Green Brick Partners, Inc. (GRBK)

[Enterprising Investor]

Green Brick Partners: Uniquely Structured Land Developer With Significant Embedded Value (2/02/16)

Summary

•Green Brick Partners is a small homebuilder focusing on the Dallas and Atlanta markets.

•GRBK is backed by David Einhorn who founded its predecessor JGBL, is the chairman of the board, and 49.4% owner.

•Sources of value include the land the company purchased during 2009-2015, the NOLs obtained through the recent reverse merger, and the underlying operating business.

•Our target price on GRBK using a blended valuation is $10.55 (83% Upside).

Green Brick Partners (NASDAQ:GRBK) or "Green Brick" is a land developer and homebuilder that came into existence through a relationship between David Einhorn, Greenlight Capital Founder, and James Brickman, a veteran of real estate construction. Einhorn and Brickman were friends for many years before creating a vehicle in 2008 to take advantage of the distressed housing industry called JBGL (I assume this stands for James Brickman Green Light). The company was created with two branches; JBGL Capital LP, and JBGL Builder Finance. I will get into the exact company structure later in detail, but a key point to remember is it is largely a land developer and financier but also owns controlling stakes in four homebuilders.

The company has a storied past since founding, and it is very interesting for anyone that follows David Einhorn and his hedge fund Greenlight Capital. The current corporate vehicle came to be through a "reverse" merger between a previously backed Greenlight Capital investment BioFuel Energy Corp. (which was a defunct shell company prior to the merger) and JGBL in October of 2014. BioFuel purchased JGBL via a loan and rights offering from Greenlight and Dan Loeb's Third Point Capital which raised the cash in order to facilitate the transaction. It's all pretty interesting and worth a read in the "Basis of Presentation" section of its 10-Q.

Why exactly did Greenlight and Third Point want to complete this reverse merger to bring JGBL to the public markets? Because BioFuel Energy Corp. had $64m of deferred tax assets related to its NOLs which were rolled into the surviving entity Green Brick. It was a way to retain the value of BioFuel Energy while at the same time bringing JGBL to public markets cheaply. Basically, it solves two separate problems for David Einhorn at the same time all while retaining some value for him and his investors.

Business Structure

Green Brick Partners is structured in a way that reduces execution risks while still allowing the company to take advantage of some of the upside from a strong residential real estate market. The company owns 50% controlling stakes in the following four homebuilders: CB JENI Lifestyle Homes, Southgate Homes, The Providence Group, and Centre Living Homes. All of its homebuilders operate either in the Dallas/Fort Worth area or Atlanta area. Below is the corporate structure:

[charts and tables deleted]

Green Brick holds and purchases land for development. Its land inventory was built up starting in 2009 and was purchased at likely some distressed prices. It is a pretty good assumption that a portion (likely around 25%) of the land inventory held on the company's books is worth considerably more now than when it purchased it. Green Brick develops the land and then provides financing to its controlled homebuilders to build on them or sell them to third parties. The controlled homebuilders are obligated to finance all properties and construction through Green Brick. Green Brick gets to participate in the profits from the residual profits of its controlled homebuilders as well. Through this model, Green Brick derives revenue through three channels; sale of residual units, sale of land and lots, and interest and fees associated with construction financing.

These three revenue sources tend to vary wildly based on when lots are being sold, developed, or constructed upon. These quarterly variations are likely one reason why the stock is so cheap right now. Last quarter, the company reported net income of just $2.8m (an all-time low since becoming public), and it cut the full-year guidance. The explanation for this rough quarter and guidance cut was explained via a press release in November 2015:

“Due to a number of factors including weather, new community development, labor shortages and an extended building cycle pushing back closings in its core markets, the company is amending its previously disclosed 2015 guidance."

It sounds in part like timing and in part like market effects that actually highlight the tight housing markets in which the company operates. The underlying fundamentals of the company and the housing markets it operates remain strong, and the weakness was not indicative of an impairment of the long-term business prospects. The management of the company focuses on the long-term prospects of the business and does not try to game the quarterly EPS, which I always think is a positive when looking into company management.

