Here's Hoping For a U.S. Concrete, Inc. Buyout

The market has been very rough on my Small Cap Watch List this quarter. Obviously including Impac Mortgage (IMH) on the list was not a good start, but the housing market isn’t the cause for all the woes - at least not directly. Pretty much everything is down and homebuilder NVR’s (NVR) 10% decline puts it among the top performers while furniture maker Tempur-Pedic (TPX) has turned in the best performance on the list.

In the bottom camp, however, has been another construction related stock - namely U.S. Concrete, Inc. (RMIX). Down nearly 20% since the end of June on the heels of a lowered outlook, it is starting to look ugly. The Zacks rank, which tracks earnings momentum, is the second-lowest possible rating. Free cash flow in 2006 was a big goose egg thanks to unusually high capital expenditures and the debt load now exceeds the market capitalization.

Still, the stock is also now trading with a single-digit P/E multiple and 7.6x EV/EBITDA multiple, both of which are reasonable. The market price is barely above book value and the price/sales is a measly 0.35x. The company also has more than $75 million in working capital, which is a double-edged sword. In a slowdown working capital could be reduced and boost cash flow - provided the customers to whom they sell the inventory and from whom they are owed receivables are able to stay in business too. Combining this with the fact that capital expenditures were abnormally high in 2006 suggests that the “normal” free cash flow is closer to the $25 million they realized in both 2004 and 2005.

My spirits rose a bit when I saw the 8-K they filed yesterday, saying:

On July 31, 2007, we entered into new Executive Severance Agreements with several of our officers, including the following “named executive officers” identified in our proxy statement relating to our 2007 annual meeting of stockholders: Michael W. Harlan, Robert D. Hardy and Thomas J. Albanese. The new agreements generally replace other agreements or term sheets previously agreed to between us and the applicable officers. Each Executive Severance Agreement provides for severance payments and other benefits following termination of the applicable officer’s employment under various scenarios, as described below. Each such agreement also contains a confidentiality agreement, requiring the applicable officer to maintain the confidentiality of confidential information we provide him, as well as a non-competition agreement that generally extends for one year after the officer’s employment terminates (subject to extension in the event of a change of control, so that the non-competition agreement will extend to cover the number of months used to determine the severance benefits payable to him (as described below)).

Could all the focus on a potential change in control signal that one may be in the works? It is possible. I think the odds of a private equity buyout are relatively low due to the fact that there is little room for additional leverage and the valuation already appears reasonable rather than cheap. Then again, the low market capitalization would make it an easy bite.

Still, I think that if there is to be a buyout it would probably come from a competitor who would have greater opportunity to cut costs through economies of scale. Yahoo! Finance lists six cement makers with market capitalizations of $2 billion or more - all of whom would also find U.S. Concrete to be a bite-size addition to their current business.

Here’s hoping.

RMIX 1-yr chart:

Comments

[rock boy:]

Not sure if you should be as optimistic that this signals an increased likelihood of a change of control. As disclosed in the proxy back in April, each of the managers already had this program in place pursuant to employment letters or previously issued employment agreements. The new CEO got the same deal as the old CEO (3x annual base plus bonus) and the CFO got stepped up from 1x to 2.5x (he also got promoted), and it looks like the rest of mgmt stayed in line with their old deals.

Besides, not sure how a buyout of this business would happen. Though it trades at only 7.5x EBITDA, RMIX is buying concrete producers for 4-5x EBITDA. There are not much in the way of synergies (by mgmt's own admission) so outside of arbitrage it is not clear what value they are creating.

Finally, to your point that a cement producer would want to buy a concrete mfr - I'm not really sure that is the case. Domestic cement mfrs enjoy very good pricing power given the shortage of domestic cement (and high cost of imports) in the US. Generally, cemenet mfrs do not have issue finding customers for their product so they have little need to forward integrate. Concrete producers are much more of a commodity who quite frankly are getting squeezed between the pricing power of the cement (+8% pricing) and aggregate (+12-14% pricing) makers (the combined cost of which which represent about 50% of revenues) and the the housing slump (about 50% of concrete is used for residential).

2007 Aug 07 08:23 PM

[William Trent1:]

Rob, Thanks for the clarifications. You clearly know the industry well. The only question I would have is, given that RMIX's acquisitions are much smaller could the lack of synergy (and thus lower multiple) stem from scale issues?

