Cornerstone Building Brands (CNR) – Merger Arbitrage – 13% Upside

Current Price: $21.84

Offer Price: $24.65

Upside: 13%

Expected Closing Date: TBD

Press release

 

North American exterior building products manufacturer Cornerstone Building Brands received a non-binding proposal from its major shareholder (owns 49%) PE firm CD&R at $24.65/share. The merger is conditioned on approval by a special committee and also consent from the majority of minority CNR shareholders. More information and the decision of a special committee are likely to be announced tomorrow (1st of March) together with the earnings report. Special committee approval is likely and the offer comes at a 43%+ premium to the unaffected price (there was a leak on Bloomberg 4 days before the announcement). The spread is expected to close once a firm agreement is in place. There is also a decent possibility that the offer will be increased upon signing the definitive agreement. The offer comes at 7.7x E2021 adj. EBITDA normalized for acquisitions and divestitures and 10.1x 2019 adj. EBITDA, which seems a bit weak compared to historical multiples and in line with peers (i.e. no control premium). CD&R is likely trying to opportunistically capitalize on several overhangs that have so far kept CNR prices depressed.

Aside from a steep downside and some shareholder approval risk, the spread also exists because of the non-binding nature of the proposal as well as the fact that CD&R has called its offer “best and final“. However, I believe that this is just a negotiation tactic – the buyer also said that the final deal is subject to negotiations and they reserve the right to modify the proposal at any time. Due to the offer (and potentially pending negotiations) Q4 earnings release was delayed by one week and the conference call was canceled. CD&R also hinted that they are not willing to sell, which reduces the chance of a competing bid.

 

CD&R and merger background/rationale

CD&R is a large PE group that knows CNR business inside and out, hence, why they said only minimal due diligence will be required. The bid at $24.65/share clearly signals they think the company is worth much more.

CD&R has been an investor in NCI Building Systems (commercial – metal systems, roofing, panels) since 2009. In 2018 it acquired Ply Gem (residential – windows, doors, and sidings) and merged the two companies. The merger closed in Nov’18. The company changed its name to Cornerstone Building Brands in April’19. CD&R holds a 49% stake in the combined company since then. The merger combined two different businesses with very limited synergies, minor cross-selling opportunities and came just at the time of US housing market turbulence starting in mid’18. The market hated it, which resulted in a steep sell-off right after the merger was closed. This same overhang of having two different businesses and effective control by the PE firm has kept CNR share price low/behind most peers even amidst the housing market explosion in covid years.

Since the merger was closed, CD&R has managed to implement cost-cutting measures and improve the balance sheet of the combined company. The business mix has changed over time as with more sales now leaning on the legacy Ply Gem side (residential), which has been riding housing boom tailwinds since H2 2020. Management mentioned, that the commercial business (legacy NCI) has historically lagged housing cycles by 1.5-2 years, which has finally started kicking in during the last couple quarters as well.

The offer came just 1 week before the Q4 earnings and earnings releases got delayed subsequently. CNR peers (BECN, DOOR, JELD) have all reported relatively strong Q4 results and outlook for 2022.

Given all of the above, it seems that CD&R’s offer is quite opportunistic here.

 

Board approval

Special Committee is likely to approve the offer. The talks had begun and the committee had already been set up even before this offer and apparently the price had already been increased in discussions. In its letter, CD&R states that this public offer price “has significantly increased in value since the outset of our exploratory discussions with the Special Committee and its advisors regarding a potential transaction”. The fact that 4 days after receiving the latest offer, the board has suddenly decided to postpone the earnings release and cancel the conference call is quite intriguing and potentially suggests that negotiations are ongoing.

 

Valuation

The key question here is whether CD&R will raise the offer to persuade shareholders to sell and show that the Special Committee has done its job.

The offer comes at 7.6x E2021 normalized adj. EBITDA and 10.1x 2019 adj. EBITDA multiples. Just before the 2018 merger NCI was trading at 10x adj. EBITDA and Ply Gem was acquired at 10.9x adj. EBITDA multiple. CD&R was presenting these as “attractive prices” compared to peer acquisitions:

Ply Gem business (residential, windows, and sidings) is in much better shape now due to cost-cutting efforts and the booming housing market.

CNR doesn’t have any direct peers, however, the ones that are somewhat comparable (but with lower EBITDA margins) trade at similar multiples.

