007

GECKLE TIMOTHY J

20,000

$38.09

$761,730

59,986

Sale

(Senior Vice President)

(Direct)

8/3/2007

VARELLO PAUL J

5,569

$34.79

$193,757

0

Sale

(Director)

(Indirect)

7/27/2007

DREIER R CHAD

80,000

$33.47

$2,677,480

456,923

Sale

(Chairman, CEO and President

(Direct)

Director)

5/18/2007

MILNE GORDON A

10,000

$44.51

$445,100

47,300

Sale

(Executive Vice President)

(Direct)

5/17/2007

GECKLE TIMOTHY J

10,000

$44.28

$442,755

59,984

Sale

(Senior Vice President)

(Direct)

5/1/2007

MILNE GORDON A

7,000

$44.65

$312,550

47,300

Sale

(Executive Vice President)

(Direct)

5/1/2007

NICHOLSON LARRY T

4,667

$44.65

$208,382

10,942

Sale

(Senior Vice President)

(Direct)

5/1/2007

SCHREINER DANIEL G

3,667

$44.65

$163,732

38,922

Sale

(Senior Vice President)

(Direct)

5/1/2007

ELDER ERIC E

3,667

$44.65

$163,732

39,152

Sale

(Senior Vice President)

(Direct)

5/1/2007

FRISTOE DAVID L

3,667

$44.65

$163,732

14,246

Sale

(Senior Vice President)

(Direct)

5/1/2007

GECKLE TIMOTHY J

3,667

$44.65

$163,732

59,984

Sale

(Senior Vice President)

(Direct)

5/1/2007

CUNNION ROBERT J III

3,667

$44.65

$163,732

51,235

Sale

(Senior Vice President)

(Direct)

4/27/2007

DREIER R CHAD

80,000

$46.75

$3,740,072

456,922

Sale

(Chairman, CEO and President

(Direct)

Director)

2/21/2007

BANE DANIEL T

3,000

$53.87

$161,610

1,606

Sale

(Director)

(Direct)

The following table summarizes the Company's purchases of its own equity securities during the six months ended June 30, 2007:

(in thousands, except share data)

TOTAL NUMBER

APPROXIMATE

OF SHARES

DOLLAR VALUE OF

TOTAL

PURCHASED AS PART

SHARES THAT MAY

NUMBER OF

AVERAGE

OF PUBLICLY

YET BE PURCHASED

SHARES

PRICE PAID

ANNOUNCED PLANS

UNDER THE PLANS

PERIOD

PURCHASED

PER SHARE

OR PROGRAMS

OR PROGRAMS

January 1-31

45,000

$

54.42

45,000

$

199,139

February 1-28

270,000

54.64

270,000

184,386

March 1-31

580,000

45.19

580,000

158,175

April 1 - 30

-

-

-

158,175

May 1 - 31

160,000

44.92

160,000

150,988

June 1 - 30

210,000

41.34

210,000

142,307

Total

1,265,000

$

46.86

1,265,000

On December 12, 2005, the Company announced that it had received authorization from its Board of Directors to purchase shares totaling $250.0 million. During the six-month period ended June 30, 2007, approximately 518,000 shares were repurchased in accordance with this authorization. At June 30, 2007, there were no remaining shares available for purchase in accordance with this authorization.

On December 6, 2006, the Company announced that it had received authorization from its Board of Directors to purchase shares totaling $175.0 million, or approximately 3.1 million shares, based on the Company's stock price on that date. During the six-month period ended June 30, 2007, approximately 747,000 shares were repurchased in accordance with this authorization. At June 30, 2007, there were approximately 3.8 million shares available for purchase in accordance with this authorization, based on the Company's stock price on that date. This authorization does not have an expiration date.

I foresee things turning around for Ryland in the second half of 2009 (using proprietary methods) & the company as stable by 2012, assuming the real property markets do not veer significantly off of my projected track. This is also assuming Ryland is around for the next 8 quarters. If one didn't know any better, one would assume that the insiders have their doubts. Here are some visualizations of Ryland's metrics as I have calculated them.

Revenue Growth: Except for Texas, negative till 2nd quarter of '08. Despite the fact Texas is performing better from a revenue perspective, it may be hard to actually make money in TX. We shall see.

Gross Margins: Single digits till 2011

Image029

Gross margins (excluding impairment and write-downs), % - still in the single digits till 2011

Image045

Cancellation rates are going to get worse before it gets better, so we might as well get use to it.

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Not only will profit from mortgage origination drop, it might actually drag the company further into the negative if they get stuck with some bad loans on the books.

Image035

Debt to capital looks to increase for several quarters. I think the company is playing a dangerous game with the share buyback program. Hey, management! Instead of trying to make the shares look more valuable, why don't you plow the funds back into the operation to actually make the shares... well, more valuable!

