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CEOs

The Time is Right to Sell a Building Products Company

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In the period from 2005 to 2007, there were scores of building products companies that were sold when earnings were high and multiples paid on EBITDA were strong. The sellers that chose to come to market during that ideal time period were later regarded as geniuses or very lucky, because the window to sell a building products company slammed shut behind them.

However, that window seems to be open again. We believe that the current market conditions are again optimal for business owners looking to exit their building products manufacturing or distribution companies. In fact, there are market conditions that favor sellers today that were not present during the selling bonanza at the end of the last strong building market.

Strong Earnings & Active Strategics

The first key reason to sell a building products company right now is that strong earnings have returned to this market segment. Many building products companies had their best year of profitability in 2014. Some are even poised to set back-to-back records with a strong pipeline of business in place for 2015. Such performance will help guarantee high valuations and sale prices.

Strong earnings not only increase valuations, they also increase the ability of other operating businesses to attract capital and to make acquisitions. As a result, there are more strategic buyers – those already operating in the building products industry – capable of undertaking meaningful acquisitions, right now, than at any time in the last decade. Many larger strategic buyers are under particular pressure from their boards or controlling shareholders to achieve growth. Completing accretive acquisitions of smaller competitors is a more preferable way to grow than, for example, trying to increase market share by cutting prices.

In addition to available capital, building products manufacturers and distributors are also on an acquisition spree because they are looking to become a one-stop shop for customers. There is a prevalent trend among customers in the building industry to buy products from one-stop suppliers. Thus, a window and door distributor comes to view themselves as serving the building envelope and begins to sell siding as well. Or a wood door manufacturer realizes that his engineered wood methods lend themselves equally well to manufacturing hardwood flooring. Whatever the case, customers want to buy a wider variety of products from a smaller number of highly-reliable suppliers. The learning curve to enter a new product area is always extremely steep. A well-chosen acquisition can sharply accelerate that curve and establish a strong and proven platform in a new product area. For sellers, this means that there is probably a much larger cohort of potential buyers for their company than they might initially have thought.

Building products companies at the lower end of the middle market are often driven by a trend in the opposite direction. After a dearth of research and development (R&D) during the downturn, companies have started to innovate again. In just a few years, market expectations will be set for most building products to offer a compelling set of new features. These include innovations such as accessing, operating and determining the status of various smart products through phones, tablets and other devices, as well as features like extremely high energy efficiency, automation and automatically adjusting to changes in light, temperature and other conditions in the environment. For companies that lack a hefty R&D budget, it will be difficult to be in a position to offer many of these features. Far better to sell when earnings are high and the market has yet to punish the technology “have nots”.

Renewed Interest from Financial Buyers

Private equity (PE) funds are strong acquirers of building products companies right now as well. Many PE funds have raised a war chest of capital but most complain that they are not currently seeing enough strong opportunities. There was a rush to complete transactions at the end of 2014 that has given way to a reported dip in new opportunities to pursue in early 2015. That means that a company with an attractive growth profile and strong earnings will attract a great deal of attention in the current market.

Added to the already strong brew of high earnings and a high level of interest among buyers is a level of capital availability that has not been seen since 2007. The same lenders and investors that had a very negative view of the building segment during the downturn are now courting building products companies as a safe bet for the next cycle.

Lenders that lose a big loan deal to more aggressive competitors loudly bemoan the fact that loans are being made at senior debt rates that virtually constitute an equity level of risk. For the providers of that debt capital, that is a valid concern. For sellers of building products companies, though, this environment of easy debt means that buyers are universally armed with a larger slug of debt and can afford to pay much more for a strong company. On the equity side, the current capital overhang of uninvested capital held by PE funds is estimated to be at an all-time high. This means that PE funds are able to actively pursue acquisitions themselves or support other acquisitions with minority equity capital. While interest rates will inevitably increase as the recovery progresses, they are still historically low and are another significant source of support for acquisition financing.

Important to Manage Expectations

When you have a finite group of strong companies with great growth profiles approaching a much larger group of buyers that are armed with a sea of easy capital, acquisition prices are going to increase sharply. This has definitely been the case for building products companies.

However, many sellers falsely apply EBITDA multiples from public transactions and envision applying those multiples to their earnings. The problem with this strategy is that EBITDA multiples rise and fall like the stock market, and are a combination of art and science. There is no guarantee that the current high multiples will be here in a few years or that high multiples for one business will apply to another.

Much of what is driving current multiples is the growth trajectory on which companies find themselves. After years in the doldrums, the typical building products company is seeing double-digit growth that will likely be sustained for the next several years. It does not take a very large drop in the future EBITDA multiple at any given level to wipe out the additional value that would have been created by an increase in the absolute EBITDA level.

When a group of well capitalized buyers drive up the EBITDA multiples in a given industry, they begin to compete more heavily on the terms of transactions as well. This is definitely taking place in the building industry, where historically widespread structuring tools, such as seller financing, are becoming less common. Seller financing is essentially an I.O.U. where the seller loans the buyer part of the purchase price and is paid back over time. Another tool that is decreasingly common is the earnout, wherein a portion of the purchase price is contingent on the future performance of the business. It is difficult to know what the performance of a company would have been, absent of changes that are made by new owners. This, combined with the fact that sellers prefer all-cash offers, have led to the decline of both earnouts and seller financing.

In contemplating the sale of any valuable asset, it is easy to be haunted by the question of whether to wait for even higher prices in the future. Today, valuation multiples have escalated nearly to the mathematical limit of what can be paid by a buyer that needs to earn equity returns on their capital. Buyers are willing to pay these high prices because they can see three to five years of strong growth ahead for the economy and the building industry. When it comes to selling a building products company, there truly is no time like the present.

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