Pulte Homes Inc. in Bloomfield Hills might be on to something. Corporate history has shown that companies that aggressively expand market share or sales during economic downturns are more apt to reap greater gains during the next recovery. While it doesn’t work out for every business, consider some of the success stories.
In the late 1920s, C.W. Post and its chief rival, Kellogg Co., which both got their start in Battle Creek, saw cereal sales initially fall due to the 1929 stock market crash and the ensuing Great Depression. Post decided to batten down the hatches by cutting advertising and scaling back operations. Kellogg took the opposite route. The company introduced new products like Rice Krispies and expanded its advertising budget. The result was a 30-percent jump in profits in four years. As a result, Kellogg was able to stake out a dominant position in the industry — a plateau it still holds today.
Other companies have launched products or new sales programs during recessions and come out on the winning end. Apple introduced the iPod in 2001; the transistor radio came out during the 1954 recession; and the 8-track tape player was introduced in 1965, during the 1964-65 economic downturn. In fact, the 8-track tape player was a big hit for Ford Motor Co., which by most measures had a two-year head start on its chief rivals, GM and Chrysler.
So where does Pulte Homes fit in? At the start of 2009, the company was the nation’s fourth-largest homebuilder. But it will vault its way to the No. 1 spot before year’s end by completing a merger with rival Centex Corp. in Dallas, the nation’s third-largest homebuilder, for $1.3 billion in stock. The deal, announced in April, is expected to close in the third quarter.
Some housing experts say the deal will help Pulte realize savings as it ramps up the merger, mostly by eliminating overlapping positions, consolidating offices, and negotiating lower prices for lumber and other building materials due to its increased size. Because it was a stock transaction, Pulte will be able to conserve cash and avoid taking on added debt by tapping financial markets.
Longtime homebuilder Gil Silverman, who oversaw the construction of around 15,000 homes in metro Detroit over a 50-year period, says he’s encouraged that Michigan and the region will realize new jobs as Pulte moves to consolidate some of Centex’s operations in Bloomfield Hills. But he wonders how the expanded company will deal with lower appraisals due to a rise in foreclosures in recent years.
“Pulte will realize cost savings as they consolidate duplications in the combined labor forces, but that only lasts one or two years,” says Silverman, president of Holtzman & Silverman Realty Co. in Southfield. “Construction labor hasn’t gone down, and material prices are down a bit, but not by much. The thing to watch is how they’ll handle the foreclosure issue. They’ll have to be very diligent about monitoring their sales activity so they can position themselves for growth.”
The combined company expects to save $350 million annually, and Pulte President and CEO Richard J. Dugas Jr., who will be chairman and CEO under the merger, says the deal will lead to a quicker route to profitability once sales pick up. He also cites positive signs in the marketplace, as the company’s first quarter sales appeared better than the previous quarter. Still, that may be more a measure of seasonal variations.
Overall, the deal positions Pulte as a true generational company. Centex is a strong player in the starter home sector, while Pulte’s strengths are in middle- to upper-middle-income homes, as well as the active adult market — resort-style developments targeted to people aged 55 and older that Pulte competes in with its Del Webb brand.
By making itself a dominant player in the starter home market, Pulte will be better positioned for the next upturn as the sector requires lower mortgages, while tax credits and other subsidies are made available to first-time buyers. Still, selling more lower-priced homes won’t affect the company’s revenue stream as much as a recovery of more expensive residences.
As the housing sector deals with a wave of foreclosures brought on by aggressive lending practices and other factors, Pulte’s acquisition of Centex provides much-needed cash to weather the downturn, analysts say. At the time of the merger announcement, Centex had a $1.7-billion cash reserve, which matched what Pulte had on hand. The combined $3.4 billion in cash will be a critical component in paying down debt while maintaining operations (Pulte is taking on a net debt of $1.8 billion in the deal, although Centex has $1.2 billion of tax benefits that aren’t carried on its balance sheet).
“Home sales are down and you have a lot of write-downs on land and inventory,” says Steve Taglione, president of Westminster Abbey Homes in Bingham Farms. “All of these factors are causing homebuilders to consolidate to weather the downturn. But I think once the market turns around, Pulte will be well-positioned to serve a variety of markets so that it isn’t too heavy in one market segment.”
In addition to making it the nation’s largest builder — a milestone Pulte first reached in 1995, before other competitors took aim at the top spot (which didn’t necessarily translate into higher profits) — the merger with Centex provides other benefits. At the time of the transaction, Centex had roughly 68,000 lots under control, while Pulte had close to 121,000. In turn, Centex holds a strong position in Texas and the Carolinas that will provide Pulte with an important foothold in what are considered growth markets (even by today’s standards). What’s more, the transaction will help limit Pulte’s heavy concentration in the active adult sector.
The deal “signals to me that Pulte management believes the market is not going to get any worse from here,” says Paul Puryear, an analyst with Raymond James & Associates. “But I don’t think the rest of the industry shares that view.”
While some analysts predict further industry consolidation, increased competition will continue. Taking a page from the automotive industry, Pulte rival Toll Brothers Inc. recently launched an incentive program in metro Detroit and other regions that includes home-staging services and extended build times for buyers who need to sell a home. A new mortgage protection plan, meanwhile, covers up to six months of mortgage payments — up to $2,500 per month — for a qualified job loss within the first two years of a closing. To tap the limited-time offer, buyers are required to take out a mortgage with the homebuilder’s finance company.
