Foundation Building Materials (FBM) has gone public in an IPO which has not been well received. Demand for the shares of the building materials distributor, which employs an aggressive roll-up acquisition strategy, has been very soft on the back of poor margins and high leverage being employed.
These reasons and an unusual tax receivable agreement with the sponsor of the company makes it very easy for me to avoid the shares. Despite the ¨discount¨, I see no imminent appeal given the lack of profits, or outlook for profits in the near term.
A Solid Foundation?
Foundation Building Materials is a distributor of wallboard and suspended ceiling systems, operating in both the US and Canada. The company has expanded from just 1 branch to little over 200 in the time frame of little over five years, with the vast majority of growth resulting from an acquisition-driven strategy.
The company carries over 35,000 SKUs, and 85% of sales are derived from the specialty building product segment, with the remaining sales generated by insulation products. The strong focus on growth allowed the company to take a near 8% market share in the US wallboard market. To achieve this scale, FBM has made 19 acquisitions since 2011, while it has incentivized owners and branch managers as well. Over 100 employees now hold an equity interest in the company.
The company buys wallboard, metal frames, suspended ceiling systems, insulation and related products from large suppliers including Armstrong World Industries and USG. It then re-distributes these to over 30,000 customers through its +200 branches.
The Deal & Valuation, Highly Leveraged
The structure of the deal is rather complicated: Lone Star and employees combined own a holding company, which in its turn owns the majority of FBM´s shares. The remainder will now trade freely on the market.
The company sold 12.8 million shares at just $14 per share, far below the preliminary offering range of $17-$19 per share. The company raised $179 million in gross proceeds with the offering. With nearly 43 million shares outstanding, equity of the business is valued at $600 million at that price. It should be said that shares have recovered to $15.50 per share on the day of the IPO.
The company posted revenues of $1.76 billion in 2015, accompanied by operating profits of $45.4 million, for margins of merely 2.6%. The leveraged balance sheet resulted in large losses for investors on the back of sizable interest expenses. Growth continued in the first nine months of 2016, with sales increasing by 6.8% for that period, but unfortunately FBM did not split out organic and acquisition-driven growth. It is disappointing that operating margins for the first nine months of the year were down by 80 basis points to 2.1% of sales.
This is troubling as the company operates with a pro-forma cash position of $40 million and net debt of $500 million. Given the disappointing IPO price, and consequentially the proceeds from the offering, net debt is currently standing at close to $550 million.
That is a big number with adjusted EBITDA coming in at just $88 million for the first nine month of 2016. With adjusted EBITDA guided at $25 million for the fourth quarter, the full year adjusted number comes in at $113 million, for a near 5 times leverage ratio. Refinancing of current expensive debt, at perhaps a 6% rate of interest, could reduce interest expenses to $33 million per year.
With adjusted EBITDA hitting $113 million on a pro-forma basis, D&A expenses annualizing at around $75 million, and interest expenses coming in at $33 million (after refinancing), net earnings will be nonexistent this upcoming year.
For me the IPO of FBM is very easy to avoid. The company is highly leveraged, and even after taking into account the IPO proceeds, the company will not be able to post earnings in what is still a sound economic environment.
The high leverage, cyclical end markets, dominant shareholder and questionable tax receivable agreement with Lone Star, make me very cautious. FBM has an agreement with Lone Star to compensate its ¨backer¨ roughly $200 million in future tax benefits, to be paid out in cash to Lone Star in the years to come. In that sense, I am not surprised to see the market reacting negatively to the offering, even as this ¨discount¨ can not persuade me to think otherwise.
A peer like GMS (GMS), which went public in May of last year, posts sales of $2.1 billion on a trailing basis and operating profits of $77 million, for margins of 3.6%. The company is valued at $1.8 billion including debt, equivalent to 0.85 times sales and 23 times operating profits, and the earnings multiples look very steep after interest payments and taxes.
FBM is valued at $1.15 billion in sales, equivalent to just 0.6 times anticipated sales. On the other hand, adjusted operating profits are only seen at $38 million this year, for margins of merely 2%, little over half those reported by GMS. Closing this margin gap is not only a formidable task, but even if FBM manages to close the gap, both companies trade at steep multiples if you ask me. After all, the usage of leverage in a cyclical industry remains a dangerous undertaking in my view.
The absence of profits, complicated deal structure and leverage concerns outweighs the potential appealing multiples relative to some other competitors. I find it very easy to avoid this IPO for now, and am keeping an eye on the developments going forward.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.