As JLL Partners proved last week, a firm doesn’t have to start a real estate fund to profit from the hot housing sector. Such was the case when JLL exited from longtime acquisition platform Builders Firstsource (BLDR) via the public markets. The IPO priced at the mid-range of the $15-$17 offering, with an additional 1 million shares above the original 12.5 million allotment sold. Although down the first few days of trading, Builders regained some ground and at press time was trading at $16 per share, giving the company a market cap of $520 million with debt around 3x EBITDA (pro forma). This yielded JLL roughly 3x its capital while still retaining a 55% stake.
A source close to the deal said that while investors didn’t get the “pop” that they have come to expect during the first week of trading, the general consensus was that the company was a longer-term play. The company is dependent on the housing market, but because it doesn’t operate in the Southwest, the fastest growing market in the United States, the company is viewed as more insulated from a downturn than some of its competitors. Its margins are already strong, but investors feel they have room to get stronger.
“Most investors were okay with the capital structure of the company and while they wanted to own a lot at $16, the deal would have been harder to get done at $17,” the source said.
JLL originally teamed with ex-CEO John Roach to acquire Builders Firstsource from Pulte Homes in 1998 at a price of $30 million. The firm used it $375 million JLL Partners Fund II to pay for the deal. Subsequently, Builders was used as an acquisition platform, as JLL made additional equity investments totaling $237 million. Over the course of the next five years the company acquired 23 separate companies and integrated them into the third-largest building supply company in the U.S. The company, which focuses on the “pro-segment” of homebuilders, built revenues to $2 billion and gross net of $500 billion.
After CEO Floyd Sherman joined the company in 2001, however, revenue started to grow at a much slower pace, and Builders slipped from the second-largest supplier of building materials to its current position as third. But sources say that’s partly because Sherman’s mandate was largely to integrate the acquisitions, whittle down working capital, and ready the company for a sale. The first attempt at exiting, however, didn’t go as originally planned. JLL had hired UBS and Deutsche Bank to auction the company off in 2004. Home Depot showed the most interest and was prepared to offer the highest price of 7x to 8x EBITDA, which would have valued the company around $800 million to $900 million. At that price JLL stood to walk away with a 3x return on their money, including a $127 million recap. A source elaborated that Home Depot was interested, “but took a closer look and saw something they didn’t like, while the other bidders were talking numbers in the low $700 [millions].”
The auction turned out to be a moot point. “Due to an unexpected increase in earnings and a better public market environment, we decided the time was right take the company public” this time using UBS and Deutsche as underwriters, said Ramsey Frank, managing director with JLL. That unexpected jump in earnings was in part the result of rising timber prices, which account for 40% of the company’s sales.
Last week’s exit comes at an opportune time for JLL. According to Form D filings, the firm is in the midst of raising its largest fund yet, with $950 million committed thus far. That said, JLL’s Frank noted there was no additional pressure to return money to investors in Fund II, nor was their added incentive because of JLL’s current fundraising efforts. “While our first and third fund were top 10%-15% percentile for their vintage, our 1994 Fund II was average, but we were in no rush to get money back to our LPs,” he said. “Generally we have good relationships with our LPs, and a few years extension on an agreement is standard. Further, we have distributed more than $2 billion in the last few months, and for a firm our size that’s quite a bit, in addition to raising a fifth fund that’s going quite well.” Calls to several LP’s were not returned by press time. As to whether the markets were reacting poorly to the IPO because the company was over-levered, Frank said, “We didn’t use too much leverage, the company will end up at 3x pro forma EBITDA.”
Apart from the $327 million JLL raked off the top, the company has an additional $100 million or so in debt left over from its acquisition period. All told, it’s around 3.2x pro-forma EBITDA after using IPO proceeds-middle of the road by most standards. However, as one source familiar with the deal put it, “Builders has the most leverage of all their competitors and pretty volatile earnings because of their reliance on commodities.” It has more than $400 million in debt, the majority of which is at floating interest rates. Moreover, if interest rates continue to rise, causing the housing market to cool and timber prices to fall, Builders will take a hit. On the other hand, there could be some upside for JLL. Currently the company trades at 8x P/E, a discount to other comparable public competitors, such as BMHC. If they can get debt levels down and begin trading at 13x P/E, as does BMHC, then JLL will nearly double their remaining capital.
In any event, the deal clearly has been a good one for JLL. The firm recapped the company a second time for $200 million in 2005. Following the recap the company was taken public with a relatively small float of 13.5 million shares (including over allotment) with $70 million of the proceeds going to JLL. The firm also still holds 55% of the company, which at the current market cap would put the unrealized portion of their investment at $275 million. All told, it is turning out to be a 3x return on capital while holding on to some upside.