How 3 of LBM’s Most Acquisitive Firms Value Companies and Predict What’s to Come
By Craig Webb
Executives from three of the most active companies in LBM’s M&A market say they intend to keep pursuing potential deals in 2022, operating in an environment in which potential tax changes, COVID, supply chain shortages, housing demand, and the economy provide special challenges to assessing a prospect’s worth.
L.T. Gibson, Steve Swinney, and Robert Debs also emphasized during the Nov. 10 webinar that they particularly prize companies with strong leaders who want to stay in place after the deal, as well as businesses with accurate, insightful financial statements.
The event was moderated by Building Industry Advisors’ Michael Collins, sponsored by Buildxact, and available for video replay by clicking here. It took place at a time that, year to date, has seen roughly double the deals and close to triple the locations that had happened through this point in 2020. But one also should note the urge to merge didn’t really begin until this time last year, as the final six weeks of 2020 saw the consummation of another 15 deals involving 304 locations, plus the Builders FirstSource-BMC merger. The pace hasn’t slowed since.
The Appetite Remains Strong
“The pandemic, the rise in lumber [prices], it’s got a lot of people’s P&Ls looking healthier than they’ve been before,” said Gibson, US LBM’s president and CEO. US LBM has done 15 deals so far this year, and Gibson said he expects to close three or four more by year’s end.
Gibson said the number of deals US LBM will consummate next year likely will “normalize” in 2022, explaining: “There probably will be fewer targets available, so we’ll probably do a bit less. But it doesn’t change our appetite.”
Swinney, president, and CEO of Kodiak Building Partners, said he expects to close more deals over the next 12 months than the three acquisitions involving five locations that have taken place this year. “The success rate may go up, but when you’re doing what we do, in terms of being active in this market, it never stops,” he said. “You’re always wanting to be talking to someone and looking at any opportunity there is and have those conversations and explore those scenarios.”
Nation’s Best Holdings, formed just two years ago, has made eight acquisitions involving 10 locations this year. Robert Debs, vice president, said talks under way now are likely to bring in two more companies late in the first quarter of 2022. “We want to grow at the proper pace, and we want to make sure our existing portfolio is doing well before we start looking at other companies,” he said. “We see continued activities in late Q1 and the second half.”
Eliminating the Static
All three said much of their work today involves recognizing and accounting for a slew of one-time events and other factors that can skew current numbers and make it hard to envision the company’s future.
“You’ve got two years of anomalies with the pandemic and also inflation,” Gibson said. “ … Our job lately—and it’s been a more difficult job these past two years—is to normalize those earnings: To look at what percentage of the business is in lumber, what impact that lumber has had on it. It’s different for everyone depending on when they bought and sold it, so what you’re looking for is a trend. You’ve got to lean into 2018 and 2019 a little more than usual in order to normalize 2020 and 2021. … We really try to peel back the onion and understand what the underlying earnings are, and that’s what we value the business off of.”
At Nation’s Best, the focus is more on small, often rural stores that have a heavy percentage of retail customers and hardlines sales as well as home centers and bigger lumberyards. Those stores got a sales boost since the COVID pandemic began, and Debs looks for operations that expect to keep up those sales after the virus wanes. “We’re looking at 2018 and 2019 [financials] more than usual, but I’d say we’re giving 2020 and 2021 a fair bit of credit, especially depending on their product mix,” he said.
“The important point for sellers to understand is that for all of us, when we’re looking at a business, we’re looking at the future of that business,” Swinney said. “What happened in the past in and of itself doesn’t matter to the buyer because they’re never going to be a part of that. We’re buying and investing because of what we think can happen in the future.
“Of course, you are going to look at the present and the recent past to help you get a handle on what the future is going to look like,” Swinney continued. “We all are probably doing a lot of work right now as we look at businesses to really try to get our arms around what do we think will happen next year and the year after that and the year after that in light of what their earnings are today and what are their performances today, and how commodity effects are impacting that. And so, yes, you’ve got to get your arms around the commodity piece, but you’ve got to remember it’s always with a mindset of trying to set the stage for what the future is going to look like in that business and that market. That’s what we all wrestle with.”
