Compass Point On Ryland, Standard Pacific Deal: 'Merger of Equals Makes Sense, But Upside is Limited'

In a report published Monday, Compass Point analyst Wilkes Graham maintained a Neutral rating on

and

, with price targets at $9 and $47, respectively, after the companies agreed to a "merger of equals." On Sunday, June 14, the companies announced that their Board of Directors had unanimously approved a merger agreement to combine both the entities to create a single company with a market cap of roughly $5.2B. "The combined entity will own or control approximately 74k homesites in 41 markets across 17 states with new home offerings spanning from entry level to high-end luxury," analyst Wilkes Graham said. Management expects production, purchasing and other synergies from the transaction to result in annual cost savings of $50M-$70M, with the majority of the savings being recorded by late 2016. In the report Compass Point noted, "The geographic footprint and price points of the two companies have a fair amount of overlap, and the combined scale should allow for synergies that are required, along with multiple expansion, to make this transaction work for investors…we estimate that, if realized, these synergies could result in a 10-15% higher valuation than where SPF and RYL trade today (consistent with our current Price Targets)." The deal appears to be marginally better for Standard Pacific's shareholders, since they will own 60 percent of the combined entity and the stock trades slightly lower than the combined valuation than does Ryland. "This transaction appears to us as a logical attempt by two quality builders to squeeze out a bit more juice in an industry where, with topped-out margins, the juice has run dry," Graham wrote. While the merger does make sense, Graham believes that there is limited upside to the share price of the companies. There is 10-15 percent upside from the current valuations, assuming "the majority of synergies are realized in 2016," the report added.