Value Investors Club / BLUELINX HOLDINGS INC (BXC)

Description

BlueLinx Holdings, Inc. (“BXC” or the “Company”) is a two-step home building products distributor with a

footprint concentrated in the eastern and central US. In January zzz007 posted a solid write-up on the

Company. Subsequent to that BXC has undertaken a highly attractive acquisition, currently trades at just

4.3x pro forma LTM EPS with a +20% FCF yield and thus warrants revisiting. This valuation disconnect

primarily stems from investor confusion, limited IR, lack of sell-side coverage and chart anchoring/

investors thinking they have “missed it.” Erratic trading around the recent Russell 2000 reshuffle and

headline housing concerns have likely also contributed to recent price weakness. We believe the risk-

reward profile now is arguably as appealing as it has ever been despite the stock’s appreciation since

October 2017. There are a number of near-term catalysts that should lead to +100% upside with

downside protection derived from the Company’s large asset base and strong free cash flow profile. In

June there were material insider purchases at the level close to where the stock is presently trading.

CATALYSTS

Near and medium-term catalysts to value realization include: 1) reporting of combined Q2 financials and

an update on the integration process in August; 2) continued monetization of its 33 owned warehouses

illuminating the value of its assets and going toward debt paydown (targeted leverage ratio reduction

from 4x to 2.5x over the next year); 3) increased institutional awareness from expanded corporate

communication and sell-side initiations by Wells Fargo, BTIG and likely others; and 4) ongoing

operational improvements converting to financial performance.

CEDAR CREEK ACQUISITION

BlueLinx’s acquisition of Cedar Creek changed the entire setup and is worth discussing up front. BXC

paid $413M in cash equating to 6.9x and 3.8x 2017 pre-synergy and post-synergy EBITDA, respectively.

The transaction was announced March 12 and closed on April 13. Due to its overlapping footprint, BXC

was uniquely well positioned to bid on this business, precluding some peers from participating. This

transaction is highly accretive, doubles the size of the business and increases its scale which will improve

margins and delevers the balance sheet on a pro forma basis.

With the transaction, management announced it expects that at least $50M in annual cost savings will

be realized within 18 months. These saving represent a 50% increase in EBITDA and will be derived from

fleet consolidation, procurement and G&A reduction. We were initially skeptical of the magnitude of

this guidance, however, subsequent research led us to conclude that these levels will likely prove to be

conservative. First, $50M represents 1.5% of combined revenue. This is in-line with those of the BLDR-

ProBuild and BEC-Allied deals yet BXC’s geographic overlap is significantly greater than that of those

entities (see map). Conversations with industry participants further indicated that BXC goals were

attainable. Second, the former CEO of Cedar Creek’s new employment agreement as COO of the

combined business includes an incentive performance bonus tied to achieving a minimum of $50M in

annual integration synergies. Presumably he would not have agreed to this baseline if he did not believe

it attainable. Third, these cost savings estimates assume 100% retention of the combined sales teams.

They have publicly stated this to avoid disruption in the ranks but it is pretty clear there is going to be a

reduction here as well. Fourth, the guidance comes from a well-informed position as going into the

transaction these companies knew each other well, had been in discussions for a while and is supported

by synergy analyses undertaken by McKinsey. These estimates also do not include revenue synergies nor

any continued margin improvement from the overhaul completed last year (more below). The

transaction was de-risked somewhat when Cedar Creek reported a clean audit from PwC in late June.

