Berkshire Hathaway
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Berkshire Acquires Clayton Homes

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By EliasFardo
April 3, 2003

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I believe that we are buying Clayton at a good time. Conseco Finance is an example of the problems in the financing arm of this industry. Its downfall was from bad management, bad accounting, bad lending and a bad equity structure. We should be able to avoid all four of those. And since financing capacity is lacking now, someone with the finances of Berkshire is in an excellent position.

The industry has been hit hard, so hard that the manufacturing housing communities are actually experiencing increased vacancies. In 2001, occupancy seemed to fall about one and half percent in the companies I follow. In 2002, in their core portfolios, Chateau had a fall of 3%, Sun had a fall of 2%, and Manufactured Home Communities had a fall of 1% in occupancy. However, all of these still had an increase in operating income in their core portfolios because they were able to increase rents.

A serious problem for occupancy has been repossessions. In 2002, Chateau had a lender who had foreclosed on 800 units declare bankruptcy and stop making land rental payments. This is indicative of the fallout in manufacturing, retailing and financing through out the industry. The retailing end is so difficult that Chateau closed its only retail location and took a large write off for inventory. A company like Berkshire is in a prime position to take advantage of all that.

Berkshire will also have an opportunity to deploy large amounts of cash in communities if it desires. A mature, investment grade manufactured home community sells at a cap rate of from 8 to 8 � percent. As I mentioned before, even in times of falling occupancy, communities are able to get increases in rent. These increases have recently been averaging between 4 and 5 percent per year. So, with a cash return of 8%, and what should work out to an increase in value of 4 to 5 percent a year, communities provide a decent, low risk return. A mature, investment grade community is almost like an annuity. The average house, once placed in a community, stays for about 30 years. So, a mature community continues to collect a steam of stable, slightly increasing land rentals. In a bad year, occupancy may fall a percentage or two, but earnings will still increase.

The Clayton communities get only about $200 per month on land rent, which is much less than the over $300 per month for companies like Chateau and Manufactured Housing Communities. And the Clayton communities have occupancy of only 75%, which means that they are probably developing communities. So, for what little I know about this industry, these seem to be on the low side of investment grade. But, Berkshire can put hundreds of millions of dollars into high quality existing communities if it wants. Chateau, for instance, will sell about $100 million of communities in 2002 to reduce debt. A large, mature, investment grade community can go for $20 million, so it does not take many transactions to add up.

It will be interesting to see how it is reported. Clayton could be reported in various different segments in Berkshire. It has an insurance operation, which could go in the insurance reporting segment. It has financing which could go into the financial products segment. And it has manufacturing, retailing and community ownership, which could go into some of the other segments. Or, it could be determined that Clayton is basically a financial company, and it could all be put into financial products. I would prefer that Clayton be set out in its own segment like Shaw.

I really like this acquisition.

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