1. Presented by: Andre Lodhar Roy Fernandes David Storey Sarah Witol
Manufactured Homes
Presented by: Andre Lodhar
Roy Fernandes
David Storey
Sarah Witol

2. Manufactured Homes Founded in 1975 with 2 retail stores
By 1987 possessed a network of 120 retail outlets, all in Southeasters U.S.
Potential customers were those who could not afford traditional housing, or were looking for a second home
Customers were typically in the 18 to 40 age range who earned $20K per year or less

3. Manufactured Homes con’t
Mobile home ranged in price and in size, but Manufactured Homes mainly sold the lower end units
Behind the industry average of 30% sales to higher models, only achieving 20% of their volume but did not care
Targeted low end market :
They felt that by fulfilling an essential housing need sales were not affected by general ecomomic conditions
Customers to work very hard to keep their primary residence

4. Porter’s 5 Forces Buyer Power
Many sellers of mobile homes, but has targeted the low end market, thus price sensitivity is very important
Manufactured Homes allows as little as a 5% down payment to take possession
No real Brand Identity in the market
Buyers are concentrated in areas (close to trailer parks)

5. Porter’s 5 Forces Supplier Power Discounts based on volume purchases
Products are rather standardized (especially low end mobile homes)
Market concentration in specific states
Manufactured Homes has the ability to manufacture homes on their own incase the market outpaces supply

6. Porter’s 5 Forces Barriers to Entry
Capital requirements, to have stock of mobile homes on hand
Distribution areas are concentrated, so high competition in these areas already
Manufactured homes rely on their niche market of low end homes, any other seller could go after that market

7. Porter’s 5 Forces Threat of Substitutes
Depreciation is high on the homes, selling and moving to a different unit is expensive
Purchasers could walk away from their mobile home (force the company to re-claim the home) and purchase a new one
Clients could upgrade with Manufactured Homes as they sell different models

8. Porter’s 5 Forces Rivalry
Competitive advantage for Manufactured Homes are their niche market of low end mobile homes, availability of financing with small down payments
Concentrated strongly in the Southeastern USA where they have a strong presence with 114 outlets in 7 states
Other sellers are concentration on more profitable higher end units

9. Porter’s 5 Forces Rivalry con’t
Strategic stakes are high due to re-possession of homes where people have defaulted on payments, market specific
Low exit barriers to retail outlets, but high barriers to those that manufacture the homes as well

10. Industry Direction
Southeastern USA is the fastest growing market of mobile homes, due to the weather climate, availability of land
Shifting towards higher end mobile homes
Net sales from 1986 are 54% higher than a year earlier, sales in 1985 were 125% higher than the preceding year
Southwestern states starting to experience higher concentrations as well

11. Current accounting Net worth
Cash Other Assets = Liabilities REt Salest Expensest
Net worth
Home buyer makes a down payment and signs an installment contract with Manufactured Homes (assume purchase price of $100,000)
Cash Installment contract Sales
Receivable Revenue
Inventory COGS
Reserve for losses Bad debt
on credit sales expenses

12. Current accounting Net worth
Cash Other Assets = Liabilities REt Salest Expensest
Net worth
Company transfers installment contract receivables to financial institution and receives cash:
Cash Installment contract
(Face value of note) Receivable
Record present value of participation income
Cash Finance Participation Finance Participation
Receivable Income
Company records an expense of the estimate of customer prepayment and defaults
Reserve for losses Credit loss
on credit sales expense

13. Method #2 The cash from the bank is treated as a loan
The company transfers installment contracts with recourse to bank
The company records present value of interest rate differential (spread)
Major advantage of this method is no estimating of credit losses required
According to the SEC this is the method that should be used if estimating ability is poor

14. Method #2 This is the alternative method with no estimating required.
Note there is no receivable for finance participation and the revenue recorded in net worth is only the amount immediately paid by the bank. The portion held is not recorded until it is actually paid back at a later date. (if it is in fact paid at all)

15. Sales Analysis
*assuming that 80% of SG&A is related to the sale of new homes
The sales of new homes is not a significant contributor to Net Income!