Image043

Hence, the z score bankruptcy analysis. As you can see, it looks like Ryland fell off of a cliff here. While they are not in the guaranteed bankruptcy area, they are definitely well entrenched in the "at risk" portion, and hoveing right above the high risk of bankruptcy. I forecast them getting out of it in 8 quarters if they right the boat by acting prudently, ex. aligning management and shareholder interests, halt share buybacks, etc. Then there is the unknown of the market. My estimations may very well be too conservative if the banks get more aggressive than I forecast in dumping their REOs.

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Image027

Welcome to another senior level class. As I stated before, the purpose of senior level classes is to give you a peak behind the curtain of how homebuilders operated. The good (none), the bad (lies) and the ugly (incompetence). You may ask yourself how I define a lie... incompetence is pretty easy. A lie is when I listen to a conference call of a major homebuilder, the executives tell a story to the usual cast of dimwitted characters (analysts) and a strategic picture is painted. I then call my high level friend (VP of Finance) that works for that builder and walk him through what his executive team has stated. Hmmm lots of discrepancies, lots of items missing, lots of lies.....

However, a conference call is just that, a bunch of talking heads spinning stories. Thankfully we have the trusted auditor providing us an independent and unbiased review of management's statements (the financials). Well lets look at who these wonderful auditors are.... lets start with the top 5 homebuilders... Pulte Homes (Ernst & Young), DR Horton (Ernst & Young), KB Homes (Ernst & Young), Centex Homes (Ernst & Young), whew... Lennar (Deloitte)... wow what are the odds? Ok I live in Florida and it is a debacle today... so who are some of the big Florida players, the ones who are getting the $@#@@# kicked out of them... WCI (Ernst & Young), TOUSA (Ernst & Young), and KHOV (Ernst & Young)... KHOV did 3 acquisitions at the very peak of the bubble in Florida - Cambridge, Windward, and First Homebuilders.. have you seen the write offs on these 3 acquisitions!!!! huge!!!!

In lesson 9 I stated I would walk through a financial model in lesson 10 to show the huge reduction in book value (that isn't being taken by the builders). I got sidetracked and gave a macro view in lesson 10. So in lesson 12, I am going to walk you through all the moving parts (inputs) in a financial template and show you why book is substantially impaired.

Notice how almost every builder now is trading at 0.25 to 0.70 of book. If their land actually were worth closer to 1.00 of book like EScrooge thinks, then how come a private equity or hedge fund doesn't buy these companies at such huge discounts to book? Why are builders trading at liquidation or below liquidation prices? Why were hedge funds and private equity taking positions in builders earlier this year at higher book (0.8) and now you are not seeing it anymore at such low ratios? People the word is out on the street and yours truly is doing my part in educating people with substantial capital of what is really going on. I am not stating that I am moving the market, but I am educating my sphere of influence and everyone on Wall Street has a huge rolodex (talks). Wall Street hedge funds, institutional investors, private equity, etc... are picking up on this before the banks. The banks still are not in tune with what is going on.

{Before you read this post, you may want to read part 1 of this guest bloggers tutorial, since he is not going to explain basic terminology of land.} I feel this is one of my more important posts, whereas many of my other posts will add further proof to what I am stating in this post. That builder book value and equity is closer to worthless (zero) than many think.

Land is illiquid and for the most part does not generate income but does generate expenses. The exception being leasing land for someone to use for agricultural purposes. If the very nature of land is illiquidity, then what is its liquidity in the biggest real estate crisis since the depression? What is liquidity? Isn't liquidity the ability for a buyer and seller to meet at current market rates? Stocks for the most part are liquid because when I hit sell on my fidelity account someone else is on the buy side. With land, it is difficult to find a buyer at your price in a timely manner. How about now? How much is land really worth if you had to liquidate it today for cash. I believe as do many of the people in private equity, that land is down 50%, thus the land on builders books are down 50%. Bye bye equity.

When I say land is worthless what do I mean? I mean that you paid $100 for land with $25 of your money and $75 of the bank's money. If it is worth less than $75 then you lost all your equity and you are upside down. Yes it has a value to the bank, but for your purposes it is a liability that still generates expenses. It is worthless, because when you sell it, you have to bring money to the closing. It is worthless, because if I were to build homes next to your site, I would buy land at ½ what you paid giving me a huge cost advantage. Most public and private builder land falls into this worthless category.

 

The Aug 8, 2007 issue of big builder magazine had a piece that showed 3 reasons why housing tanks. Overbuilding (supply side), job loss (demand side) or both. I want you to think about this sentence real hard.... Real hard........... I love macro-economics and we are about to delve into that realm.