Compatible Culture, Strong Leaders
All three spoke at length about how hard they’re looking for evidence that the prospective acquisition’s culture matches what they’re creating. As Debs put it: “Who we partner with is just as important as what it is we’re buying.”
In general, they want businesses that care about their employees long-term and look for examples of that—how companies are dealing with COVID, for instance. Debs, Swinney, and Gibson all said they strongly prefer companies with great leaders who want to stay in the business after it is acquired.
“In the vast majority of cases, we do keep that person in place and partner with them going forward. That’s definitely our preferred model,” Swinney said. In fact, “If we were looking at a company and we don’t think that person’s capable of the role, it would be a huge red flag in the whole acquisition,” he added. That said, strong leaders typically create strong teams, so even if the leader wants to depart post-transaction, Kodiak will still be interested because it’s likely the next level of leaders have what’s needed to step up.
Gibson said US LBM looks hard at the quality of the team when it’s considering an acquisition. “If you don’t have a team going forward, the business might have less value,” he said. One exception is when US LBM has an operation nearby and can use that firm’s existing management team to lead the acquired business.
Good Data Matters a Lot, Outside Audits Less So
Good candidates don’t have to own lots of technology, the three said; that’s something they expect to bring to the deal. But they did stress that they like to see companies that can present them with accurate profit-loss statements and balance sheets. “You would think most companies have an ERP system that they leverage well, that have accurate financials,” Debs said. “But it’s not always the case.”
Added Swinney: “Having good data and analytics that allow you to get down and really understand the trends of your own business as you’re running it are things that certainly help us.”
Some dealers thinking of selling having an outside firm audit their finances. But none of the three said such an audit matters much to them, mainly because they’re accustomed to doing their own research into a company’s numbers.
“You don’t pay up because they have audited financials, but the numbers will come closer to your valuation,” Gibson said. “The value of audited financials is speed: you have a better idea of the company’s value and you can get through due diligence quicker.”
The Economy and Taxes
Gibson subscribes to the view that America could support 1.4 to 1.5 million housing starts annually, but he also believes that where homes get built in the future could change from pre-COVID times. In the past, a buyer might focus on cities and states that generated jobs and thus attracted people. But now that so many people can work from anywhere, it’s important to also look at what Gibson called “residential-friendly cities and states”—places where people want to live rather than have to live. “That’s the next wave, and understanding those dynamics are really important,” he said.
Debs likes the fact that people are going into hardware stores more frequently and are shopping at independent companies more often. “On the lumber side, everyone would like more stability, but I would say we feel very bullish,” he said.
Swinney was more cautious, expressing concern about the labor market and inflationary pressure.
“We’ve got plenty of work to do. Our customers have all kinds of demands for us,” he said. “Our biggest challenge is having enough labor to get that done. … And, so while I think the demand side is strong and the outlook is positive for that, for some time to come we in the near term are going to be dealing with headwinds to actually be able to turn into sales and into profits.”
One big question mark is whether Congress will raise the taxation rate for capital gains and whether that higher rate will be applied retroactively to deals concluded this year.
“Individual tax strategies can be difficult,” Gibson said. “If capital gains changes and it goes up, it’s probably going to cost a seller money regardless of how they structure the business or when they sell the business. But there’s a right time to sell; for competitive reasons or for your family. It really is a decision that the ownership has to make that’s right for them. Even if they change [tax rates], I don’t know that it’s enough for anyone to change how they view their goals for their life. … It’s just a fact of life, and it may not change at all.”
Swinney called the gains-tax issue “one of many factors the seller should be thinking about when they consider this. But let’s hope it doesn’t become such a big factor that it really does drive the decision. Because if it does, we probably have a lot bigger problem with capitalism and the future of our economy.”