Armstrong World Industries Emerges from Bankruptcy

| About: Armstrong World (AWI)
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Almost six years after filing for bankruptcy under the weight of mounting asbestos liability lawsuits, Armstrong World Industries (NYSE:AWI) emerged from bankrupty last week and was largely ignored. The manufacturer of flooring, cabinets and other building products averaged volume of only 60,000 shares per day in its first three days of trading, and very little has been written about the company’s rebirth.

The company has not released many figures yet, though it will release Q3 numbers and give guidance at the end of October. In addition, reports issued during bankruptcy are available and can provide some indication of the company’s state.

The restructuring plan called for the issuance of 56.4 million shares, with two-thirds of them going to a trust to pay out remaining asbestos liability claims. The remaining third went to unsecured creditors. In addition, the company received $1.1 billion in financing, much of which went to the creditors. At Friday, October 20th’s close of $39.45, I believe the company has a market capitalization of $2.225 billion. Note that all of these numbers are based on my understanding of various company filings and have not been confirmed.

For the first six months of 2006, Armstrong reported $68.2 million in net earnings, showing substantial growth form $17.7 million in the first six months of 2005.

Q3 should show a benefit from lower oil prices. On the other hand, the slowing housing market should negatively impact revenues and earnings. I haven’t had the time to put together an adequate model, and no analysts have yet put anything together, so for the purposes of simplicity, I’ll treat the first six months of the year as the current run rate, and say that the company has earnings power of $136.4 million this year. Admittedly this is a poor measure, but we’ll have better numbers next week, and it’ll at least give us an idea of how the company is valued. This number gives Armstrong a P/E of 16.3 -- substantially higher than competitors like Mohawk (NYSE:MHK) and Masco (NYSE:MAS), which have P/E ratios between 13 and 14.

On the surface, this doesn’t look like a particularly compelling valuation, but companies coming out of bankruptcy can sometimes show strong earnings leverage, so I’ll be watching next week’s earnings carefully.

As an aside, I should mention what first attracted my notice here. Armstrong Holdings (ACKHQ) was the former owner of AWI, but had all of its ownership cancelled on AWI’s emergence from Chapter 11. Though Armstrong Holdings has no other assets, it does have a series of claims against AWI. These include tax refunds and various intercompany charges and credits.

On Friday, Kellogg Capital Group, which owns 11.7% of Armstrong Holdings, filed a 13D that included a letter Kellogg sent to management demanding information on the value and status of these claims. The text of the letter:


Kellogg Capital Group, LLC is the beneficial owner of 4,765,326 shares of common stock of Armstrong Holdings, Inc. (”AHI” or the “Company”). We purchased the shares based on our belief that they represented an attractive investment opportunity, particularly in view of claims AHI has against its former subsidiary, Armstrong World Industries (”AWI”), which is emerging from bankruptcy. Currently, little information is publicly available regarding AHI in its current state and the potential for unlocking the value of assets it has vis a vis AWI. AHI’s potential assets as we understand them are:

o An inter-company claim against AWI worth up to $12 million

o An unknown portion of a $37 million tax refund

o Substantial NOLs potentially benefiting both AHI and AWI

o Recoveries of taxes paid by the “Armstrong group of companies” in 2006

We write to you because we wish to learn more about these assets (and any potential others) and your efforts to maximize their value through negotiation with AWI and otherwise. Additionally, we are concerned by potential conflict of interest, independence and other issues at AHI based on the board’s composition. We believe these issues could impair the ultimate value of these assets if they are not resolved. A key factor in maximizing the value of the aforementioned assets will be AHI’s tenacity in negotiating with or litigating against AWI. Currently, AHI’s board has very close ties to AWI. First and foremost, Mr. Lockhart, AHI’s chairman, is also the chairman of AWI. Until AWI’s emergence from bankruptcy, AWI and AHI were integrally intertwined by virtue of AWI being AHI’s sole operating subsidiary. Additionally, AHI and AWI shared board members and executives. As a result, AHI board members M. Edward Sellers and Jerre L. Stead have long-term ties with AWI. Messrs. Sellers and Stead make up the Special Committee charged with negotiating the claims against AWI. Mr. Sellers is the Chairman and CEO of Blue Cross Blue Shield of South Carolina and The Companion Group of Companies and serves on the boards of six other corporations and endowment funds. Mr. Stead is the Chairman of IHS, Inc., a NYSE company, and serves on the boards of four other publicly traded companies. We hope these proven corporate leaders have the time necessary to aggressively pursue AHI’s claims.

Furthermore, it is unclear how the interests of the AHI directors are aligned with those of the stockholders to maximize the value of the foregoing assets. Based on AHI’s Form 10-K for fiscal 2005, as of January 24, 2006, Messrs. Lockhart, Sellers and Stead owned 100,124, 0 and 4,400 shares, respectively, of AHI common stock (not including stock options), constituting in the aggregate less than 1% of the outstanding common stock. With this nominal share ownership, what incentive does management have to maximize value for shareholders? We worry that AHI might be treated as a very small loose end to a historic and massive bankruptcy case that management will be more motivated to expeditiously resolve rather than to maximize its full value for the benefit of the shareholders. At least in perception, we think that the above issues raise legitimate conflict of interest and independence questions. There are remedies - we will offer a few ideas. The board might consider the appointment of an additional director who is a clear “outsider” to overtake or oversee the role of the Special Committee - someone who could authoritatively serve independently in a trustee capacity. We also believe the board should provide more transparency and disclosure to the shareholders it represents regarding its involvement in the AWI bankruptcy. Specifically, the Company should issue a press release or other public filing that provides clear and detailed disclosure about all of AHI’s claims, AWI’s defenses to such claims and estimates of recovery ranges for all claims as well as a timeline for such recoveries. We are particularly interested in understanding the nature of the tax assets in question as well as AHI’s and AWI’s opposing views on their usage. An open forum is all the more important right now as these negotiations will be taking place behind closed doors rather than in the light of the bankruptcy court where shareholder scrutiny is available. To our knowledge, no settlements have yet been reached with AWI on these four claims. We also have no information that would imply that AHI needs a timely resolution to any of its claims. As such, we urge you not to enter into any settlements prior to the installation of greater oversight and accountability measures at AHI either in the form of our recommended actions or otherwise. Please contact us at your earliest convenience to schedule a conference call. Thank you for your consideration.

On this news, ACKHQ was up 121% on Friday to $.35. This leaves it with a market cap of $14.2 million. Depending on the actual value of these claims, it could either be extremely cheap, or a worthless piece of paper. Good luck to the Kellogg Group and any other intrepid speculators, but I’ll be watching from the sidelines.

Disclosure: Neal Shanske owns none of the stocks discussed