Management & Business Philosophy

Understanding management and its long-term incentives is important to understanding the long-term prospects of any company. As I highlighted above, Green Brick was founded and is run by Jim Brickman and David Einhorn. Mr. Brickman is the current CEO of Green Brick. He has 35 years of experience within the real estate industry. Reading transcripts from previous investor calls and press releases, Mr. Brickman continually stresses that they manage the company for the long term and they are building a sustainable long-term land development and homebuilding business. Mr. Brickman is a substantial owner of the company, owning 3.2% of it directly and more of it through family trusts. He is what I would call an owner operator, as he owns a significant stake in the company while he runs it.

Mr. Einhorn is a significant shareholder, owning 49.4% of the outstanding shares of Green Brick and is the chairman of the board of the company. Green Brick is a core holding of his, as he founded the company and shares his "Greenlight" name with it. GRBK is a long-term vehicle for Einhorn set up to achieve +20% returns on equity over the long term through the structure he and Brickman designed. While Einhorn has received some flack lately from some of his recent investment mistakes, his long-term track record speaks for itself. I tend to believe that the structure is unique and reduces risks while incentivizing its controlled homebuilders to build efficiently, which Einhorn and Brickman leverage to build long-term value.

Sources Of Value & Valuation

Green Brick has two balance sheet items that I believe the market is currently undervaluing. Much of the land held on the company's balance sheet is held in inventory at a cost basis, meaning it largely undervalues those assets. Specifically, the land purchased between 2009 and 2012 is likely held at a discount to current market prices. It is hard to tell exactly how much of its land that was purchased at distressed prices still sits on its balance sheet, but based on the rapid growth of the land in inventory over the last five years, I suspect it must be below 25%. The current land inventory is held at $318m, which may be worth $350-400m at current land prices. It is very hard to tell, but you can assume it's worth at least book value, call it $300m. The second balance sheet item that should benefit Green Brick for the next few years is $83.4m in deferred tax assets related to the BioFuel Energy shell company that Green Brick assumed in 2014. Both of these items alone likely cover the current enterprise value of the company at $300M, which basically gives you the operating business for free. That is embedded value. Another way to look at it is, if you were going to try and rebuild this company today, what would it cost. It would cost at least $500m to recreate Green Brick for the land, NOLs, and the stakes in the homebuilders.

A company like Green Brick can be valued in two different ways. The first way is via a discounted cash flow analysis focusing on the future cash flows of the business. The second way is via a sum-of-the-parts analysis evaluating the current valuation of the assets on its balance sheet and then adding market valuation assumptions of the operating business on top of that. Please note this valuation does not take into account the recent announcement of its Frisco Springs development or the associated debt it took on in order to facilitate that transaction.

Utilizing a DCF Model focusing on the future cash flows of the company, I calculated a per share value of $9.14. See below a summary of that Model. This gives little value to its embedded balance sheet value (discount land and tax loss assets).

Utilizing a sum-of-the-parts analysis, which may be slightly more appropriate as the company has significant embedded balance sheet value, I calculated a value per share of $11.70. I assumed an EBITDA valuation of 4x for the current land development and homebuilding operating businesses and a 10% mark up on the valuation of its inventory due to the fact, I believe, some of it was purchased at distressed prices during 2009-2012. See below a summary of the model:

Blending the two valuation methods, I came to a target price of $10.55 per share.

Conclusion

Green Brick Partners is a great value at $5.75 a share if you believe the operating model is worth anything, and likely a fair value just for the balance sheet assets. The current net current asset value of the company is $5.05 per share, which even understates the current value of the land inventory that the company holds on its balance sheet. I believe shares in the company are worth around $10-11, roughly 83% upside to the current share price of $5.75. The management and insiders involved are incentivized and aligned to deliver long-term value to shareholders, which will be realized over the next few years as the company's operating history grows and the underlying value of the land is realized.

http://seekingalpha.com/article/3855996-green-brick-partners-uniquely-structured-land-developer-significant-embedded-value