Private equity puts down foundations

Private equity puts down foundations
Published: 04 September 2007

The recent spate of news stories on private equity funding, and some growing unease about their sometimes, rather secretive, methods of doing business, prompts us to look at their activities in the building materials and cement sectors. Certainly HeidelbergCement’s recent generous valuation of  Hanson was probably (well at least in part) influenced by the high prices being paid by private equity investors, especially for operations generating good cash flows that make it easier to support high levels of debt – a private equity speciality.
 
A good example of rising valuations can be seen in distributor Wolseley paying a high Euro1982m for DT Group (Dansk Trælast), the largest builders’ merchant in Denmark and Sweden and the second largest in Finland, with a turnover of Euro2359m and an EBITDA of Euro169.5m, in July of last year, a price far removed from the Euro750m private equity investors had paid for the business just over three years earlier.
 
Roof tiles offer no less than two major examples of recent private equity deals in the building materials industry.  The first was the sale of clay tile and hollow brick producer Terreal by Saint Gobain in 2003 to venture capitalists, a private equity was often referred to at the time, and the management, for Euro514m.  This was followed in early December last year, by a much larger roofing deal as Lafarge agreed to sell a 65% stake in its roofing business approximately Euro1270m.  That deal placed an enterprise value of some Euro2400m on the business, in which Lafarge has, for the present, wisely retained a 35 per cent stake.
 
However, the largest recent private equity deal related to the building materials industry is the sale in the United States by Home Depot of its builders’ merchanting operations to a consortium of three private equity groups.  Originally agreed in principle in June at a price of US$10,800m, the deal was re-negotiated in August, to a cash value of just US$7,900m, with the vendor retaining a 12.5% stake in the business, on top of which it has to guarantee US$1000m of the debt being issued to finance the transaction.  This does, however, also illustrate clearly how the period of cheap and easy credit has come to an abrupt end in the wake of investors waking up to the risks involved in lending funds at low rates with poor covenants and at generous valuations, circumstances that clearly limits the scope for re-financing, and with it limits the financial flexibility.
 
The forthcoming disposal of Tarmac, probably in the spring of 2008, first looked like creating a serious competition between rival private equity groups for a sizeable deal, and most likely reaching valuations that it would be difficult for industrial buyers to justify.  However with the end of the recent lenient borrowing conditions in combination with higher interest rates would suggest that trade sale, or even a flotation, now looks like a more plausible outcome.
 
On the negative side, the sheer size of Tarmac makes it a formidable task for any industrial buyer that also has heavy investment programmes and especially capital intensive cement plants to finance.  Furthermore, Holcim, Lafarge and Cemex would all need to make substantial disposals in order to obtain clearance for such a deal.  One group that would not have any problems on this score however is the Irish-based CRH, which presently has no significant interests in cement, aggregates and concrete in Great Britain, and would also be in a position of generate material synergy benefits on the Continent. A major step in the right direction, provided CRH is not, by then, feeling a significant profit squeeze from its extensive North American operations, following more downward pressures on the US economy.