For months now, deal people from the private equity houses have been tracking the exhausted US homebuilders across the unforgiving plains of the capital markets. Rather like over-equipped, under-exercised, would-be big game hunters riding air-conditioned Hummers, they have been taking the range of the builders again and again, glancing at their camouflage-printed GPS devices, raising the hostile-offer guns to their shoulders, then shaking their heads and taking another swig of the bottle offered by the snickering native bearers.

The US homebuilders are probably the fattest target around for the leveraged buy out investors. They have low stock prices that are only slightly above or even below possibly understated book values. They have been fairly conservatively financed by entrepreneur founders who have had to survive several recessions or even brushes with bankruptcy. And they have large inventories that could, theoretically, be sold off to help fund takeovers.

You would think with at least $190bn in equity to deploy, and a year end fast approaching, that the private equity people would want to work off some of that excess weight of money and actually buy some companies. So far, though, they aren’t doing it. But they’re certainly thinking about it. Apparently, that’s enough to earn the management fees.

Susan Berliner, who follows the homebuilders for the fixed income sell side of Bear Stearns, says, “We realise leveraged buy-outs are a risk. The homebuilders show up on every [statistical] screen, including ours.”

Bear’s bondholder clients, of course, don’t like the idea of LBOs, particularly LBOs of investment-grade companies. Theextra leverage piled on rates the risk of their own debt, unless the deal people tender for the outstanding bonds. Investment-grade companies, such as homebuilders Pulte or Toll Brothers, have bond indentures with fewer barriers to leveraged takeovers. The high yield issuers, such as Hovnanian or Beazer, have stricter covenants.

Of course there’s a reason the homebuilders are so cheap. “The difficulty,” Mr Berliner points out, “is that no one knows where the bottom will be. An [LBO firm] could take them private, but you don’t know how long a period there would be until you could take them public again. It spooks people.”

If anything, I am even more of a bear on the prospects for the US housing market than the average investor, but that doesn’t mean I think the world will be coming to an end any time soon for the homebuilders

These firms tend to be run by men who are optimistic to the point of dementia. You’d have to be, to look at a piece of swamp land and see a shiny gated community of McMansions leveraged up to the cupolas.

“They’re egomaniacs,” says a Wall Streeter who has ministered to the homebuilders over the years. “They’re also not that sharpest knives in the Ginsu set.”

They may not know as much as they should about how to make use of the capital markets, but they do have a feral instinct that seems to be missing in private equity hacks.

For example, they don’t have the overheads you find on Wall Street, the mortgage finance world, or, for that matter, the building materials suppliers. The selling, general and administrative costs for these companies is about 10 or 11 per cent. A typical retailer or manufacturer might run twice that.

When times get bad for the homebuilders, they can cut back on their land acquisition, which many of them have already done. They can stop building houses and send the crews home, then sell out of their inventory. It will take a while, but the large national homebuilders can keep sales going at a reduced pace, with some hit on realised prices on speculative builds. Those homeowners who are defaulting on their mortgages at a higher rate every month have already paid the homebuilders for their houses.

What about those giant land inventories? They can be a problem. But some builders, such as Hovnanian, manage their risk by using options rather than outright sales. Some options are more burdensome than others, as the LBO artists’ pet geeks find out when they go through the documents. Others with huge inventories, such as Toll Brothers, have to hold on to land for the endless permitting process in places such as New Jersey. Robert Toll insists he could sell his whole nine-year supply of land on the spot for a profit. Right now, he’s probably right.

Also, eventually, those land inventories will be needed for future building. I think that’s a long way off. Even some builders concede they don’t have “visibility” until after 2008. I think it’ll be longer. Still, eventually . . . 

A bigger waste of money is the builders’ continuing share repurchases, unless they think they ought to just give up and liquidate. If they do have cash, and above average management ability, then they should wait to pick up cheap, smaller competitors in a year or two.

There’s a lot to be said for rationalisation of this still-fragmented industry, and it will happen in a painful, bloody, way. If the LBO people actually provided management value added, like they did in the 1970s and 1980s, they’d buy an investment-grade homebuilder or two and get involved.

That isn’t to say I think the homebuilders are a great investment for the passive portfolio investor. They’re not, particularly when you consider that you’re entrusting your savings to people who think of themselves as swashbuckling entrepreneurs. But the private equity people could perform a function here if they had the intelligence, patience, and vision they claim in their PowerPoint presentations.

They don’t. So this investment interruptus with the builders is another illustration of why they should give a lot of their capital back to the limited partners at the end of this year.

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