  • BECN (roofing and other building materials) – 9x 2021 adj. EBITDA
  • DOOR (interior/exterior doors) – 6.7x 2021 adj. EBITDA
  • JELD (windows, doors, and wall systems) – 7.7x 2021 adj. EBITDA.

 

CNR background

CNR is one of the largest manufacturers of exterior building products in North America. It operates 67 manufacturing facilities in US and Canada, supported by 40 distribution facilities (works with plenty of other dealers/distributors as well).

The segments are:

  • Commercial (legacy NCI) – design and manufacturing of low-rise non-residential construction materials. Primarily – metal systems (structural members and panels), metal roofing and wall systems, insulated metal panels (act simultaneously as exterior wall, insulation, and finished interior wall), etc.
  • Windows (legacy Ply Gem) – windows and doors (vinyl, wood, aluminum, etc.) for residential new construction and repair/remodel markets. The company holds the largest market share for vinyl windows.
  • Siding (legacy Ply Gem) – cladding, fencing, and stone products for residential new construction and repair/remodel markets. Includes vinyl siding, composite, steel, and other sidings as well. CNR holds the largest market share in vinyl sidings.

On the supply side the company is mostly exposed to steel (commercial) and PVC, resin, glass, and aluminum commodity prices although price volatility is mostly transferred quickly to customers due to quick inventory turnover.

This presentation shows how the business looked at the time NCI/Ply Gem merger. NCI/commercial business exposure is now a bit lower due to faster growth of Ply/residential since the merger – commercial generates 32% of sales vs 38% after the merger.

Estimated cost cuts and synergies at the time of the merger:

Historical financial information is shown in the table below – CNR has done several acquisitions and divestitures recently, so the numbers below are Pro-forma (reported in CNR press releases).

Due to strong financial performance, CNR has reduced its leverage (net debt/adj. EBITDA) from 5.2x to the most recent 3.4x. Management intends to lower it by 0.75x-1x turns more in 2022.

In the latest guidance, the company was estimating Q4’21 adj. EBTIDA to be at $170-$185m, which should result in $680m adj. EBITDA in 2021. In Aug’21 CNR divested part of its commercial business ($1.2bn proceeds), which from the Q3 Pro-forma segment result adjustments in the press release, apparently, was generating small adj. EBITDA losses. Moreover, recently CNR made an acquisition of UCC (metal roofing to residential). UCC generated $255m TTM sales and in the conf. call management said it expects mid-teens adj. EBITDA margins before synergies (30%-50% EBITDA estimated). Putting these together suggests that CNR adj. EBITDA generation should stand at around $710m per year going forward.

Segment performance:

The commercial segment has been seeing traction over the last couple of quarters as it finally caugt up with the booming housing market (higher volumes, increasing backlog). During the last Q3 conf. call management expected strong continuing performance of the commercial segment, but also said that on a normalized basis commercial adj. EBITDA margins should be in the mid-teens. Worth noting that on the supply side commercial business is exposed to steel prices, which apparently were going down throughout the whole Q4.

Residential (windows and sidings) has been performing strongly during 9M 2021. Windows adj. EBITDA margin dropped to 8.6% in Q3 due to certain labor shortages and freight issues, but management said that in Q4 it should get back to 11-12% again.

So far the US housing market is still booming (SF housing starts) while the supply of the existing homes is at record lows. Homeowner improvement and repair spending is growing as well and is expected to accelerate in 2022. Worth noting, however, that mortgage rates (30-years) went up by 1% since the start of the year to around 4% amidst fear of FED rate hikes in 2022.

12 COMMENTS

  1. HomeSpunoff

    Ilja, thanks for the writeup. A few questions…

    i. If the deal falls through, what do you believe the share price downside may be? Do you think the downside will be falling from $21 per share (approximately where it trades today) to approximately $14 per share (where it traded in early Feb2022)?

    ii. Any thoughts on the quarterly earnings and press release today (3/1/2022)?

    iii. What would you estimate the probability (%) of this deal falling through?

    2
    1. Ilja

      Hey, HomeSpunoff, thank you for the questions.

      I don’t look at these types of events it in terms of probabilities. These are mostly just binary events. But my bet is on this merger closing. Although at the current spread it also looks interesting just as a short term play on definitive offer announcement after which the spread should narrow <10%.