16. Income
Two Primary sources of income:
Sales of mobile homes
Finance participation

17. Current accounting Net worth
Cash Other Assets = Liabilities REt Salest Expensest
Net worth
Company transfers installment contract receivables to financial institution and receives cash:
Cash Installment contract
(Face value of note) Receivable
Record present value of participation income
Cash Finance Participation Finance Participation
Receivable Income
Company records an expense of the estimate of customer prepayment and defaults
Reserve for losses Credit loss
on credit sales expense

18. Red Flags Estimates of credit losses: page 194 – 195
Lower interest rates :
Increased refinancing
Shift in demand for Mobile homes to Conventional homes
Increase in number of prepayments
$2M write-off in Q for increase in credit losses
Refusal of finance companies to refinance repossessions
Provision for credit losses in 1986 = $3.8M (p.203 Note 7)
Provision for losses in first 9 months = $318,539 (p.211)
Suggest large Q4 adjustment of $3.5M
Decrease in Finance participation income
increased cash sales
increased non-recourse sales
increased manufacturing sales
decrease in interest rate spread

19. Red Flags P. 192 – Expenses appear to be misstated
P. 193 – Appears that major Q4 adjustments are being made
company not estimating but looking back and adjusting in Q4
P.196 – Subsidiary set up – MANH Financial Services Inc.
banks refusing to finance
banks losing confidence in Manufactured Homes
P. 206 Note 13 – Recognition of $180M debt which is not on the B/S
P. 208 – New item suggests that credit losses and prepayments are a problem
selling installment contracts are becoming a problem
P. 211 – small provision for losses in first 9 months of 1986 but large full year provision (P. 203)

20. Future Potential of MH Investor Attractiveness Factors
MH currently sells a product for which there is no clear demand
Focused strategy targeted at profitable segment of the market
Rapid Growth enabled via backing of large financial institutions (GE Credit, Prudential Insurance)
The company had no problem initially getting all the loans it could handle.

21. Future Potential of MH However,
Business of buying and selling homes does not appear to make money. The finance participation income is what drives the profits
MH has a consistent operating cash flow deficit and is heavily leveraged
Grim looking future due to limited room for error due to leverage and past accounting practices
Finance participation is hurt by prepayments and defaults. Especially prepayments as MH appears to be having trouble estimating leading to large 4th quarter write offs. This is turn is causing the financial institutions to take a more risk averse approach.
Market rates also continue to drop, leading to an increase in prepayments (via mortgage refinancing from current customers).

22. Post-Case Highlights
Loss of $4.5 million in the 4th quarter of 1987 resulting in a $0.8 million profit for the year.
Loss driven by 300% increase in reserve for credit losses appears to have been forced by auditors
Management blames on aggressive marketing program and conservative fiscal policy.
Loss is much larger than that of 4th quarter 1986 as stated in the case. The problems are growing exponentially. Management in denial (to shareholders).

23. Post-Case Highlights cont..
Upon disagreement of the auditors over 1987 interim statement credit loss estimates the company changed auditors.
In effect, the auditor felt that MH was understating the provision for future losses on credit sales and thereby overstating earnings before income taxes.
Bad press not helping things.

24. Post Case Highlights cont…
In 1988 the loss grows to $8.5 million for the year.
Financial institutions were now refusing to accept the transfer of instalment notes seriously impacting the finance participation income.
Customer defaults and pre-payments forced further increases in credit loss reserves.
Severe cash shortage resulted from the operating losses and increases in repossessed homes inventory.
We know what’s coming next……Enron!

25. Post-Case Highlights cont…
SEC announces investigation into MH’s accounting practices primarily focused on the apparent lack of ability to estimate credit losses and thus improperly recognize finance participation income.
Stock price drops significantly after Barron’s publishes an article questioning MH’s accounting practices.

26. What Happened? (1988 figures)
303M was added to install contract receivables and liabilities (to show the loan). The finance participation receivable disappears as well. The held back finance participation income now becomes a liability destroying shareholder’s equity.

27. Debt Ratios (1988 figures)
The increase in the debt/capital ratio shows the high leverage growing exponentially leading to the backing off of the financial institutions.

28. Debt Ratios (1986 figures)
If we include the 180 million in installment sales contracts sold with recourse mentioned in Note 13 as debt, we get a glimpse into the future:
This jump in leverage should have been a warning sign for things to come!

29. Questions ?