2007 Aug 08 07:54 AM

[rock boy:]

Good question. This is truly a local business. Let's say within Dallas (RMIX's largest market), clearly they are a logical buyer for assets because (i) there are some synergies by consolidating depots etc. but you don't really do much about the biggest cost which is materials like cement and aggregates; and (ii) you might take out someone who is polluting price in the market. So buying smaller players at 4-5x EBITDA can create some synergies. However, outside of tuck-ins, my understanding is that the biggest players in consolidated markets (i.e. like RMIX's operations in Dallas) might go for as much as 6-7x EBITDA. Still below where the stock is currently trading. So then you need to ask yourself, would a cement maker buy them to forward integrate? I don't think that makes much sense as noted in my prior post. Also, most of the large cement players would only want concrete companies in markets that they are already in. So for example, TXI which has plants in TX and Southern CA might want concrete operations in those markets (in fact it does have concrete in TX - this is how the business started about 50 years ago) but wouldn't really want concrete in MI, Northern NJ, Northern CA etc. which are the other markets that RMIX operates in. TXI wouldn't want to buy these plants in the hope of eventually building cement operations there because it is virutally impossible to get any new cement plants permitted (this is another reason why I think cement is a better business than concrete).

All that said, the stock was up 16% today so I might be wrong (though I suspect that the other shoe is about to drop that a major hedge fund is in liquidation and was liquidating a number of long and short positions today regardless of price). Earnings will be interesting tomorrow.

Good luck.

2007 Aug 08 07:31 PM

[William Trent1:]

Thanks.

2007 Aug 08 09:28 PM

[rock boy:]

No problem. At the end of the day, I think this is a good company that is basically a call option on a recovery in housing. That said, the prospect of a turnaround in housing continues to get pushed out which just extends out when this company will start to get interesting. At current prices, it feels like you have to bet on a recovery starting in Q4 which I don't think is likely.

2007 Aug 09 10:38 AM

[William Trent1:]

So... did you find the earnings as interesting as you were predicting?

2007 Aug 09 11:37 AM

[rock boy:]

Not that surprised by the results. Obviously the other income line helped them in getting to the midpoint of the revised guidance. It looks like they've pulled down 2H volume guidance from flat to down mid to high single digits which makes more sense in the current environment. However, to make guidance I think they are going to need the June price increase to stick and material margins will need to continue to expand which might be difficult in this environment and they are going to need a big Q4. So overall, the guidance looks more achievable now than it did after the Q1 call but I still think there is risk to the guidance. The real question now is valuation -- the stock is now trading at where it did after the Q1 call on lower guidance and well above where it traded in January before the company reiterated guidance (which it has now lowered). It wouldn't surprise me if the stock gives back most of its gains from yesterday over the next two weeks.

2007 Aug 09 12:19 PM

[rock boy:]

Now RMIX looks really interesting after last night's pre-announcement. The stock is now trading at about 6x 2007 depressed EBITDA that I figure is in the low $80's. That is a valuation I can get very excited about. With any stabilization in housing, EBITDA goes back into the mid $90s, the multiple goes back to 7-7.5x and the stock is a $9-10 stock a year from now. You may get their sooner if there is a buyout though I think that is less likely given the current credit markets. Even without multiple expansion you get back to $8 from $5.25 today.

2007 Oct 25 12:44 PM

[misterconcrete:]

Rob, as a former employee of US Concrete in the Mid-Atlantic region, I certainly like the buying price the closer it gets to $5. I read yours and Mr. trent's posts on a buyut. The consensus is that a cement manufacturer would not buy into US Concrete is more than likely right on the head. This stock is known to wallow between 8 and $5. (Though last year it spiked way up near $16) They report higher revenue (after each successive acquistion) though lower profit, yet the pressure on the market is severe right now, which is keeping the stock price down.

A ready mix/aggregate company would be a more obvious match to purchse US Concrete, rather than a cement manufacturer. I always said that when the coverage of US Concrete and another prospective buyer looked appealing, a buyout could happen. Maybe a firm like Florida Rock, or perhaps even Aggregate industries ( I am also a former employee there ) would be the eventual buyer.

US Concrete has some weaknesses...High debt, and in most of their markets they have to buy aggregates, cement, and admixtures from outside sources. No vertical integration like Florida Rock or Aggregate industries. Mr Martineau's vision of purchasing companies within each reguion based on the EBITDA multiple was always refreshing.

2007 Oct 26 01:02 PM

[Jason Kaspar:]

I am trying to look at a breakup value of this company and was wondering if you had any insight what their aggregates are worth? Is there any way to get a ball park valuation of their 88 million tons of reserves at their 8 aggregate facilities? Looking at the ready mix concrete plants it looks like they have been buying them somewhere between $2.4 million and $2.9 million per location. As you mentioned it is the classic buy at a cheaper valuation and receive instant multiple expansion by the market. Also do you have any opinion on their $165 million acquisition of Alberta Investments in July 2006? Seems to be at the very peak of the market and appears like they may have overpaid. Any thoughts appreciated.

2007 Nov 02 03:17 PM