 

Supply

1) Existing inventory of resale homes from 1989 to 2005 has bounced between 1.5 million and 2.25 million. I sent this realtor report to MFKOPP of the fool. Today we stand around 3.8 million in resale inventory. That is 1.6 million over the peak from a 16 year period. Hmmmm... When you have oversupply what does that do to you as a builder to compete? Lower prices substantially. Normally, builders do not consider resale as competition. I am not going to explain this here. However, when oversupply of resale is at unprecedented levels then it has to be factored in. Why? Remember I stated in blog post 9 of 20 that most builders had B land with some A and C land. The reason why you buy a lower class of land is because it is more plentiful. The reason why people buy in a lower class of submarket (land) is because you get more house for the dollar or more yard for the dollar. However, if you live in an MSA where inventory is through the roof, then all of a sudden those great A submarkets or B+ submarkets that you couldn't afford are now affordable. In other words, people will take advantage of this downturn to buy in more desirable communities instead of newer communities that are farther from the job and retail corridors. This situation puts pressure on new home prices and land prices... downward pressure

2) In 2005, I as well as other finance officers were projecting out the forecasted amount of lots we needed for 2006-2008. Most of us were projecting 10% growth. Per http://www.census.gov/, new home sales in 2005 were 1.28 million, which means we were projecting 1.41, 1.55, and 1.70 million unit sales through 2008. This means buying or tying up lots through options to meet these projections. In 2006 per http://www.census.gov/, 1.05 million units were sold and in 2007 the projection is 0.87 million and I would guess that 2008 will be 0.80. The difference in what builders forecasted and the actual sales is 1.94 million lots. That means that all builders not just publics had bought or optioned 1.94 million lots more than the actual 3 year demand. Now many of those options have been dropped, but who is the bagholder if they are dropped. See blog post 9 of 20. It is the LLC that bought the land and either developed it or entitled it using bank debt. That bank debt was on a project by project basis. Read my previous posts regarding bank risk. That land is worth 50 cents on a dollar... who is holding the bag now?

3) We are not even including all the speculators that I referred to in blog post 9 of 20 that never even got a deal under contract with builders. How much land did they buy with the intention of entitle, develop and flip or entitle and flip to a builder? At what point do the banks call in those loans?

4) Two million arms are set to reset this year. Realtors nationally are stating they can't close deals because the appraisal is coming in lower than the selling price. Why? Because homes are being appraised using new housing comps which are through the floor. So if you have an arm, how can you refinance if your appraisal is lower than your mortgage? do you smell a lot of future foreclosures?

 

These 4 facts show that the supply of land inventory or resale housing or future foreclosures is enormous. People wake up, there are 2 million lots available that shouldn't be available. Do you not think this has a significant impact on the valuation of builder land inventory. Builders are so stupid, they never had a class on Just In Time inventory. Maybe if some of them had an auto background they would realize how stupid they were in being vertically integrated and building up inventory before it was needed.

 

Demand

Here is the great part... I mean if you still own a builder stock after this blog post you are truly an bona fide idiot.

 

Remember my reference to big builder magazine (which is a great rag by the way). It said demand issues were related to job loss. Guess what? Jobs come back. Your city or MSA goes through a recession but in a few years or less jobs come back. Sometimes it takes a much longer time, but most markets in which public builders build have positive job growth. Everyone keeps talking about the economy doing well and creating jobs. Really, what happens if the economy doesn't create jobs or like last month loses jobs? That would really kill builders. But guess what, they are dead anyways because its not the economy stupid... here is what people are missing

 

40% of all mortgages for new housing in the markets that public builders were in were exotic subprime and alt-a loans. People took out these loans because they couldn't qualify for more conventional loans. These loan packages are gone for good... No one is writing this garbage any more. Liar loans, gone, interest only, gone, 5% down ARMS, gone.... Get it? They are gone people. If they do return, the interest rates and the scrutiny of the loan will be so high that most won't get done. The majority of that 40% of demand is permanently gone. Poof! Unlike job losses where demand comes back, this demand is not coming back.

 

The longer a builder is on land the higher the chance he goes bankrupt. The higher his debt to equity, the higher his chance of bankruptcy.

 

A parcels are still worth $1 on a $1. B parcels are worth somewhere between 50c to 60c on a dollar and C parcels are worth 30c to 40c on a dollar. Go back to blog post 9 of 10 and see what builders own. You cannot have the huge home and lot supply that we currently have without a major hit to land prices. If you're a farmer or a speculator with a 10 year plus time frame you don't care about this downturn. If you're a builder or an investor who had a 5 year or less timeframe, you are screwed. The macro economic data i showed you above is undeniable. If you truly understand supply and demand and its effect, how can you not see that builder book is worthless.

 

For those of you who still don't believe me, in my next blog post I am going to review multiple builder financial statements and 10Qs and walk you through how the builders are able to hide the fact that their land is worthless. When you walk through the logic with me, you will get it!!!!!! Remember I used to be on the builder team and understand how the game is played. You will see how right I am, I am going to show you the tricks and the illusions that builders are using.