WCI bets on Bal Harbour

WCI bets on Bal Harbour

HOMEBUILDING by Jean Gruss | Editor/Lee-Collier

WCI Communities' executives fight to keep the company's cash coming in as they soothe anxious lenders who are owed $1.9 billion. Meanwhile, billionaire investor Carl Icahn and two hedge fund allies formed a majority on a newly created board to be elected Aug. 30.

WCI Communities, in a fight for its corporate life, is banking on one project to carry it through this year: One Bal Harbour in condo-busted Miami-Dade County.

WCI Chairman Don Ackerman and President and CEO Jerry Starkey are counting on that luxury condominium project in the posh enclave of Bal Harbour to generate enough cash to carry the company through one of the worst real estate downturns in decades.

Real estate investors and lenders are watching closely. The Bonita Springs-based builder is considered a bellwether on the health of the residential real estate market. As one of the few publicly held homebuilders in Florida, its finances provide a glimpse into the usually private world of condo developers.

Starkey and Ackerman are confronting a crisis that even the best of turnaround specialists would find daunting: how to keep the company alive when its operations are losing money, cash on hand is only two times quarterly interest expense and orders are down 41%.

They'll also have to contend with a new board that is likely to be elected at WCI's annual meeting Aug. 30. The new directors will include billionaire investor Carl Icahn and two of his lieutenants, as well as hedge-fund managers from S.A.C. Capital Advisors and Sandell Asset Management. Together, Icahn and his hedge-fund allies are the company's three largest single shareholders and will constitute a majority on the board. WCI's new board will include just three members of the current board: Ackerman, Charles Cobb Jr. and Hilliard Eure III.

Even if a new board replaces the current management, any new leaders will have to be sure all the buyers who signed contracts for the condos at One Bal Harbour show up with the money to close on their units by the end of the year. (WCI executives and board members couldn't be reached.)

The $350 million in cash WCI hopes to generate from One Bal Harbour will be used to pay down WCI's towering debt, now totaling nearly $1.9 billion. WCI's bonds have been trading at distressed levels lately and that's a sign lenders aren't confident in the company's future prospects. Both Standard & Poor's and Moody's Investors Service downgraded WCI's bonds two weeks ago to a few notches above default levels with a "negative" outlook.

One ray of hope emerged Aug. 20 when WCI and Icahn announced they were exploring the possibility of raising new capital to strengthen the company's balance sheet by selling additional shares at a discount to existing shareholders.

Bal Harbour is one of the most upscale communities in Miami-Dade County and WCI's project there is a stunning waterfront complex of 185 condos and 111 condo-hotel units. Its projected sell-out value is $488 million and it will generate $350 million of free cash flow, the company says. That's about half the total free cash flow the company says it will generate this year.

But much has changed since buyers clamored to sign contracts to buy all the units at One Bal Harbour in late 2003 and 2004. Miami is experiencing a condo bust that experts say will only get worse because 20,000 more units are under construction.

Buyers are walking away from contracts they signed during the boom and WCI is projecting 12% will default on all its towers (WCI doesn't project default rates on individual condo towers). Other luxury homebuilders are reporting much higher cancellation rates. For example, Pennsylvania-based Toll Brothers, a builder of luxury single-family homes, says the most recent quarter's cancellation rate reached 37%.

"Because of the shakiness of the marketplace, it's our opinion that they're going to see higher cancellation rates than their projections," says Jack McCabe, a development consultant in Deerfield Beach. "We're seeing some projects with 30% to 40% cancellations."

However, McCabe cautions that One Bal Harbour might perform better because of its unique location. Another plus: buyers bought the condos at 2003 prices, two years before prices reached their peak in 2005.

Still, buyers agreed to pay an average $1.9 million per condo. Condos ranged in size from 2,000 to 8,500 square feet and cost from $1 million to more than $10 million.

The key for WCI now is to hold contract-holders' hands and make sure they show up at closing when the building is completed later this year. Their big concern is how many of those buyers were speculators who intended to flip, or immediately turn around after closing and sell their units for what they hoped would be a higher price. Now, if they can't sell them at a higher price, WCI executives fear they may walk away because they figure they'll lose less money by forgoing their deposits.

There are now 116 condos for sale at One Bal Harbour, says Peter Zalewsky, a real estate broker whose firm, Condo Vultures Realty in Bal Harbour, represents buyers. "A lot of Realtors bought in there with the intention to flip," Zalewsky says.

But One Bal Harbour may be the least of WCI's challenges.

"We tentatively concluded One Bal Harbour is not where the problem lies," says Eric Landry, an analyst with independent research firm Morningstar in Chicago. He calls One Bal Harbour "an A+ property in an A+ area."

Landry says Bal Harbour is such a global wealth magnet that buyers are unlikely to default. He says the sale listings are higher than the prices buyers agreed to pay for them in 2003, an indication buyers aren't scrambling to get out of their contracts.