      1. My guess is really as good as yours. I think about the downside as pre-announcement price (pre-leak it was just above $17/share). It would also depend on what kind of financial performance guidance they would issue afterwards.

      2. Posted a comment on it down below.

      3
  2. sacredbiotech

    They’ll have to raise the bid to at least $26.50 for this to close.

    2
    1. HomeSpunoff

      What is your reasoning for $26.50? Based on where other building materials distributors are trading (as mentioned in the writeup), the $24.50 seems to be a reasonable price.

      Can you point to other deals (ideally, take-privates by PE) from 2021-2022 that have been done at higher multiples? My understanding is the multiples at which deals are being done isn’t necessarily higher now in 2022 than it was in 2021 (and perhaps slightly lower).

      1
      1. sacredbiotech

        On historical valuation multiples at this point the bid was either announced promptly after forming the special committee so there is another month or two before a deal is locked in, higher probability if market is weak as shown in the tape and in earnings…..OR there is pushback from the special committee on the best yet to come and raising the bid up to a 10% premium from historical valuation multiples is reasonable. …..I want confirmation on who is on the special committee……If it’s the affiliated transaction committee members then the chair/former CEO Jim Metcalf who was a cash buyer under $9.00 per share is up over $8M on a buyout which is a meaningful gain for him can push this through with time….only issues I see is Gary Forbes who isn’t making much on this transaction ($900K gain vs. $250K annual comp on board) doesn’t have anything else to do and he is the board member who remembers the 2000s stock price so he can tell that story to the others…….Kathleen Affeldt is a similar story old board member losing $250K annuity vs. $500K gain on sale…I can make up stuff that has them pushing back on losing their annual compensation with belief in the new building cycle ala 2000s expectations in valuation with PE buyout a sign of that……waiting and watching here

        1
  3. Ilja

    The spread has widened to 17%. Part of that is due to a bit mixed Q4 results + suspended guidance (and no conf. call to give more details) and the fact that the special comittee hasn’t provided any answer yet.

    Both Q4 revenues ($1471m) and adj. EBTIDA ($184m) were just a hair below the upper range of the previous guidance.

    Commercial segment growth has accelerated with Q4 revenues at $525m and EBITDA margin of 21.5%, however, Sidings and Windows performed weaker than expected with Sidings adj. EBITDA margin dropping to 16.4%. Adj. EBITDA margin for Windows was 8.8% despite management previously saying that it expects a rebound to 11%-12% in Q4. The explanation for both segments was again labor shortage, manufacturing inefficiencies and supply chain issues, which management also previous said had been sorted out (apparently not). This margin performance fell short compared to peer performance. So its a bit difficult to understand what’s going on. Cancelled conf. call and no further guidance did not help either.

    Don’t quote me on that but the whole set up really seems to favor the buyer here.

    4
  4. HomeSpunoff

    DT, I believe you have real-time access to VIC…is there anything recent on VIC’s CNR comments that could be added or disagrees with the thesis & comments here? Thanks!

    1
    1. dt

      Not much to add. A couple of participants of VIC board also appear to be puzzled by market’s skepticism of this offer. One of the potential explanations is that two somewhat similar transactions (i.e. main shareholder trying to buyout minorities, at non-binding offer stage) have failed recently – SGMS/SCPL and JBS/PPC. That might at least partially explain market’s reaction.

      However, in both these cases the stocks of target companies traded above the offer prices and the market was clearly demanding an increase. The situation with CNR today is very different with the stock trading at a 17% spread.

      1
  5. HomeSpunoff

    Thanks DT and all. I bought this in size today. Question for SSI folks who own CNR…do you plan to continue holding if the deal falls through?

    I’m still uncertain as to whether I would hold if the deal gets called off, because other building materials companies, such as Boise Cascade (BCC), trade at a cheaper multiple (i.e., P/FCF and P/E).

  6. HomeSpunoff

    Thanks Ilya and all! Question for Sacredbiotech / Ilya or others…what do you think is the probability of CD&R increasing its bid price or another bidder coming in higher?

    Based on my reading of the proxy…If Cornerstone terminates (for instance, if CNR were to accept a third party’s higher bid), Cornerstone pays $105M. If CD&R terminates, it pays $210M.
    Source: “the Company will be required to pay to Parent a termination fee of $105,000,000. Parent will be required to pay to the Company a termination fee of $210,000,000”
    (https://sec.report/Document/0001104659-22-030880/).

    1

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