Presentation on theme: "Presented by: Andre Lodhar Roy Fernandes David Storey Sarah Witol"— Presentation transcript:
1Presented by: Andre Lodhar Roy Fernandes David Storey Sarah Witol Manufactured HomesPresented by: Andre LodharRoy FernandesDavid StoreySarah Witol
2Manufactured 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 homeCustomers were typically in the 18 to 40 age range who earned $20K per year or less
3Manufactured Homes con’t Mobile home ranged in price and in size, but Manufactured Homes mainly sold the lower end unitsBehind the industry average of 30% sales to higher models, only achieving 20% of their volume but did not careTargeted low end market :They felt that by fulfilling an essential housing need sales were not affected by general ecomomic conditionsCustomers to work very hard to keep their primary residence
4Porter’s 5 Forces Buyer Power Many sellers of mobile homes, but has targeted the low end market, thus price sensitivity is very importantManufactured Homes allows as little as a 5% down payment to take possessionNo real Brand Identity in the marketBuyers are concentrated in areas (close to trailer parks)
5Porter’s 5 Forces Supplier Power Discounts based on volume purchases Products are rather standardized (especially low end mobile homes)Market concentration in specific statesManufactured Homes has the ability to manufacture homes on their own incase the market outpaces supply
6Porter’s 5 Forces Barriers to Entry Capital requirements, to have stock of mobile homes on handDistribution areas are concentrated, so high competition in these areas alreadyManufactured homes rely on their niche market of low end homes, any other seller could go after that market
7Porter’s 5 Forces Threat of Substitutes Depreciation is high on the homes, selling and moving to a different unit is expensivePurchasers could walk away from their mobile home (force the company to re-claim the home) and purchase a new oneClients could upgrade with Manufactured Homes as they sell different models
8Porter’s 5 Forces Rivalry Competitive advantage for Manufactured Homes are their niche market of low end mobile homes, availability of financing with small down paymentsConcentrated strongly in the Southeastern USA where they have a strong presence with 114 outlets in 7 statesOther sellers are concentration on more profitable higher end units
9Porter’s 5 Forces Rivalry con’t Strategic stakes are high due to re-possession of homes where people have defaulted on payments, market specificLow exit barriers to retail outlets, but high barriers to those that manufacture the homes as well
10Industry DirectionSoutheastern USA is the fastest growing market of mobile homes, due to the weather climate, availability of landShifting towards higher end mobile homesNet sales from 1986 are 54% higher than a year earlier, sales in 1985 were 125% higher than the preceding yearSouthwestern states starting to experience higher concentrations as well
11Current accounting Net worth Cash Other Assets = Liabilities REt Salest ExpensestNet worthHome buyer makes a down payment and signs an installment contract with Manufactured Homes (assume purchase price of $100,000)Cash Installment contract SalesReceivable RevenueInventory COGSReserve for losses Bad debton credit sales expenses
12Current accounting Net worth Cash Other Assets = Liabilities REt Salest ExpensestNet worthCompany transfers installment contract receivables to financial institution and receives cash:Cash Installment contract(Face value of note) ReceivableRecord present value of participation incomeCash Finance Participation Finance ParticipationReceivable IncomeCompany records an expense of the estimate of customer prepayment and defaultsReserve for losses Credit losson credit sales expense
13Method #2 The cash from the bank is treated as a loan The company transfers installment contracts with recourse to bankThe company records present value of interest rate differential (spread)Major advantage of this method is no estimating of credit losses requiredAccording to the SEC this is the method that should be used if estimating ability is poor
14Method #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)
15Sales Analysis*assuming that 80% of SG&A is related to the sale of new homesThe sales of new homes is not a significant contributor to Net Income!
16IncomeTwo Primary sources of income:Sales of mobile homesFinance participation
17Current accounting Net worth Cash Other Assets = Liabilities REt Salest ExpensestNet worthCompany transfers installment contract receivables to financial institution and receives cash:Cash Installment contract(Face value of note) ReceivableRecord present value of participation incomeCash Finance Participation Finance ParticipationReceivable IncomeCompany records an expense of the estimate of customer prepayment and defaultsReserve for losses Credit losson credit sales expense
18Red Flags Estimates of credit losses: page 194 – 195 Lower interest rates :Increased refinancingShift in demand for Mobile homes to Conventional homesIncrease in number of prepayments$2M write-off in Q for increase in credit lossesRefusal of finance companies to refinance repossessionsProvision 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 $3.5MDecrease in Finance participation incomeincreased cash salesincreased non-recourse salesincreased manufacturing salesdecrease in interest rate spread
19Red Flags P. 192 – Expenses appear to be misstated P. 193 – Appears that major Q4 adjustments are being madecompany not estimating but looking back and adjusting in Q4P.196 – Subsidiary set up – MANH Financial Services Inc.banks refusing to financebanks losing confidence in Manufactured HomesP. 206 Note 13 – Recognition of $180M debt which is not on the B/SP. 208 – New item suggests that credit losses and prepayments are a problemselling installment contracts are becoming a problemP. 211 – small provision for losses in first 9 months of 1986 but large full year provision (P. 203)
20Future Potential of MH Investor Attractiveness Factors MH currently sells a product for which there is no clear demandFocused strategy targeted at profitable segment of the marketRapid 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.
21Future Potential of MH However, Business of buying and selling homes does not appear to make money. The finance participation income is what drives the profitsMH has a consistent operating cash flow deficit and is heavily leveragedGrim looking future due to limited room for error due to leverage and past accounting practicesFinance 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).
22Post-Case HighlightsLoss 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 auditorsManagement 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).
23Post-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.
24Post 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!
25Post-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.
26What 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.
27Debt 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.
28Debt 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!