Private-Equity Buyers See Mostly Upside in Housing

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Private-equity firms are stepping up investments in building-product companies and home builders — a bet on the housing market's rebound — but some of the investors freely admit that focusing on the ailing industry is fraught with risk.

The investments are in a variety of styles. Some financial sponsors buy businesses that are sorting out debt issues in bankruptcy court; others adopt the roll-up approach with a series of purchases. Some buy just one business for their portfolios, and others snap up companies in a variety of locations to diminish geographic risk.

Buyers have plenty of opportunities because builders and product companies are aggressively selling themselves.

"It's just a matter of when the market will turn around and what improvements can be done in the interim," said Bryan Tolles, a vice president at BlackEagle Partners LLC, a Bloomfield Hills, Mich., sponsor firm that invests in middle-market building-product companies through roll-ups done by its US LBM Holdings platform.

Perhaps acknowledging the uncertainties in housing and the state of the economy, he also said, "This is not a quick flip for us."

Likewise, Morty White, a managing director at Wynnchurch Capital, does not expect his firm to divest its investment in the Cincinnati building-product company Senco Brands anytime soon. Wynnchurch is still actively looking in the building product field.

"This is a long-term investment, and the economy will eventually improve, and solid companies like Senco will see even better days," he said. "When most people think of the building sector, they think of doomed businesses, but there are definite gems out there."

Builders and building-product providers have attracted a broad range of investors. Blackstone Group's portfolio includes Summit Materials, an asphalt, paving and construction outfit that bought the construction product company Harper-Kilgore last month. In July, Wynnchurch snapped up the Canadian modular home builder Pro-Fab. And this month Oaktree Capital Management purchased Universal Building Products in a bankruptcy court-supervised sale.

There is plenty to be gloomy about when it comes to home builders and building products. Two weeks ago, Moody's Investors Service downgraded its near-term outlook on housing, saying it does not expect that market to hit bottom until the third quarter of next year. The rating agency earlier expected a bottoming out two quarters sooner.

Confidence among the builders themselves is skating near all-time lows. "Consumer uncertainty has increased, and builders feel their hands are tied until potential homebuyers feel more secure about the job market and economy," said Bob Jones, the chairman of the National Association of Home Builders.

Moody's says the faltering recovery is keeping job creation lackluster and depressing consumer and business confidence — all drivers of housing demand. The agency said the annual home sales rate in the last 12 months was 5.7 million, a pace matching that of the mid-1990s.

"The industry has been on a roller coaster in terms of performance. Things look like they are getting better, then they get worse," said Bernard Markstein, a vice president and senior economist at the builder trade group. "Our hope was that, by the time the last tax credit expired, the economy would be doing better and housing demand would have smoothed out, but … we reached the expiration of the credit, and the economy was still weaker than expected."

BlackEagle, however, expects a turnaround in the sector.

"We started this platform with the thesis that the housing market will return to" normal, Tolles said. "The median in housing starts was over 1 million for 40 to 50 years. Right now, we are near 500,000, which just isn't sustainable."

This month the Commerce Department said the August rate of single-family housing starts rose 4.3% from July but was down 9.1% from a year earlier, at 438,000.

"Building products has become more popular as contrarians have entered the sector," said Robert Crowley, a managing director at Moelis & Co. "Many believe the current level of construction is low and not sustainable. Eventually that has to snap back to more normal levels. I do think you will see activity pick up as people become more optimistic about the economy."

BlackEagle has made a series of purchases in the last 12 months to diversify revenue sources for its LBM Holdings, which now has 30 sites in six states. In June, LBM bought Millwood Lumber in Millwood, N.Y., and in February, it acquired Edward Hines Lumber in Chicago.

"In our platform, we make sure to partner with companies that have a long-standing history of success, as well as a diverse customer base," Tolles said. "We also capitalize our companies conservatively and make sure they can withstand a prolonged downturn. Overall, revenue is down at LBM from its peak, but the business is still profitable."

The wreckage in the housing market has prompted many builders to hang it up — bankruptcies in the sector began to rise in 2007 — or seek a partner. Tolles said he and his colleagues at BlackEagle were shown more than six potential building-product deals in one week, and these companies continue to market themselves.

Jeff Rosenkranz, a managing partner at Metronome Partners LLC, expects investors to continue to show interest in the building-product sector.

"Private-equity buyers are looking at the industry and seeing a housing market that got oversold and a building-products market that got depleted," he said. "The downside has really been tested, and the companies that are doing OK are the strong companies. From a macro perspective, the downside is pretty limited at this point, and the upside for these companies is becoming greater. The housing market was oversold, but the level of building activity today is too low to be sustainable, given the size of the country and the future growth of the country."

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