“There are many pluses in this deal, including Pulte’s excellent quality control and the ability to integrate that with Centex,” says Dominic J. Moceri, a partner in Moceri Homes in Auburn Hills, which offers five master-planned communities in the region. He also cites Pulte’s industry-leading position as another benefit.
“Two leading economic indicators are autos and housing, and once there’s a worldwide economic recovery, Michigan will be at the forefront,” Moceri says. “The other thing about Pulte is they are a notable competitor. They buy land at the right price and they design their homes very well. That keeps the rest of the industry on its toes. It’s also significant to note that the brain trust of Pulte will remain in this region. And it’s still that way for autos.”
As Pulte’s longtime CEO, Dugas says the company had been pursuing a merger with Centex since 2005, but the two sides could never make a deal work. All that changed on Feb. 4, when Centex CEO Tim Eller placed a call to Dugas. “I remember Tim said: ‘Do you remember those discussions we had a back in 2005?’” Dugas recalls. “And I said yeah. ‘Well, we think it’s a good time to pick that back up again.’ The rest happened very quickly,” Dugas says. “We spent three or four weeks working on the rough terms, and then three or four weeks on due diligence and other matters, and we announced the deal on April 8.”
Poised at the top of the homebuilding business, Dugas believes the new company will be able to realize profits much more quickly than if Pulte had remained a separate entity. Still, getting to this point hasn’t been easy. The global financial meltdown and a slowdown in housing starts over the past three years contributed to a 70-percent drop in employment at Pulte. The same was true at Centex.
“We had spent time reducing our inventory over the last few years on our traditional subdivision projects, but because the Del Webb brand has many more homes in a given project, we were too dominant in that segment,” Dugas says. “Then along comes Centex, and now we really control four segments of the market, meaning we’re more balanced.”
Before the merger, Pulte’s Del Webb unit accounted for roughly 45 percent of annual sales, while Pulte made up the rest (including a small builder in Florida called DiVosta). Post-merger, the company will be better balanced — roughly 25 percent of annual sales will come from first-time homebuyers, 25 to 30 percent will come from first-time move-up buyers, and 8 to 9 percent will be second-time move-up buyers, with the balance made up of Del Webb buyers.
As Dugas stitched the deal together, he consulted the company’s founder and chairman, Bill Pulte, on several occasions. One idea that may prove to be a hit is positioning Pulte Homes as a name brand. The homebuilder pursued a branding concept a few years back by creating commercials and airing them during the Macy’s Thanksgiving Day parade, but never stuck with it (though the company’s Del Webb brand is arguably the strongest brand in the marketplace).
“We really believe in the power of the brand, and we think there is a value in drawing people to that brand,” Dugas says. Over the next two years, as the new company gets its footing, Dugas plans to establish the Centex name as the brand for starter homes ($100,000-$200,000), Pulte will become the brand for move-up buyers ($200,000-$400,000), and Del Webb will continue its dominance in the active adult market.
The new company also will tout its quality prowess. Between them, the companies have won around 300 top-place finishes from the annual J.D. Power and Associates quality ratings. The next builder down has around 50 such awards. In turn, the larger company will begin to formulate standards for starting entry-level communities as well as move-up projects.
“In the past, you had the corporate structure here in Bloomfield Hills, but all the divisions around the country kind of ran themselves and each developed different operating practices,” Dugas says. “Now we’re saying, let’s standardize the procedures and come up with a recipe book that shows a team in Albuquerque, for example, how to put together a starter home community in terms of what land to buy at what price, what floor plans will be offered, and a number of other things. We think there’s a lot of value we can derive from standardizing our operations.”
While the housing market has evolved over the past two years from getting the most home for the buck to seeking out affordability, Dugas says buyers are still embracing conservation — even if it means paying a bit more for energy-efficient appliances. “I think the green movement is here to stay, and we seek out energy efficiencies in everything we do, from appliances to the furnace, to windows, to low-flow toilets. This isn’t something that’s going away.”
Other trends, like large kitchens that open up to great rooms, are still popular, but Dugas says more people today are looking to integrate outdoor living spaces into their overall home design.
The company also is contemplating a return to factory production. A few years back, its Pulte Home Sciences division, which today is more of a research group, was building floor and wall panels inside factories and then delivering them to home sites. The effort produced better overall quality, but the company could never get enough volume to make it cost-effective.
For example, the company had a factory on the east side of Detroit that could service up to 8,000 homes per year, but they were only building around 1,000 residences at the time. Dugas thinks that adopting a franchise model where smaller builders from, say, northern Michigan market and sell homes, using components pre-built by Pulte in a factory in the central part of the state, would provide the necessary volume to make the plan work. But that’s only after the housing market begins to turn itself around.
“In addition to the franchise model, we would like to be known as the best and most profitable homebuilder in the United States,” Pulte says. “We want that known among our employees, our customers, our lenders, the cities we work in, our suppliers, and on Wall Street. We just need to drive that message home.
“We want to be the best in the eyes of all of those people — like GM was in the 1950s, like Motorola was, and like Kodak once was. We want to be known as the best, and we want to stay there. We can’t afford to lose site of that principle. It’s the very foundation of our future.”