By Nick Gaidai
Often overlooked by private equity players due to its cyclicality, the U.S. building-products sector presents a strong case for value-adding investors.
Operationally minded PE shops that are able to navigate homebuilding cycles, execute on disciplined bolt-on acquisition strategies and adopt new technologies can deliver returns in the high teens by investing in this lucrative, yet underserved, space.
Two key demand drivers for the building-products space are the homebuilding and repair-and-remodeling markets.
New housing starts have been on the rise with a 13.5% CAGR since 2009, but the figures are still lower than pre-crisis levels.
Research conducted by Freddie Mac suggests the growth trend for existing- and new-home sales will continue through 2019.
Undersupply of for-rent inventory on the back of strong demand for housing driven by a maturing millennial population and shifting household formations is another indicator of market potential.
Markets in the Sun Belt generated significant post-crisis growth, which contributed to the top line of building-products manufacturers and distributors. These markets are expected to be the major growth driver going forward due to migration and lax zoning laws.
The sector is still relatively dispersed throughout the U.S. with a lack of national players.
This creates immense opportunities for industry consolidation, primarily in the light-building-products space, as heavy materials, such as aggregates and cement, require larger capital expenditure and are restricted by logistical limitations.
One such example is Foundation Building Materials, a specialty distributor of wallboard and suspended ceiling systems across the U.S. and Canada. Founded in 2011 by a group of experienced managers, the company was acquired a year later by CI Capital Partners for an undisclosed amount.
Using FBM as a platform, CI completed seven bolt-on acquisitions and exited the investment in 2015 to Lone Star Funds in a $560 million deal. In 2017, FBM completed a $179 million IPO, securing partial exit for Lone Star at an about 1.7x cash-on-cash return.
Another example is Jeld-Wen, a PE-backed global manufacturer of residential doors and windows with sales in more than 85 countries across North America, Europe and Asia.
Canadian PE shop ONEX invested $871 million in Jeld-Wen in 2011. In early 2017, ONEX partly exited the investment at about 1.8x cash-on-cash when Jeld-Wen went public on the NYSE, securing $661 million in gross proceeds.
Later that year, the company did two secondary offerings with total gross proceeds of $980 million.
Throughout the holding period, ONEX has completed several add-ons to drive Jeld-Wen’s top-line growth. At this writing, ONEX holds a 31% stake in Jeld-Wen.
The building-products sector has historically been a laggard in adopting new technologies. Industry executives rationalize this by the fact that their key clients – homebuilders – don’t use technology.
McKinsey’s research supports this notion: Construction has been identified as an industry with a low level of digitization of assets, usage and labor.
Leveraging technology solutions driven by big data and the internet of things will enable PE owners to optimize cost structures and widen margins.
Predictive analytics and machine learning can be used to unveil supply-chain inefficiencies, enabling cost-cutting opportunities.
Installation of sensor devices on distributors’ fleet vehicles – and the subsequent collection and analysis of gathered data – will present opportunities to improve route planning, thereby optimizing high-cost last-mile delivery.
Many PE investors worry about where we are in the cycle. While research from Morgan Stanley suggests that the U.S. economy has passed the cycle’s midpoint, there is still growth momentum driven by productivity gains on the back of investment in capex.
As valuations keep rising, driven by record levels of undeployed capital, now is the time to consider adding building-products companies to PE portfolios to ride the last wave of this economic cycle.
Nick Gaidai is an MBA candidate, Class of 2019, at the Wharton School of the University of Pennsylvania. He previously was investment director at Diligent Capital Partners, the Ukraine mid-market PE firm. He also served as adviser to the prime minister and presidential administration of Ukraine. He can be reached at [email protected] and https://www.linkedin.com/in/nickgaidai/