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Welcome to the 112th Pari Passu newsletter.

While this publication strongly focuses on restructuring, sometimes, it is worth diving into stories and lessons from the healthy side of things. Today, we are exploring the amazing story of NVR.

While this company has a Chapter 11 under its belt (we will never get too far from our favorite topic), this is the unique story of a 1,000-bagger that features possibly the greatest pitch ever in the history of the Value Investor Club (VIC).

Let’s get to it.

Table of Contents

• Founding

• Fresh Growth

• Modern NVR

• Business Overview

• Business Model

• Key Business Metrics

• Financials

• VIC Pitch

• Business Fundamentals

• Lessons Learned

Founding

The origins of NVR began 76 years ago in 1948 with a Pittsburgh-native man named Edward Ryan. Ryan was a discharged Army Air Corps lieutenant from World War II that also enjoyed the work of carpentry and house building. One day, Ryan was approached by a buyer after he built a house meant originally for him and his wife. This interaction inspired him to start his own business called Edward M. Ryan, Inc. Builders in 1948, which eventually turned into the incorporated Ryan Homes in 1961 [1]. 

Within the management of Ryan Homes, an executive named Dwight Schar was on the rise to become one of Ryan Homes’ most important assets. Between 1969 and 1973, Schar was at the front of the company’s land acquisitions and developments in Ohio, Kentucky, and Indiana. Schar then became Vice President and Group Manager of the Washington D.C. operations during 1973 to 1977.

In 1980, Dwight Schar made the most of his expertise and started his own home building business called NVHomes in the North Virginian area. NVHomes proved to be very successful and were already making $1 million in earnings by 1983. By 1986, NVHomes strongly compounded (practically doubling every year) their earnings to $14 million, which lead to the limited partnership of NVH L.P. and its initial public offering at $289 per share. Right after in 1987, Dwight Schar made the pinnacle decision to acquire his former employer Ryan Homes through a leveraged buyout for a total valuation of $312 million [2]. It was at this point that the company was renamed to NVRyan L.P. 

In the meantime, the 1980s served to have fantastic fundamentals for the homebuilders business as the American economy was very strong. Under Reagan’s presidency, LPs in real estate also highly benefited from favorable tax laws which allowed these businesses to write off losses that were incurred from real estate investments. This enabled a period for NVR to tap into ‘easy’ capital, where Schar turned to leverage and bought a lot of land for future use. By 1988, earnings for the company reached an impressive $33.5 million. The company was then renamed again to NVR L.P. in 1989 [3]. 

The end of the 1980s and turn of the decade did not prove to be fruitful times for NVR as compared to before. As a result of the Tax Reform of 1986, the tax benefits NVR thrived under were being slowly reduced over time, which made it harder for NVR to gain access to capital. As many similar companies experienced the same problem, there was essentially an oversupply of houses in many US regions. This, in addition to a slumping economic recession towards 1990 where interest rates rose sharply into double digits, led to a considerable decrease in the demand for homes all the way through 1991, with industry-wide completions falling by more than 50%. 

This period was very difficult for NVR’s finances as sales and earnings were harshly impacted; the company experienced an earnings loss of $260 million in 1990. Sales went from $1.15 billion in 1988 to $600 million in 1991, roughly a 50% decrease. NVR’s assets lost a lot of market value as well, going from a valuation of $2.4 billion in 1988 to $1.6 billion in 1990, a 33% decrease. To finally put it into picture in terms of houses, NVR built just 3831 housing units in 1991 compared to 5240 in 1990, a 27% decrease. After realizing these numbers, NVR was severely distressed and was heading towards an unavoidable bankruptcy in the early 90s [3].

Reorganization

In 1990 and 1991, a large reorganization made way as Schar took a step back from the typical homebuilding business model and noticed the many flaws that came with it as seen during the hardships from the early 1990s recession. The main issue at hand was that during these periods of financial distress, the land values were locked in with homebuilders and served essentially as a ‘speculative’ investment. Management reflected from this dire situation and decided it was time for a critical strategy change at NVR. Not only did NVR previously succumb to a lot of debt from the leveraged buy-out of Ryan Homes in 1987, but it was also in a dangerous financial state after the years of  ‘easy capital’ it pursued during the 1980s.

First, a financial subsidiary of the company (NVR Finance) was established to take on the role as both a mortgage and savings bank. This allowed the company to finance about 75% of NVR home sales by assuming the mortgage origination and servicing. NVR Finance proved to be a clever strategy to allow the company to realize more earnings from its main homebuilding operations. In addition, NVR started to adopt a ‘preorder’ method in which its operations only began building homes as they were ordered. This was performed as NVR would develop a model home in the center of a neighborhood that was basically the sales center, which contrasted with the prior homebuilder business model that relied on speculative home development. 

Lastly, the revolutionary idea that indefinitely changed NVR was the decision to switch to an options-based business model, where NVR would write options on land rather than spending capital on it. At only 5-7% of the land capital cost, NVR’s options were only exercised after home buyers were qualified for their mortgages. This allowed NVR to be extremely capital efficient and even boosted development timelines, as premanufactured segments of homes were already handled in off-site facilities. As a result, NVR boasted an average 86 day home completion rate in 1992 [3]. As we will dive later into this article, this methodical dynamic between NVR’s sales and working capital requirements was a key part of Norbert Lou’s famous VIC thesis in 2001.

