Horton CEO Sells Stock: Bear or Tax Bill?

FORT WORTH, Texas ( TheStreet) -- The chairman and CEO of homebuilder D.R. Horton sold 117,00 shares priced at $10.23 in a recent insider transaction.

It might seem that the last thing a homebuilder like D.R. Horton needs to do at a time when the market is sour on the sector -- Toll Brothers earnings today were another bleak report on industry health -- is to have its top management sell its own shares.

Does it send the message to investors that not even management thinks the shares will go up any time soon? Right or wrong, it seemed to send that message to the market yesterday.

"We've got Toll's disappointing numbers today, and D.R. Horton dropped yesterday 4% when the CEO exercised his option to sell shares. You always wonder when you see that," said Michael Widner, analyst at Stifel Nicolaus.

Still, while insider stock sales will always raise an eyebrow, in the final analysis the skepticism may not be merited when it comes to executive compensation being paid in stock. It's always going to be notable when a CEO exercises his right to unload the shares of his own company at a profit, especially when that company and its sector are reporting big losses. In the end, however, it is often related to a government tax bill, and not any CEO vote of no confidence in his own company.

D.R. Horton was near a 52-week high at several points during August and September, but since then has trended down. D.R. Horton's recent disappointing earnings brought the stock as close as it has come in a long time to some analyst price lower price targets around $9. Yesterday, when the sale by chairman and CEO Donald Tomnitz was reported to the Securities and Exchange Commission, the stock dipped to its lowest level in three months, or a decline of 4%, out of line with yesterday's movement in homebuilder stocks.

In the early afternoon Thursday, D.R. Horton was down marginally, trading at $10.

BGB Securities analyst Merrill Ross explained that when these corporate managers changed to stock-heavy compensation so as not to upset the cash reserves of their companies, the issue of taxes took on a different component. The U.S. government taxes the same way whether income is in cash on hand or stock-based. Managers often need to exercise shares to cover the tax bill.

"I would tend to not shoot first, but ask questions -- and in this case, with a substantial income received in shares, the unintended consequence is that the managers can't avoid having to pay tax on it," said BGB's Ross.

That's exactly what D.R. Horton says occurred yesterday, but that doesn't explain why the market exacted a 4% price on shares as a result of a tax-motivated insider sale of shares. In fact, when the SEC filing is reviewed in its entirety, it shows that the CEO of D.R. Horton was actually a net purchaser. He exercised his right to purchase an additional 166,000 shares at the exercise price of $5 at the same time that he sold 117,000 shares at $10.23.

Regardless, the 4% whack to the D.R. Horton share price yesterday caught the company's attention.

"We were surprised that the stock got hit as hard as it did yesterday, since when we look the filing he increased his position overall. That was a bullish sign," said a D.R. Horton spokeswoman, adding that homebuilders usually trend up or down as a group.

The spokeswoman also noted that the options were set to expire in October 2010 and there is a limited window for executives to exercise them.

"Maybe people are not looking at the filing in detail," the D.R. Horton spokeswoman speculated. Other homebuilders do put out press releases before their management team exercise options to try to head off any speculation that the company is bearish on itself. The D.R. Horton spokesman said the company has no plans, at least in the immediate reaction to yesterday's stock dip, to make a change in its insider sales announcements.

BGB's Ross explained that many of these companies are providing compensation packages to managers at a level that might now seem outsized and based on what now seems a distant bull market. Moving to stock-based compensation allowed them to keep those same levels in place but take cash out of the equation, and while that creates the incentive to build the wealth of the company back up, it can result in market misperceptions in the case of insider sales.

What's more, investors who have lost on a homebuilder like D.R. Horton may not so quickly see the stock-incentive logic when a company posts loss after loss.

"Even when they sell shares to meet the tax bill they are still often walking away with half of the share sale in cash, and some people might think that's too much for a company like D.R. Horton that has posted big losses for consecutive years," Ross said. "Some people might find that morally repugnant."

On the other hand, Ross noted that being a CEO of a homebuilding company is not the easiest job in the world right now. "It's a pretty demanding job at time like this, and if they pull off a turnaround, people might be more inclined to approve of their pay, whether it's in cash or stock," Ross said.

-- Reported by Eric Rosenbaum in New York.

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