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Volume 11, Issue 6 - July/August 2010

Trend Tracker

Mergers and Acquisitions
2010 Is Slower Year Than Expected
by Michael Collins

At the end of 2009, we predicted that merger and acquisition (M&A) activity in the door and window industry would continue in 2010 at roughly the same pace as seen in 2009. That has turned out not to be the case, and it is interesting to examine the reasons. As shown in the graph at right, 2008 saw some 31 acquisitions completed, which was nearly equaled by the 29 transactions in 2009. With only five acquisitions of which we are aware so far in 2010, the pace of M&A activity has slowed drastically.

Reasons for the Decrease
There are numerous factors that have contributed to the decrease in M&A activity thus far in 2010. Up until recently, financing has been very difficult to obtain. When private equity (PE) funds and companies are unable to borrow a portion of the cost, they are less likely to complete acquisitions. Another reason for the slowdown stems from a trend that is, in itself, positive for the industry. A number of the sales conducted in 2009 involved companies that, in a stable market, would not have been for sale in the first place. Thus, as the market has improved and companies have started to stabilize, there are fewer sales driven by the necessity of a lack of financing. Another offshoot of this trend that has had a dampening effect on sales of companies is a gap that existed between the prices buyers have been willing to pay for companies and the owners’ beliefs regarding the fundamental value of their companies. Owners did not wish to sell at a price that would fail to capture the long-term value of their companies, simply because they were selling on a downstroke. This misalignment of the supply and demand curves causes the number of transactions to drop.

Another key factor that we believed would drive sales of door and window manufacturers in 2010 was the pending increase in the capital gains tax. With capital gains taxes now at 15 percent, and likely to increase to 25 or 30 percent when the current tax rate expires on December 31, 2010, we believed that a slight “rush to the door” would be created in the industry. However, with earnings down, many companies have instead focused on making improvements in their level of earnings before interest, taxes, depreciation and amortization (EBITDA), a proxy for cash flow. This strategy can be beneficial, even under a modest increase in revenues and EBITDA. This even can be true when the EBITDA margin (EBITDA divided by revenues) and the EBITDA multiple used in determining valuation both remain the same. Needless to say, the planning surrounding a business sale should involve one’s tax and legal advisors.

M&A Outlook
With some hesitation on the heels of having predicted a stream of door and window manufacturer sales in 2010 that haven’t materialized, we continue to believe that M&A activity in the industry will be strong in the next 12 to 18 months. The profitability of companies slowly is increasing as the market stabilizes. Companies have downsized and cut costs to the point where even a modest increase in sales can result in a strong increase in profitability. These extra profits not only make a case for the higher valuations that selling business owners desire, they provide additional operating profits that buyers can use to fund acquisitions. This, combined with a sharp increase recently in the availability of loans, fuels the buying appetite of strategic acquirers. PE buyers, for their part, are holding or raising billions of dollars that must be put to work in acquisitions. Dozens of additional such funds have approached us in recent months, professing their desire to invest in building products manufacturers. Thus, the pace of M&A activity in the remainder of 2010 and in 2011 should strengthen and will serve as an important indicator of the market’s belief in the recovery of this segment.

Michael Collins is vice president of the building products group at Jordan, Knauff & Company. His opinions are solely his own and not necessarily those of this magazine.