The crashing home-construction industry is dragging neighboring businesses down with it, and LBO firms are beginning to feel the pain.
In recent weeks at least three buyout-backed companies saw credit rating downgrades: Propex Inc., majority owned by
The damage is surely not confined to just these firms or companies. Deals in the housing industry and related sectors by U.S.-based firms increased steadily in the last six years before finally tailing off in 2007 as the market cooled. There were 21 deals closed in 2002 with a disclosed volume of $2.8 million, and activity peaked in 2006 when sponsors completed 91 deals with a disclosed value of just over $13 billion, according to Thomson Financial, publisher of Buyouts. Deal volume cooled slightly in 2007, with 86 transactions completed.
After a severe slowdown in housing starts in 2007, building products suppliers and manufacturers are gearing up for an even bleaker 2008. Standard & Poor’s estimates 1 million to 1.1 million new starts this year, down from approximately 1.5 million in 2007 and off by nearly half from 2.1 million in 2005. Kyle Loughlin, managing director with S&P, said exposed companies are responding to the flagging market by managing credit lines, seeking waivers and amendments on covenants, and reconfiguring working capital to free up cash and increase liquidity.
The work is starting to get intense, however, because many of these companies have already cut costs and are now looking at gouging deeper into the business, said Keith Hughes, a housing industry analyst with SunTrust Robinson Humphrey. “They’re done cutting fat,” he said. “They’re cutting into the business closer to the bone, if you will, exiting regions, or product lines, or lowering capacity.”
Meanwhile, it’s going to be hard for firms to off-load troubled businesses they can’t or don’t want to fix. Struggling companies in the building sector are not attractive, even to distressed specialists, because “no one knows where the bottom is,” Hughes said.
The construction industry is divided into three segments: new home building, remodeling, and commercial building. While the commercial building and remodeling industries typically hold up better in downturns, the 2008 outlook for each is “not rosy,” Hughes said, and both show few signs of turning around in 12 months. Businesses heavily exposed to new home building in the United States will be exceptionally vulnerable, Hughes said.
The struggling environment has applied particular pressure on highly leveraged companies. For a few, the tightened conditions have resulted in busted covenants. After breeching several covenants in September and failing to make headway in negotiating amendments on its $370 million in debt, Propex was downgraded earlier this month by S&P to ‘CCC,’ with Moody’s Investor Services following with a similar downgrade a week later. According to one source familiar with prolonged talks between Propex and its lenders, “no solution is in sight.”
Sterling Group and Genstar Capital, which purchased Propex in 2004, declined to comment. Including Propex, four of Sterling Group’s eight current portfolio companies, spread across two funds, operate in the residential and commercial housing space, according to the firm’s Web site. Four of Genstar’s 15 portfolio companies are exposed to the residential construction market, according to the firm’s Web site.
While not yet in the same state of jeopardy as Propex, MAAX Holdings and Euramax International are also at risk of covenant violations, with MAAX Holdings already missing a December interest payment. The Canadian bathroom fixture supplier, which J.W. Childs bought in 2004 and which remains the firm’s only investment in the space, saw a downgrade from Moody’s to ‘Ca’ based on the likelihood of defaulting on that interest payment.
Euramax International has yet to violate a covenant, but the increased likelihood prompted S&P to cut Euramax’s corporate family rating from ‘B’ to ‘B-’ last month. The company supplies metal siding for houses and mobile homes. Even with its high leverage, the Georgia-based aluminum and steel manufacturer may be in better shape than Propex and MAAX Holdings since it serves the less cyclical commercial construction and transportation markets in the United States and Europe. Goldman Sachs bought Euramax International in 2005 for $1 billion. Euramax and Goldman Sachs did not respond to requests for comment.
Georgia Gulf, the publicly traded integrated vinyl company backed in part by Sun Capital’s public securities investment vehicle, was downgraded on several occasions last year to its current ‘B’ rating following its $1.5 billion debt-financed acquisition in 2006 of Royal Group, a siding, windows and fencing company. Despite announcing a $71.5 million capital infusion this month from a sale leaseback, the company remains in a weak position given Royal Group’s heavy exposure to the housing market.
Sun Capital made its initial 5 percent investment in Georgia Gulf in April 2007, when the stock was trading around $16 per share. Shares now change hands at less than $5. Sun Capital owns a majority stake in seven industrial building products and services companies, representing about 9 percent of the firm’s portfolio, according to the firm’s Web site.—E.G.
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