The immediate thought that came to my mind after reading John McManus’s summation (in builderonline.com) of Tri Pointe Homes’ $2.7 billion acquisition of Weyerhaeuser Co.’s homebuilding division?
I will acknowledge that other thoughts came to mind, and this particular thought did not come as a comparable transaction, or as a valid/fair comparison for how or why Tri Pointe has been assembled and how it will necessarily be managed, versus how Fortress Group was assembled and was then managed.
Rather, the chronicle of Fortress Group is simply a lesson – or a reminder – for any homebuilding enterprise considering the consolidation route through public ownership.
The story of Fortress Group was detailed by Gerry Donohue in the October 2002 issue of Big Builder:
It is a story that some of us who were variously involved with Fortress – Ed Horne, George Yeonas, Mike Hollister, Jamie Pirrello, myself, among others – have discussed from time-to-time.
One of a number of fashionable rollup consolidations of private companies in the 1990’s, Fortress Group completed its IPO in April 1996. As Donohue reported, the anticipation was industry domination through economies of scale and access to public money, and the opportunity for owners of the acquired companies to liquefy their investments at a public multiple.
The IPO raised $27 million in equity and raised another $100 million in bonds, small by today’s standards. After paying all of the expenses of its startup, Fortress had $11 million in cash and $100 million of long-term debt, resulting in a 9:1 D/E Ratio, which – for a startup – is only excessive if it doesn’t work, i.e., if growth doesn’t outpace the debt service.
Fortress started with four building companies and grew to 13 building companies by 1998; by July 2002, it had sold all of its operating assets and ceased operations. The terms and the amount of the bond financing was the issue. During that four-year period, the company cannibalized itself, selling off building operations to service and retire debt, until it was too small to continue.
From early-on, the signs were there. Fortress was generating nowhere near the margins that it needed. But, signs are symptoms, not causes.
Donohue identified four factors that led to the demise: (1) Fortress failed to act like a publicly-held enterprise, taking seriously its quarterly forecasts; (2) it couldn’t attract the institutional investors that could create the active market Fortress needed to bid up share prices; (3) other publics – like Pulte, DR Horton, and Lennar – were performing far better; and (4) most importantly, Fortress wasn’t realizing the operational benefits from consolidation that it should have.
This last factor, Donohue said, was the most important. Gross Margin, which should have risen due to economies of scale, actually fell. Net Income Margin, which should have risen because of access to public financing, also fell.
One of the first problems Donohue identified was that the original team were financial people, not operators. Bob Short, the owner of one of the four original companies that were rolled up, said, “They had little concept of how to run the company after the rollup was done.”
“The original concept of Fortress was for the individual operating companies to have a large amount of operational autonomy”, Donohue reported. “The central office would merely be a source of capital.” Short agreed: “We had a great deal of diversity in the operations . . . on top of that, you had some pretty diverse personalities and strong egos.”
In 1999, the board brought in George Yeonas as CEO. Yeonas worked to integrate the building companies into a single operational entity, a project involving almost everything in the operating model, including human resources, information technology, culture, and strategy. This is the point where I was brought into the effort. My small part was to document, improve, and standardize the business processes across the enterprise.
I can attest to some of the deficiencies and the difficulties; every building operation Fortress acquired had its own operating and information system, its own culture and business model, its own way of doing everything, with completely different community and plan portfolios; the dissimilarities that existed between building operations are hard to overstate. There was no way to even consolidate the financials – Fortress was a roll-up with no ability to roll-up.
In order to make business sense – in order to make economic sense – consolidation through merger and acquisition has to be about the quantum of value-added, about generating additional benefit in excess of additional cost, about creating/providing opportunity that would not otherwise be available. Otherwise, it shouldn’t be done. The task of increasing/expanding value-added might be easier to accomplish through de novo expansion than it is through the acquisition of existing operations, but the requirement still applies.
Donohue concluded: “The company was a product of the belief that all that was necessary to succeed was public money and growth. In every industry, small, privately-held companies were rolled up together and sold in the public markets . . . hailed as the model for the new millennium, they failed because of old-millennium realities – too much debt, and a lack of management, integration, and corporate culture.” (emphasis added)
What are the lessons?
I think one of the key issues – the one that must be resolved upfront – is to draw a distinction between the things that work best when standardized (code, in this case, for things that should become national standards), and the things that are deserving of more flexibility, more responsiveness to local requirements.
Homebuilding will never be just another type of manufacturing; in particular, the supply chain for homebuilding is likely to remain radically different, and the degree of beneficial standardization will always be less than other industries.
Fortress made the mistake of buying whatever companies were available, without regard to how the vast differences would be bridged to build national standards. Fortress had no plan, but it is not certain whether any plan would have worked. There were too many differences.
Often, it is a decision of what needs to operate in the foreground, and what can be allowed to operate in the background, what needs to be customer-facing, and what does not. Once the distinction between what must be standardized and what can be left to regional or local discretion has been clarified, I think it becomes an issue of getting the other things right.
Getting the right things right is not a new admonition. It is the same one that Treacy and Wiersema were making almost 20 years ago when they wrote The Discipline of Market Leaders: Choose a value proposition, commit to delivering extraordinary levels of distinctive value to a narrowly-defined segment of the value spectrum, then make the operating model – the processes, the organizational structure, the management systems, the type of employees, the culture – support the value proposition.
The projects and details of an implementation plan flow from there; it’s involved, but simple enough to understand. Surely, the management world that has to execute the current wave of IPOs understands the prerequisites and requirements this environment presents, and has prepared to address them.
Fortress failed to do it. Surely, that lesson has been learned.