LEGACY PROFILE & INDUSTRY OVERVIEW

BlueLinx operates 39 distributions centers (“DCs”) totaling 9.4M square feet of warehouse space in the

eastern and central US. It distributes over 10,000 SKUs of structural (45% of revenue, 33% of GP) and

specialty products (55% of revenue, 66% of GP). Indicative structural products are rebar, plywood,

lumber and specialty products include molding, siding, roofing and paneling. Sales volumes are driven by

residential housing starts and to a lesser extent R&R. BXC sells its products to commercial builders,

manufactured housing companies and home improvement retailers. None of its customers represent

greater than 5% of revenue. This is a localized industry where proximity to the end-user is critical. It is a

very fragmented space with competitors being captive distribution arms of lumber companies and

building products manufacturers (such as Boise Cascade and Weyerhaeuser) and a host of small local

mom-and-pop operators. The closest publicly-traded peer is Huttig Building Products (HBP). Private

competitor LBM has filed an S-1 and is intending to pursue an IPO later this year.

COMPANY BACKGROUND

BlueLinx was formerly the internal lumber distribution arm of Georgia Pacific. In 2004, Cerberus Capital

acquired these assets and was subsequently taken public later that year (with Cerberus selling 47% of its

stake to the public). The Company struggled during the downturn due to the obvious market conditions

and some management missteps/ high leadership turnover. Cerberus did provide financing through

PIPEs in 2011 and 2013 following an ill-fated speculative bet on lumber prices by the former CEO, but

other than that BXC was, by all accounts, an after-thought to the major shareholder. Until its existing

management team came onboard three years ago, BXC was essentially run as a volume-focused

business with limited attention to returns and margins.

Last October Cerberus sold its shares, ending its involvement in the business. As it was an insignificant

last position in its 2004 vintage fund, the sale price was indiscriminately low at $7 per share. The

removal of that overhang opened up the float, improved the stock’s liquidity, expanded the potential

shareholder base/ index inclusion and enabled the Company to use its stock as a currency for

acquisitions and management incentives.

OPERATING IMPROVEMENTS LED BY STRONG MANAGEMENT TEAM

The Company’s CEO previously ran another building products business (Euromax Holdings) from 2008

through 2013--no doubt an inauspicious time to take over a housing products company. He successfully

completed that company’s restructuring (over-levered by sponsor) and a refinancing while also

stabilizing performance and driving growth. BXC’s CFO was formerly head of finance for Home Depot in

North America. The existing management team took over in 2014 and has undertaken steps to

significantly improve the business operationally and financially. These include divesting less profitable

locations, implementing of pricing based on return, eliminating low margin/ low return SKUs,

decentralizating sales to better connect with its local customers, delevering the balance sheet and

optimizing of working capital. Below lays out the financial performance and improvements management

has made since taking over.

Management has publicly stated they thought they were in the third inning of improvements that they

believe they can realize. This position is substantiated by the fact that peer Huttig is generating 20%

more revenue per square foot and over 20% gross margins versus BlueLinx at 12.6%. Per management,

every 1% increase in pre-Cedar Creek BXC gross margin equates to $16-18M in incremental EBITDA, so

clearly the upside potential is significant. The below table contrasts the margin structure of BXC and

Cedar Creek (CC) with that of other distributors. If the combined BXC were able to attain 6% EBITDA

margins it would generate $200M in EBITDA on its existing revenue base.

It should be noted that Cedar Creek’s CEO, Alex Averitt, is going to be assuming the role of COO,

bolstering the ranks of the combined company. By all accounts Averitt is a highly effective operator that

drove growth and efficiency at Cedar Creek. His cost cutting abilities should be put to good use in the

integration process and ongoing improvement of BXC. As noted, his employment agreement from June

includes an incentive performance bonus tied to achieving at least $50M in annual integration synergies.

REAL ESTATE

BlueLinx presently owns 33 DCs or 5.3M square feet of warehouse space from Minnesota south to Texas

and eastward. In 2016 the Company began selling assets in the form of sale-leaseback transactions with

the proceeds being used to meet required mortgage amortization payments and reduce its debt. Cedar

Creek leases all its facilities presenting the potential for BXC to outright divest of its locations. These are

highly desirable assets so this process should be orderly. As it continues, the value of these holdings will

be illuminated. Management stated that they were targeting the first week of July to decide which

locations will be retained so clarity on this should be forthcoming.