Instead, Landry is more concerned about condo towers now under construction or recently completed and for which buyers signed contracts in 2005 at the height of the boom. A Web site unaffiliated with the company, wci-cancellations.com, tracks deeds on various WCI projects. For example, WCI says 56% of the units at the recently completed Lesina at Hammock Bay in Collier County have been sold, but wci-cancellations.com reports 31% of them have been deeded.

In a note to clients, Landry says WCI's contract receivable balance totaling $1 billion "remains tenuous." That's because WCI uses the percentage-of-completion method to recognize revenue on its tower condos. The account grows as WCI recognizes noncash revenue throughout the construction process. But Landry says that may "swell to levels significantly above our comfort zone" if cancellations continue to rise.

Anxious lenders

WCI has been negotiating with a consortium of lenders over the terms of its loans. On Aug. 20, executives said they'd reached an agreement to amend the company's credit and loan facilities and avoid default. Although the agreement gives WCI executives leeway to manage through the downturn, bondholders are watching carefully.

In a recent downgrade of WCI's credit, rating agency Moody's says "the company's ability to pay down any significant amount of debt in 2007 depends in large part on timely and low-defaulting tower unit closings."

WCI's bonds have been trading at a steep discount, reflecting lender angst. For example, WCI's bonds maturing in 2013 recently traded at 72 cents on the dollar, versus 100 cents on the dollar in March, according to NASD BondInfo.

WCI executives have insisted the company has sufficient liquidity and available credit. But now, the company says it might have to raise more capital by offering shareholders discounted shares.

"The new shareholder representatives on the board have expressed an interest in exploring a rights offering on terms and conditions favorable to all shareholders, should it be determined that additional capital is required," Ackerman says in a statement.

WCI condo

revenues drop 99%

If WCI Communities is a gauge of Florida's condominium market, then its recent quarterly results show how difficult it is to sell condos today.

That will make it even more important for executives at the Bonita Springs-based homebuilder to make sure all those buyers who signed contracts to buy WCI condos during the boom years show up for closing this year. If buyers back out, it's going to be difficult to resell the defaulted units.

For the quarter ending June 30, WCI's condo division revenues fell 99% to $2.1 million from $214 million in the same period a year ago. The Bonita Springs-based company says the decline was due primarily to buyers who defaulted and construction delays. In fact, condo orders were negative as 68 defaults outnumbered 11 gross new orders during the recent quarter. That led to a reversal of $59.3 million.

In addition, the revenue numbers are skewed by the fact that 21 condo towers were under construction in the second quarter of 2006, versus seven in the most recent quarter.

For the six months ending June 30, six condo towers with 625 units were completed and delivered with 79 defaults. Year-to-date, the company says its overall default rate is 17%.

During a conference call to discuss quarterly earnings, WCI CEO Jerry Starkey says the company will increase focus on reselling defaulted and unsold units.

Icahn, top investors gain board control

When WCI Communities' stock fell more than 60% this year, some observers speculated Carl Icahn had abandoned his bid for the company and perhaps sold his shares.

Not anymore.

Icahn and the WCI board that spurned his $22-per-share offer in the spring agreed to form a new board of directors that will include the billionaire investor and two of his lieutenants. In addition, at least two other hedge-fund allies will join Icahn on the board: S.A.C. Capital Advisors and Sandell Asset Management. Icahn, S.A.C. and Sandell are the three largest single shareholders and they will essentially have gained control of the board when they are elected Aug. 30.

The latest securities filings show Icahn still owns 14.5% of the company's shares with a market value of $102 million, according to recent filings. But WCI agreed as part of its deal with Icahn to change its poison-pill provision to allow any single shareholder to acquire up to 25% of the company, up from 15% earlier.

Meanwhile, New York-based hedge fund manager Steven Cohen's S.A.C. Capital Management is the company's third-largest holder, with a 9.5% ownership stake valued at $85 million.

It appears that Cohen is angling to acquire more shares too. On Aug. 17, S.A.C. received clearance from the Federal Trade Commission to "enter into a transaction" with WCI, according to Dow Jones Newswires. The nature of the transaction wasn't disclosed.

WCI Chairman Don Ackerman is the only company insider with a significant stake, controlling 8.2% of the shares outstanding.

Holders of 5% or

more of WCI stock

Holder name % of shares outstanding

Icahn & Co. 14.5%

Sandell Asset Management 9.7%

S.A.C. Capital Management 9.5%

Highbridge Capital Management 8.5%

Dimensional Fund Advisors 8.4%

Don Ackerman 8.2%

Hotchkis & Wiley Capital Mgmt. 6.6%

Canyon Capital Advisors 5.9%

Marvin Schwartz 5.3%

Source: Thomson Financial

REVIEW SUMMARY

Industry. Homebuilding

Company. WCI Communities

Key. Maintaining free cash flow is critical to surviving the residential real estate downturn.