BIA Executive Insights
Analysis, strategy, and insights for decision makers in the building products industry.

March 2019
The Market's Pulse Is Stronger Than You Think
By Michael Collins, Managing Director, BIA
Our recent travels have taken us to the International Builders’ Show (IBS) in Las Vegas and the ProSales 100 Conference (PS100) in San Antonio. Taken together, these gatherings represent the critical link between home builders and LBM suppliers that provide every component needed to build a home, from the basement to the attic. Attendance at both is an ideal way to take the pulse of the residential building industry, which we have found continues to be overwhelmingly positive. 

We had headed to IBS with some trepidation about the market. While we publicly admonish the pundits for creating the risk of a self-fulfilling prophecy by talking about a coming soft patch, privately we were left wondering. In Q4 2018, many companies reported to us that their sales were lagging. Wet weather, cold weather, snow … weather of all varieties was causing slowdowns. In some ways, it reminded us of the summer of 1997, when the value of Thailand’s currency imploded and the resulting financial contagion briefly reached the corners of the globe. In the earnings calls of public companies large and small back then, lackluster results were blamed on the Thai currency meltdown in the U.S. and abroad. 

It was with no small amount of relief that we attended the IBS show and heard dozens of different manufacturers and builders report how well they were faring. The prior quarter’s doldrums have been shaken off and companies reported having had record January 2019 results and great year-on-year comparable results through the last week or so of February. Such strong months for manufacturers mean that builders are buying their products in force.

The tone at IBS was extremely upbeat and foot traffic was steady all three days, reflecting these strong results. The most pessimistic view expressed to us during IBS was that, perhaps in 2019, there would be growth at a slower rate than previously. No companies with whom we spoke at IBS felt they were shaping up for a down year.

Two weeks later at PS100, the same positive tone prevailed. The panelists on our M&A panel--who are discussed in greater detail later in this issue--agreed that M&A activity should remain strong the next couple of years, along with the market as a whole. They opined that the next two years would find the market continuing to grow, even if at a slower rate. In general, all are actively searching for their next acquisition. 

Among PS100 attendees, almost without exception, they used words like "slow," "terrible," "off pace," "down," and similar descriptions when talking about Q4 2018. Some bemoaned the decrease in commodity prices and the associated difficulty of generating the same total margin dollars as when underlying prices were much higher. However, for all the companies with whose presidents and owners we spoke at PS100 and IBS, January felt like walking through a door into a completely different room. Sales jumped and backlogs of booked business swelled as LBM manufacturers and suppliers benefited from increased orders. Home builders are also doing their part by adjusting the mix and price point of homes they bring to market. This has the dual benefit of addressing the fact that home prices have risen faster than personal income and meeting the unsatisfied level of demand for starter homes.

Soft sales may be blamed on bad weather, commodity price deflation or global currency movements. Strong sales, however, typically have a more obvious source. All factors that we have observed in the market point to continued strength over the next two years. 

Investors See Potential in Construction Innovations. How Should You Respond?
By Craig Webb
President, Webb Analytics
The chart above, posted Feb. 13 as part of a story on the Crunchbase website , caught my attention, both for what it reports and what its implications are for building material dealers.

“A wave of startups is looking to capitalize on opportunities within the sector,” writer Mary Ann Azevedo reported. “… Funding in U.S.-based construction technology startups surged by 324% to nearly $3.1 billion in 2018 compared with $731 million in 2017, according to Crunchbase data.”

This boom is being propelled by both investor and tech types by the belief that construction techniques are ripe for renovation. The believers base their faith on reports such as one that McKinsey Global Institute published in February 2017. In it, McKinsey concluded that productivity in construction had barely improved since 1947 while agriculture was 16 times more productive and manufacturing 8.6 times better.

Such numbers make construction look like easy pickings for people whose technological advances have disrupted many other industries, as well as for longtime building industry people who have already begun to move. Many of them and their products are cited in Building Forward , a new online series from Hanley Wood, the publisher of Builder, Architect, ProSales , and Remodeling magazines.

Reading through them, though, you tend to see the same names and companies, and research from organizations such as the Home innovation Research Labs suggest that, even five years from now, innovations like modular housing will be used by fewer than 20% of builders. Those Building Forward stories contain lots of reasons why: Basically, a huge number of current bad habits (sloppiness, lack of communication, disparate goals, and more) have to be eliminated in order for better practices to take their place.

But this doesn’t mean construction will remain stuck in a rut forever. Indeed, there are numerous factors that will push the industry to change. The labor shortage is one. Spiraling construction costs are another. Ultimately—and I’m talking about decades here—the logic of building smarter will become standard thinking.

This extended period means that the wave of change will affect different types of dealers at different times. Multifamily is feeling the first effects; Katerra’s current contracts are for apartment complexes, and after that it likely will set its sights on senior living facilities and student housing. Meanwhile, hospitality providers like Marriott International are embracing construction techniques in which hotel rooms are built off-site.

The revolution in single-family living is represented by Entekra, where a company born in Ireland has set up shop in California to deliver housing components that can be assembled in hours, not days. Owner Gerry McCaughey said several big builders are ready to buy everything he can produce. But at the moment, he’s only operating in California, and the concept he is pushing makes the most sense for companies that build lots and lots of new homes. At present, just a few states—Texas, California, Florida, Georgia, and the Carolinas—comprise a big share of all new-home construction nationwide. That’s where the Entekras of this new world likely will succeed first.

Ultimately, the wave will extend to smaller builders and custom builders (and probably to custom builders first, as they tend to do bigger and more expensive homes that are designed by architects). Companies like Unity Homes already are on the job. ( See this article in a Journal of Light Construction series on Unity.) But getting to this level will work only if builders and customers can agree to stop changing their minds while the project is under way. Much of Construction’s New Way is based on finalizing construction decisions before the first piece of wood ever gets cut. For many, that will be a hard habit to break.

