Description

Builders FirstSource

Builders FirstSource is a leading supplier and manufacturer of structural building products for home builders. This summer, BLDR acquired ProBuild Holdings, a much larger competitive company that operates lumber yards, gypsum centers and other distribution facilities serving the residential construction market. The deal, which closed a month ago, creates the number one player by market share in the industry. With debt:EBITDA above 5X, BLDR is a highly asymmetrical wager on the continued growth of new construction in the United States. If the management team is successful, the stock has the potential to appreciate to multiples of the current price. Thankfully, this management team has led the company through two downturns before and through much more difficult credit conditions.

Company Background

BLDR was formed in 1998 when JLL Partners, a middle market PE firm, partnered with Floyd Sherman, the current CEO of BLDR, to acquire companies in the building products space. The company completed 24 acquisitions through 2001, then went public in 2005. In 2006, JLL sold half their interest in the company to Warburg Pincus. While JLL is no longer a material shareholder, Warburg Pincus retains ownership of 19% of BLDR pro forma for the recent secondary offering.

BLDR generated negative cash flow throughout the housing downturn and the years after. The company survived thanks to its low leverage at the time (less than 2X 2006 and 2007 EBITDA), cash generated by working capital reductions, retroactive tax refunds received in 2010, and opportunistic debt issuances in 2008 and 2011. While their stock was down over 90% during the period, BLDR performed far better than their close peers Stock Building Supply and BMC Select, which both went bankrupt during the downturn. BLDR subsequently returned to EBITDA positive in 2012. Since then, the company has been deleveraging through earnings growth, while also resuming tuck-in acquisitions.

Early in its history, BLDR pioneered a business model now core to its value proposition. Rather than simply supplying lumber for construction sites (this does remain a low margin product line for BLDR), the company developed the prefabricated millwork and component business. In this model, BLDR assembles wall units, staircases, door assemblies, roof trusses and other products at their factories. The customer gets reduced labor costs due to the automation of a factory, just in time delivery, and faster completion times. BLDR gets margins associated with value-added manufacturing, not simple distribution, and a competitive advantage against other suppliers who cannot match the level of expertise and logistics necessary to offer this service. The comparison to ProBuild is instructive — despite being three times larger than BLDR, ProBuild derives only 32% of revenue from value-added products, vs. 53% at BLDR.

It should be noted that home builders across the country report that the shortage of skilled tradesmen is the biggest problem facing their business. The prefabricated products offered by BLDR are a great solution to this problem and should continue to gain share over time.

ProBuild Acquisition

Announced in April, this deal is the first strategic acquisition for BLDR, which in the past had growth through multiple tuck-in deals in addition to end market growth and share gains. Like BLDR, ProBuild was owned by a PE firm, in this case Devonshire Investors, a firm affiliated with Fidelity. Also like BLDR, ProBuild survived 2008 without bankruptcy despite being assembled through multiple acquisitions.

Acquiring ProBuild has several advantages for BLDR. First, ProBuild gives BLDR a nationwide footprint. Before the deal, the company generated 85% of its sales in Texas and the coastal southern states. After the deal, Texas and the South will be just 52% of sales. Second, the companies have significant cost-saving opportunities together. BLDR is paying 9.6X 2014 EBITDA, but just 6.1X EBITDA after $110 million of cost savings. Put another way, the $1.63b purchase price is less than 15x times the synergies that the combined company will generate. Third, beyond the cost synergies, there are revenue opportunities. As alluded to earlier, BLDR generates 53% of sales from value-added products, vs 32% for ProBuild. BLDR should be able to drive higher penetration of value-added products over time in their new geographies. Finally, the new BLDR will be the largest company in its industry, according to the ProSales 100 ranking.

http://www.prosalesmagazine.com/benchmarks/prosales-100-survey/2015-prosales-100-list_o

Integrating the two businesses will take time and there will be challenges. Already, the senior notes were priced above 10%, vs. management expectation of 8.5% at the time the deal was announced. Additionally, the $110 million of cost synergies will take two years to fully implement, and will cost $100 million in one-time expenses to realize. In the simple earnings model presented below, I have modeled in a slow build on the deal’s synergies, which is reflected in the Adjusted EBITDA margin. BLDR reports that the pro forma company would have earned 6.2% Adjusted EBITDA margins in 2014 with all the synergies realized, but I don’t forecast an EBITDA margin that high until 2017. Further assumptions include only 10% revenue growth through 2020 and EBITDA margins below the 2006 peak through 2019, despite the fact that the combined company will be much larger than BLDR in 2006. Should single family housing starts grow at a rate faster than the 10% modeled here, the growth trajectory could be even more attractive.

Enterprise value

Target Valuation and Returns

In a capital structure this levered, any valuation model will be acutely sensitive to assumptions about revenue growth, margin growth, and debt paydown. Rather than get too precise and thereby bogged down in the details, below I present a snapshot of the valuation matrix at YE 2018, roughly three years from now. I assume that net debt has been reduced by that point by approximately $600 million, which is less than half the cumulative EBITDA-capex I expect over that period. The column shaded in grey represents my best guess for the appropriate valuation range. As further years go by and debt is paid down, the equity value will become less sensitive to the EBITDA multiple.

Risks

Obviously, the only risk that matters at BLDR is the extreme leverage. The company is now levered at 7.3X my 2015 pro forma EBITDA. However, this number will come down fast. The integration costs are front-end loaded, and the company claims they can achieve over 70% of the total $110 million in synergies within one year. If that’s the case, and assuming the sales growth in the model above, leverage will fall below 5.0X by the end of 2016. That’s without assuming any cash build or debt payback, either of which will add modestly to the reductions. By the end of 2017, leverage will be considerably below the leverage at standalone BLDR before the announcement of the ProBuild deal.

The term structure of the debt gives BLDR plenty of time execute, with no major maturities until after 2020.

Housing starts must continue to increase for the next year or two to allow BLDR time to delever; if they stall or start to decline, this company is in trouble. Dozens of reports, white papers and studies are written weekly about the trajectory of future housing starts, so I won’t add to the collection. You can find your own forecasts and make your own judgments. Naturally, I’m a bull on housing, or I wouldn’t own this stock.

Catalyst

With the deal now closed, the major catalyst will be the achievement of the cost synergies during the rest of 2015 and early 2016, as well as continued growth in new housing starts.