Wednesday, February 3, 2010

Avatar: Not Just A Movie

Avatar Holdings (AVTR) owns and develops land for a variety of uses, including single-family homes. As most of its operations are in Florida and Arizona, its business conditions, as well as its stock price, have taken a beating in the last couple of years. While it might represent value at its current price, in a way similar to which Melcor (MRD) traded at a large discount to its value not too long ago, management's intentions make the situation a little bit unclear.

The company has lost almost $10 million per quarter in 2009, as it struggles to sell its units for more than their carrying value. While this is by no means a pretty situation, consider the depressed level of the stock relative to the company's assets:

Stock Market Value: $200
Cash on hand: $219
Land/Inventory: $287
Total Liabilities: $156

In other words, the company could lose $20 million per quarter (double its current rate) for five more quarters, and still sell at a 15%+ discount to just its cash and land assets (i.e. excluding its other assets including A/R and prepaid expenses).

Despite the company's strong balance sheet, however, management is making some interesting decisions. While they have curbed new construction in favour of converting inventory into cash, they recently issued $40 million worth of shares! Selling shares when the company trades at only half of its book value is quite dilutive, and seems hardly necessary when the company has far more cash than it has debt - until one considers the company's plans for the future: the company appears to be clearing the way to make a $150 million investment in a new highway!

Is this highway a profitable venture in which management sees a bright future? It would not appear so, as the company has twice written down this project's $47 million initial outlay. So the profits aren't there, but is the company obligated by contract to complete this project? Yes and no. There is a contract with the government, but it appears it would only cost the company $1.9 million to break it.

While management has not made it clear that it will go ahead with the project, the share issuance described above, along with the fact that it recently re-negotiated its contract with its existing lenders that would allow the company to borrow an additional $140 million, suggests this is management's preferred course of action. Unfortunately, from the outside looking in, it would appear that management is chasing a sunk cost (its $47 million initial outlay) rather than adding value for current shareholders by cancelling the contract and buying back shares to close the gap between the company's price and its value.

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Disclosure: None


Anonymous said...

I think you are off base with this analysis. In fact, the management team has given a terrific signal as to their plans with the cash... buy distressed land assets from busted builders in Florida. They made their first land purchase since 2004 in the third quarter, buying out a development (lots of land and few houses in a various stages)that was clearly distressed over in Port St. Lucie. The management team plans to use the cash to buy cheap land in Florida. The investment question isn't the highway, it's whether buying land in Florida over the next couple of years is a good use of capital.

Anonymous said...

I think you may have missed the story here Saj. Management has given a very clear signal regarding their plans. During the third quarter, they made their first land purchase since 2004 by buying a busted development in Port St. Lucie. More than half of the lots owned by Avatar were purchased before 1980. They won't be building the highway, they'll be buying Florida land. The key question is whether that's a good long-term use of capital. I wouldn't spend too much time worrying about the highway.

Saj Karsan said...

Perhaps you are right, Anon. But the St. Lucie buy is tiny from a capital perspective, and the space allocated to the topic of the highway plus the language used describing it along with the renegotiated ability to refinance suggests to me that the company wants to see it through, and it's a large amount of money to shrug off.

Anonymous said...

Saj, re: the Port St. Lucie deal, did you expect them to spend all of their capital in one deal? It might be wise to pursue Florida land rather slowly. Could you point out the specific language for the highway that leads you to believe they are planning to finish the project? The latest Q states that the company has invoked Force Majeure related to this highway, and is under no obligation to complete it. And, Polk county will not be able to seek damages if Avatar doesn't complete it. In the meantime, they've written off most of the project.

Saj Karsan said...

Hi Anon,

Sure, here are some statements from the latest 10-Q which lend themselves to the possibility this project may be undertaken:

- The company is attempting to obtain funding for the development of the highway

- The future cash flows of the highway project are not expected to be less than the carrying value

Also, the investments in the parkway are carried at $16 million on the balance sheet. This amount would be written down if the company was no longer considering this project (or would be classified as 'discontinued operations' if the company were trying to sell what it could salvage).

I'm not saying they'll do it for sure; I'm just saying it's a risk. And because of the size of the project, it's an important one.

Anonymous said...

Saj -- there could be another, simpler explanation. The company spent $46M on the Parkway, and have written it down to $16M. GAAP says that you must take a writedown if the future cash flows, undiscounted, are less than the carrying value of the asset. Ernst & Young must believe that there is enough value in the asset to require a $16M balance sheet valuation.

Clearly, the company doesn't care about that valuation. Book value is nearly $39/share and the stock trades in the $17 neighborhood. There is no financial stress, so the valuation of the Parkway is not something to argue about from the perspective of AVTR management.

More probable, in my estimation, is that the company sells this asset at a future date, either to the State of Florida or another developer. Of course, there is no reason to give it any value today, but I doubt it's much of a risk either.

I've enjoyed the conversation. Great job on your blog.