Finally, if your company deals mainly with remodelers, hearing all this talk about new construction methods is like listening to reports of a storm somewhere else in the country: It’s of vague interest, but it won’t have any impact on you.
Lots of Misconceptions Surround M&A Deals. These Active Buyers Can Set You Straight
By Michael Collins
I had the honor at the 2019 ProSales 100 Conference to moderate the mergers and acquisitions session on the final day of the event. Among a host of great ideas that they shared with attendees (see my recap in ProSales ), Jim Drexinger of American Construction Source (ACS), Dave Flitman of BMC, Steve Swinney of Kodiak Building Partners, and L.T. Gibson of US LBM helped set straight a number of common misconceptions regarding M&A terms and norms. 

Prior to the discussion, the panelists—who lead organizations with a combined $7 billion in revenues—responded to a series of true-or-false questions, as did 30 LBM dealers. The results showed interesting differences and similarities in the opinions of potential sellers and the norms as observed by myself and a (non-unanimous) consensus among the heads of four of the most active buyers in the industry. 

The most widely held misconception among attendees was the belief that, after an acquisition, buyers pull almost all administrative functions (e.g.. payroll, banking, payables and receivables) out of the acquired business and move them to the corporate level. The consensus among the panelists was that this is not the case. Some of those functions may be pulled up to the corporate level to enhance coordination and collaboration, but others continue to be executed locally, they said. 

Panelists were in strong consensus that an EBITDA multiple-based valuation approach captures the normal level of working capital in the business. In contrast, half of the LBM dealer respondents thought incorrectly that they could negotiate a separate payment for working capital in addition to the valuation indicated by EBITDA. 

Panelists and attendees seemed to be roughly evenly split as to whether a discounted cash flow (DCF) valuation methodology is the most prevalent methodology for valuing businesses, as opposed to EBITDA multiples. Gibson pointed out that neither approach is correct on a stand-alone basis and that many factors go into deciding on the valuation of a company. Other panelists said a DCF model helps them create their valuation. 

There was relatively little disagreement between buyers and sellers on other aspects of an acquisition. For instance, acquirers and attendees both believe an EBITDA-multiple based valuation excludes the value of real estate. This means sellers are able to add the price that their real estate will fetch to the business valuation. In order for a buyer to view the valuation in this way, the projections must include a market rate of rent for the facility (another point on which there was consensus). 

The panelists said they don’t rely on headcount reductions or the closing of facilities in order to achieve their required returns on a company. Swinney pointed out that buyers are looking to grow and improve businesses, and “you can’t do that by letting go of key people of by having fewer outlets to serve customers.” 

If you are unsure how an aspect of the M&A process works, please reach out to us with your questions. 
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Recent Dealer and Distributor Transactions
SRS Distribution bought Roofing Products & Building Supply , a roofing specialist with three stores in Louisiana.

L&W Supply acquired Delta Gypsum , a six-unit specialty dealers with five stores in North Carolina and one in Tennessee.

Mid-Cape Home Centers purchased Wood Lumber , Falmouth, Mass.

GMS bought Commercial Builders Group , a two-unit specialty dealer based in Louisiana.

Spahn & Rose Lumber acquired Dunn Lumber , Lake Geneva, Wis., and will keep it operating under that name.

Easton's Ace Hardware , Lawton, Okla., was purchased by Comanche Home Center .

BMC expanded in the Charlotte, N.C., market with the acquisition of Locust Lumber . That dealer has facilities in Locust, Monroe, and Vass, N.C.
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BFS, BMC Warn Last Year's Sky-High Lumber Will Cause Sales Declines in 1Q Earnings
The toboggan-like slide down the pricing hill that lumber has seen this past year will lead to lower sales this quarter at America's two biggest full-service lumberyards. Officials at Builders FirstSource forecast that sales for January through March will show, percentage-wise, a decline in the low single digits, while BMC's leaders estimated sales could be 1.7% to 7.6% lower.

That's what happens when the spot prices for framing lumber and panels are 30% lower this year than they were in the same period a year earlier, as the latest Random Lengths report indicates. On the other hand, profit margins can rise as prices go down; BFS predicts its gross margins for all product sales will go up as much as 200 basis points this quarter.

The predictions came during calls to analysts in which BMS and BFS reported what they regarded as upbeat report. And w hile it isn't publicly traded and thus didn't give predictions to analysts, it's logical to assume that US LBM also will be challenged revenue-wise this year because of lumber's runup in 2018. The company reported it swung to a $38.3 million profit in 2018 from a $10.9 million loss the year before on an 8.3% rise in sales to $3.35 billion.

For the other publicly traded construction supply operations (except BlueLinx, which reports April 13), the results continued to show variations in strategies. Companies in acquisition and growth mode such as Foundation Building Materials posted a loss, as did Huttig Building Products, which is busy building up its new Grip-Rite business. Beacon Roofing Supply didn't mind barely eking out a net profit because its adjusted EBITDA margin stood at 9.2%. Notably, only three of the six public companies had a positive tangible net worth.
We Can Answer Your Most Pressing M&A Questions

* How do the most active buyers in today’s market value my company?
* What parts of the business should I change to improve its valuation?
* When is the right time to sell?

These are questions that are commonly asked by the owners of building products manufacturers and distributors. Our work in selling and raising capital for companies puts us in a unique position to help answer these important questions. Regardless of when you might decide to approach the market, please contact me to have a confidential discussion about your company and ways to maximize its value for the owners. 

Michael Collins
Work 312-854-8036
Cell 312-282-5462