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Homes on the Range

Author: Bob Lang (info)
Website: http://trade-mentor.com
Posted: May 23rd, 2007 at 8:19 am EST
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One of the biggest drivers of this recent rally has been merger/acquisition activity. A recent statistic mentioned that some 60 of the SP 500 companies are potentially in play. A fascinating concept but with companies flush with cash and earnings power clearly on the upswing it makes for historically undervalued firms. Consolidation is generally bullish when held in the context of supply and demand. Simply put, takeovers pull stock off the table and with the same demand it will drive prices higher. There has been one unloved group that may be poised to enter the M&A frenzy…homebuilders.

We have yet to see a merger in the homebuilder group. It’s quite notable about the overbuilding the last few years…not to mention the mortgage situation. Everyone has heard about the housing bubble and the backlash. Further, these homebuilders have come out and stated publicly that earnings will be bad this year. However, price action of late has been good…really good…in the face of higher interest rates (highly unusual).

There are alot of companies out there….BZH, TOL, HOV, PHM, RYL, SPF, DHI, LEN, KBH..just to name a few. Flush with cash? In most cases, yes. Earnings prospects? Dim, at best. So why combine forces? Perhaps there are other reasons, but the plain truth is that these firms are undervalued historically. The group has been beaten down for more than a year. These firms are regional, too..and a combination could possibly strengthen a larger builder’s position. Is the housing boom going to be rekindled? Likely not, but this consolidation idea is intriguing.

One final mention is about option activity. Recently there has been a flurry of buying in many of these names…which ‘usually’ tells us something is imminent. Call option buyers expect some sort of upside and speculate using near term contracts. For example on Tuesday May 22, SPF at the money calls had 250% turnover of the open interest. Maybe someone knows something. Whatever the case, when the first shoe drops on a merger you can expect to see a flurry of deal possibilities…and the prices jump.

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