Cohabitation Finds the Homebuilders

Two more big homebuilders took the plunge and moved in together this week. Analysts say the timing could be auspicious.

D.R. Horton of Arlington, Texas, said Tuesday that it would purchase Schuler Homes of El Segundo, Calif., to become the second-largest homebuilder in America.

Over the past 12 months, the companies have sold more than 26,000 homes in 24 states and racked up a combined $6 billion in revenue. Importantly, the merger enables D.R. Horton to have a presence in California, where Schuler is the dominant homebuilder.

The deal comes amid a wave of consolidation in the housing industry. In July, Pulte Homes (PHM Quote - Cramer on PHM - Stock Picks) completed its acquisition of Del Webb to become the largest builder in the United States. And Lennar (LEN Quote - Cramer on LEN - Stock Picks) sealed a deal to buy U.S. Home Corporation in May 2000.

The housing market has remained robust in a weakening economy during the past year. But there are now signs of frailty: The National Association of Home Builders' Housing Market Index registered a 14.3% drop in October, the biggest ever. And mortgage applications have slowed. But even if the economic outlook for sector is deteriorating, the acquisitions companies are making will strengthen their foundations, analysts say.

"Builders benefit from increasing market share, because it enables them to lower their costs," said Tony Crescenzi, bond market strategist at Miller Tabak. "They can grow ... even in a flat market."

Horton's cash and stock deal is valued at $1.2 billion and includes the assumption of $552 million of Schuler debt. Schuler shareholders will get $4.09 a share in cash and 0.57 Horton shares, valuing the company at $16.12 per share, a 34% premium to its closing price on Monday.

D.R. Horton expects the deal to save the company $30 million to $40 million a year. The source of the savings, according to a research note obtained by TheStreet.com from Carl Reichardt, an analyst at Banc of America Securities, will be "increased purchasing power for raw materials, elimination of excess overhead, expanding D.R. Horton's mortgage and title services, and the reduction of Schuler's borrowing costs." Reichardt rates D.R. Horton a buy; Banc of America was an advisor on the deal.

Shares of Horton fell 71 cents, or 3.4%, to $20.39 on Tuesday, while Schuler gained $3.25, or 27%, to $15.25. Other companies finished mixed on news of a deal: Lennar closed up 30 cents, or 0.88%, to $34.20, while Pulte ended down 18 cents, or 0.54%, to $33. For the year, the S&P Homebuilders Index is off 12.4%.

Given the state of the economy, though, this deal might not be enough to raise demand. Together, a lack of consumer confidence and an abundance of job losses could make buying a home unlikely for many Americans. For some people, now is simply not the right time to undertake a major investment.

Homebuilders have often led the stock market out of downturns. "The best time to buy homebuilding stocks over the last 15 years was during the deepest part of the Gulf War crisis," said Reichardt in a recent research note. "Homebuilding stocks bottomed in early November of 1990, but then tripled within fifteen months."

It remains to be seen whether they can lead the charge this time around.