Growth in ecommerce has led to increased demand and higher multiples for the category of industrial

real estate with valuations ranging from sub-5% capitalization rates for major market class A industrial

to 7.6% for secondary class B with replacement costs of $30-80 per square foot. Over the last two years

the Company has sold 19 sites, realizing $131M in proceeds or 4x net book value. Based on trading

comps, BXC’s 10 largest remaining facilities are worth $172M. If the rest of the DCs are included at a

depressed $20 per square foot, the implied value is $200M. The four locations BXC SLB’ed in January

sold for an implied $47 per square foot. It should be noted that the Company has $89M in NOLs it will

use to shield capital gains taxes on a good portion of these future real estate sales. Those NOLs begin to

expire over the next three years.

VALUATION

Lack of awareness of the merits of the Cedar Creek acquisition, the fact that BXC does not presently

screen well (unadjusted numbers show a high multiple and leverage ratio) and investor aversion to the

Company’s low margins lead to the overlooking of its asset base. Meanwhile, the aforementioned

improvements have created a sightline to margin expansion and higher returns. The market has given

them little credit for these endeavors but shareholders should be rewarded as these factors manifest

themselves further in the financials. While the Company does generate low margins, it has an attractive

FCF profile primarily due to low maintenance capex (with ample existing capacity available).

BXC is currently trading at 6.0x pro forma LTM EBITDA. Its closest publicly-traded peer HBP trades at over

12x adjusted EBITDA while almost all building products companies are trading above 10x EBITDA. 8-10x

EBITDA equates to $65-100 per BXC share or 75-160% upside from current. Regardless of peer

valuations, BXC’s 4.3x pro forma LTM cash EPS multiple (over a 20% FCF yield to the equity) is way too

low. These current multiples also do not factor in any margin improvement, revenue growth or ascribe

any value to its real estate assets. Investors derive downside protection from BXC’s relatively large asset

base.

RISKS

- Housing and Lumber Exposure: BXC’s revenue is approximately 90% correlated with US single family

housing starts so a downturn in the building industry would impact the business. However, in the event

of such a decline the Company can rapidly reduce inventory (inventory is liquid and typically turned

every month) and increase FCF. The current management team’s level of experience should serve as a

mitigant. During the financial crisis while at the helm of Euramax, CEO Lewis actually managed to

expand margins despite the challenging environment. At BXC’s current depressed multiple investors are

not paying for any upside in starts. The Company seeks to minimize its exposure to commodity lumber

and turn inventory as fast as possible. DSOs have improved to 30 days so BXC does have some exposure

to price fluctuations but it is relatively modest. A single-name building products or housing ETF short

could be used to offset housing exposure.

- Merger Integration: All indications so far suggest the integration is on-track as anticipated. Earlier this

month Cedar Creek’s audit came back clean. Even if they only realize a fraction of the cost synergies, the

stock is cheap.

- Leverage: BXC will have four turns of pro forma leverage. This is down from a leverage ratio of 8x at the

end of 2017. While optically still high, it will get paid down in fairly short order through FCF and asset

sales. The structure of the debt is also worth noting as the ABL is secured by liquid inventory thus is

somewhat more akin to a payable than for instance term debt.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1) Reporting of combined Q2 financials and an update on the integration process in August

2) Continued monetization of its 33 owned warehouses illuminating the value of its assets and going toward debt paydown (targeted leverage ratio reduction from 4x to 2.5x over the next year)

3) Increased institutional awareness from expanded corporate communication and sell-side initiations by Wells Fargo, BTIG and likely others

4) Ongoing operational improvements converting to financial performance

2 show sort by

			2018	2019
Price:	34.12	EPS	8.13	0
Shares Out. (in M):	10	P/E	4.3	0
Market Cap (in $M):	329	P/FCF	0	0
Net Debt (in $M):	580	EBIT	0	0
TEV (in $M):	918	TEV/EBIT	0	0