Despite all of the efforts management took within this period, NVR declared Chapter 11 bankruptcy in 1992. For starters, the Chapter 11 bankruptcy (aka ‘reorganization’ bankruptcy) allowed NVR to restructure its debts and operations while continuing its core functions.  The bondholders agreed to trade their debt claims for equity in the reorganized company in order to improve the balance sheet and avoid absolute financial collapse. By converting debt into equity, creditors then also avoided the potential massive losses if the company liquidated under Chapter 7. Fortunately, this plan allowed NVR to continue its operations, workforce, customer relationships, and market presence as it was still the 6^th largest developer of single-family homes by 1993.

Fresh Growth

NVR started their strong comeback once the American economy was back in the upswing again. Due to the new capital light strategy, NVR had a competitive advantage that allowed the company to grow efficiently through its dominant margins and outstanding ROIC. At the same time, it seemed Schar made sure to never rely on heavy leverage again alongside owning empty lots of land on the balance sheet. Over the 5 year period from 1993 to 1997, NVR was able to bring earnings from a loss of $24 million to a positive $29 million [4]. At the same time, NVR’s stock hit its historical bottom at $5.5 per share in late 1994, or an implied market cap of $94 million. NVR’s listing on the exchange had a significant impact on Wall Street’s views on homebuilders, as the industry was seen to be very speculative for a long term investment. However, over time, NVR inspired a broader confidence in the industry as the company was seen to be ranked amongst other strong performers in the Forbes magazine [3]. 

A core part of NVR’s strategy that emerged from this new phase was to focus on being one of the largest homebuilders in their locations. NVR eventually became a very prevalent home builder across 16 cities and 10 states, mostly from the East Coast and Midwest like New York, South Carolina, and Ohio. NVR also was Washington D.C.’s largest builder, which took up a considerable amount of NVR’s total sales. As a response, NVR looked to geographically diversify and acquired Fox Ridge Homes in 1997, which was the second-biggest homebuilder in Nashville, Tennessee [5]. In 1999, NVR then acquired First Republic Mortgage as an addition to its mortgage business. In the same year, the company then reorganized itself as NVR Inc., a holding company for NVR Homes and NVR Financial Services [3]. 

It was also in this period of the late 90s that NVR incorporated their heavy buyback strategy. In 1994, NVR had a total number of 16 million outstanding shares; this was reduced 50% to 8 million shares just 5 years later by 2001 [6]. In addition, NVR’s earnings compounded at a robust CAGR of 68% from $29 million in 1997 to $237 million in 2001 due to the unique business model, acquisitions, and strong market positions (#1 or #2) in their strategic locations [7]. As a result, NVR’s share price experienced a 20-bagger from being just $9 in 1996 to roughly $180 in late 2001. NVR was then one of the several companies that participated in the housing construction’s outperformance of every other sector in the Dow Jones and S&P groupings in 2001 [3]. Notably on June 20, 2001, a user going by charlie479 posted a write-up on Value Investors Club pitching his long idea in NVR’s equity.

Fortunately for NVR, its meteoric rise did not come close to ending any time soon (or so everyone may have believed). NVR still saw to enjoy the ranking of the 6^th largest builder in the nation during the early 2000s. The company’s earnings continued to compound to a steady level at a 15% CAGR from $330 million in 2002 to $587 million in 2006 [8]. Over this time, Schar’s legendary run as a CEO at NVR came to an end in 2005, where he transitioned to the board and passed the torch to the company’s CFO Paul Saville. It was truly an exciting time to become the CEO of one of the strongest performing companies in the market, as NVR’s stock reached an outstanding $900 per share in July, 2005. Unfortunately for NVR however, the company’s earnings did peak in 2005 with a global financial collapse on the brim, as the $697 million mark was not surpassed until 2018.

Modern NVR

The Great Financial Crisis that emerged from 2007 through early 2009 was one of the hardest times in modern American history for businesses. Out of all the industries, businesses involved in real estate, especially homebuilders, were impacted the most in a crippling manner during that timeframe. Unfortunately, many companies incurred a lot of debt leading to the crisis while they were buying a lot of land, which led to disastrous results [9]. NVR, unsurprisingly, was not able to escape from the grim environment of the overall industry and economy. As earnings peaked at $697 million in 2005, by 2008 the company’s earnings decreased 85% to $100 million, a level not seen since 1999. At the same time, NVR broke away from its heavy buyback tradition and issued 900 million shares from 2008 through 2010 (5.2 million total shares to 6.1 million) [6]. NVR’s share price subsequently fell to $340 per share (a relative bottom) by February, 2009, a decline of more than 60% from its previous all-time high.

As catastrophic that sounds for NVR, the company’s survival was a testament to how strong the reorganized business model truly was, as well as the shrewdness of NVR’s management. For instance, as Saville experienced the near collapse of the company back in the 1992 bankruptcy alongside Schar, management learned from its past and NVR strategically used its resources to pay off its debt. In 2006, NVR had $350 million in notes and loans payable [10]; this was decreased down to $90 million by 2010 [11]. NVR also posited a really impressive feat throughout the Great Financial Crisis – out of its subgroup of companies including Toll Brothers, Dr. Horton, Lennar, and PulteGroup, NVR was the only homebuilder that remained profitable over the period. This could be attributed to its options-based business model as it helped maintain higher margins and keep the balance sheet relatively cleaner [9]. Lastly, throughout the crisis, NVR still expanded into Florida, Indiana, and Illinois for a total of 9 cities. It was by the end of the crisis that the market realized there was something truly unique about NVR. NVR’s P/E would float around the mid-to-high single digits before the crisis; this changed to near 20 and even higher after, which reflects a well-earned multiple expansion for the company [12].

Similar to that of the late 1990s to early 2000s, the 2010s was a fundamentally very strong period for the homebuilding industry and NVR as the economy was supported by the…

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