Andrew Bary

Millrose Properties, a land bank spun off by the home-building company Lennar, shows that investing in spinoffs isn't necessarily a walk in the park.

The spinoff winners of the past year, including GE Vernova, Atmus Filtration, and Grail, highlight the positives. The stocks can be a good place for investors to find bargains because newly public companies often emerge cheaply, with little initial Wall Street sponsorship, and have something to prove.

But spinoffs generally come in two categories. In some cases, former parent companies are looking to highlight smaller businesses that weren't getting full credit from investors. In other cases, they are jettisoning less desirable operations that were weighing on the parent's valuation.

Millrose Properties, spun off this past Friday, is in the addition-by-subtraction category. Lennar created the company to get potentially risky land holdings off its balance sheet and boost its returns.

Millrose's key positives are a cheap valuation at a fraction of its book value and a strong balance sheet with little or no debt. But its financial arrangement with Lennar is complex and its business model comes with some unknowns and negatives.

Millrose had no immediate comment.

Millrose shares, which closed off 3.2% Wednesday to $21.79, now fetch about 63% of the company's year-end 2024 book value of $35 a share. The company's market capitalization is $3.6 billion, compared with shareholder equity of $5.8 billion .

Lennar holders got one share of Millrose for every two Lennar shares. Unlike many spinoffs, which are tax-free, the Millrose deal is taxable as a dividend to Lennar holders.

Lennar stock, meanwhile, has come under pressure as investors worry about the outlook for housing amid higher interest rates . Lennar shares were down 2.7% Wednesday to $121.60 after hitting a new 52-week low earlier in the session. Lennar is valued at $28 billion.

Millrose holds land, develops it, including infrastructure such as electrical lines and sewers, and then sells lots to Lennar, giving it funds to make new land purchases. Lennar is Millrose's only customer, but it could develop others.

The company is structured as a real estate investment trust, which means it has to distribute at least 90 percent of its taxable income to shareholders as dividends. REITs often are income plays for investors.

Lennar will pay Millrose an 8.5% annual fee for holding its land to compensate it for keeping the real estate available for Lennar to buy. That could result in about $500 million a year in revenue. Millrose is managed by an outside company, Kennedy Lewis, which will receive an annual fee of 1.25% of tangible assets.

Millrose earned about $270 million in the first nine months of 2024, excluding one-time costs for setting up the business, according to pro forma financials in an S-11 filing with the Securities and Exchange Commission in December. That implies about $360 million for all of 2024 if the fourth-quarter results matched those in the first nine months.

That could mean an annual dividend of about $2 a share based on 166 million shares outstanding, or a yield of about 9%. These are Barron's estimates, but they are consistent with an estimate from Chris Senyek, a special situations analyst at Wolfe Research, in a recent note. He added that his estimate was "highly tentative."

No dividend, however, has been set. It is expected to be paid monthly.

A key negative is that Millrose is exposed to a potential real estate downturn given its land holdings.

"We expect significant initial selling pressure on Millrose shares given the relative size of Lennar's market cap to Millrose," wrote Chris Senyek, a special situations analyst at Wolfe Research in a Feb. 6 note just before the spinoff. Senyek also sensed "tepid" interest among Lennar holders to own Millrose.ijr

So far he has been right. Lennar holders, including indexers, appear to be dumping the stock. The stock is down about 15% from its closing price of nearly $27 this past Friday. Millrose was removed from the S&P 500 index on Monday and added to the S&P 600 SmallCap index, which can be traded in the iShares Core S&P Small-Cap exchange-traded fund. Lennar remains in the S&P 500.

While Millrose's valuation is inexpensive relative to book value, the most comparable company, Forestar Group, trades at a similar level. It sells for $22.62, roughly 70% of its book value and about six times projected 2025 earnings per share. Forestar stock has been weak since reporting lackluster profits for the December quarter in January and hit a new 52-week low in Wednesday's session.

"We estimate Millrose should trade at a slight discount to FOR given MRP does not share similar growth potential as FOR and is, in a way, an accounting mechanism for LEN to become 'asset-light." Senyek wrote in his Feb. 6 note.

"Millrose's source of income will, at least initially, be entirely dependent on Lennar exercising purchase options and entering into new options on land, and there is also uncertainty over dividend yield sustainability," Senyek wrote. He accurately projected that the stock likely would trade in a range of $21 to $26.

Forestar was taken public by Lennar's rival, DR Horton, which owns 60% of it.

Lennar and DR Horton are the two largest homebuilders in the country. Lennar is retaining 20% of Millrose, but plans to spin off, split off, or otherwise get rid of that remaining stake.

Lennar benefits from the spinoff because it becomes more asset light, allowing it to earn a higher return on equity. Having the land on which it builds off its balance sheet mitigates the risk of a sharp fall in land values, which occurred during the 2008-2009 financial crisis and hammered many homebuilders.

In the December S-11 form, Lennar said the spinoff fulfilled its "long stated strategy of becoming a pure play, new home manufacturing company."

Millrose has a cheap stock and a good balance sheet, but plenty of uncertainties. High on the list is whether Lennar would keep buying land from Millrose if home-building hits a downturn.

Write to Andrew Bary at andrew.bary@barrons.com

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February 13, 2025 03:30 ET (08:30 GMT)

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