Manufactured Homes

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Background Manufactured Homes Inc (“MH”) is a rapidly developed company in mobile homes industry, with annual sales ballooning to about $180 million in 1987 from $7 million in 1982. The company developed rapidly and by March 31, 1987, had a network of 120 retail outlets located in seven southeastern states. The company went public in 1983 and was listed on the American Stock Exchange in January 1987. The late 1980’s was marked by a recession in the US. Although mobile homes provided an affordable substitute for many consumers, the industry faced a difficult selling environment and was highly competitive at that time. MH specially focuses on low-end of the market that solidified its niche position in the market. 85% of the company’s retail centers were located in North and South Carolina, Alabama, Georgia and Florida), capturing about 2.5% of market share nationally in 1986. Based on this market share, the ability of negotiations with suppliers and manufacturer is not as good as it expected or not strong in the market.

Strategies The target market of MH is low-income category, typically between 18-40 years old, blue-collar workers in manufacturing, service, and agricultural industries, who earned approximately $20,000 per year. Considering this target market, and strengths and weakness of the company, its core strategy is to be a cost leader, and increase market shares, which relying heavily on the ability of control cost, marketing and sales of mobile homes. However, the increase rate of cost of sales is greater than that of net sales. Net sales rose 13.88% between 1986 and 1987, while cost of sales rose around 62.71%, much higher than expected. This result shows that MH’s performance is clearly deviating from its strategies, and these rising cost may make it more difficult to pass long costs savings to its consumers in the long run. Besides, MH has manufacturing and financing services after acquisition and creation, but the function of these services do not directly align with overall fundamental strategy of the company as a cost leader. On one hand, according to the management statement, MH acquired a company, named Craftsman Homes, to add

manufacturing service to avoid supply shortages and to produce targeted customized products. However, this is not accorded with the core strategy as a low cost provider but differential, another popular strategy. Besides, there is no evidence of threaten to supply shortages, so the designed function of the manufacturing service does not agree with reality. On the other hand, MH created a financial service, called MANH, to facilitate marketing of new, repossessed, and pre-owned homes. However, this subsidiary works to offer risky loans to the group, when other outsides financing sources would not provide, and is not connected with marketing strategy. Overall, the manufacturing and financing business services were not aligned with the MH’s core strategy as a cost leader that used purchasing power with manufacturers to succeed in market.

Risk When we talk about that if or not should we invest in MH,never can we ignore the risk behind its main revenue resources which contain the revenue from sales of good and the revenue from selling its installment contracts to unrelated financial institution and the risk behind its low cost strategy. The two risks MH faced are Credit risks and prepayment risks. The target market, we mentioned above, is the low-income category. The company sold mainly on credit, with a 5-10% down payment and an installment sales contract for the remaining amount over 15yrs. Once it got the contract, it typically sold these contracts to unrelated financial institutions. However these borrowers usually have low credit scores, face bankruptcy or have struggled financially, so it has high default risk. Although MH had sold these contracts to other parties, it was still responsible for payments to the financial institution if the customers defaulted. Once the default occurred, the MH would renovate and refurbish them and have them resold at a price equal to or greater than the loan payoff. However they didn’t give any information about the cost for the renovation and refurbishment. Although they maintain a financial reserve equal to 1.7 percent of total net contingent liability for credit sales. But we think it was no enough to cover the risk they faced. The prepayment risk

involved the early unscheduled return of principal on mortgage-backed securities. On the other hand, once prepayments happened, there is no Credit risk anymore because the consumers had paid the balance off. But the prepayments would reduce the other resource of revenue, the spread interest from the third party financial institution. Since these loans often had no prepayment penalties or application fees, borrowers could easily refinance with a lower interest to decrease their interest rates when the market rate decreased. The MH believed that interest rates will eventually return to the double digit range, and then there would not be any prepayment risks. But the fact is that they can’t control the market rates and they can do nothing about the prepayment risks. Based on these findings, it’s not so hard to make a judgment that MH had significant risks that may affect its business, and it doesn’t have any efficient way to control these risks.

Financial Performance From MH financial statement in 1986, revenue was 120 million, net income was 2 million, asset was 81 million and equity was 14 million. So ROE should be 14.4% and leverage should be 5.7. Credit sales represent the majority of the Company's sales. In the case of credit sales, when a down payment (generally 10% of the sales price) is received, the Company and the customer enter into an installment contract. The majority of installment contracts are sold with recourse to unrelated financial institutions. The sale is recognized when payment is received. However it is with recourse. It means that if its customers do not pay it, the company must pay it to financial institutions. So MH still took the risk and only part of payment should be recognized as sale revenue. MH should reasonable estimate what percentage of revenue should be recognized as revenue. As result of this, the sale revenue the company earned should not as much as it reported in the financial report. So after adjustment, revenue, net income and ROE should go down. Also because of wrong revenue recognition, account receivable was understated. So after adjustment, current asset and leverage should go up. However MH didn’t need so high leverage.

Conclusion Though MH experienced rapid growth rates, it was coming into what seemed to be a difficult time. Since its beginning it had not had to face stiff competition and has looked to grow in regions where it was all but promised a good market share. The economy was starting to slow down and conventional housing was beginning to look better for people because lower interest rates were being offered. As time goes on competition is sure to occur and bring balance to the market and those larger companies will lose market share. What’s more, MH does have problem in its strategy, and it cannot eliminate risk. We think that investing in their stock at this point in time will result in a loss.

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