Inlet Capital Group News and Industry Notes

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Inlet Capital Group

Addressing the confidentiality concerns of sharing information with the competition

Politics can make strange bedfellows, and so can business, particularly if your business is in the construction materials industry and you are looking to exit the market. Why? Because if you want to sell your business, the most likely buyer will be among your customers, competitors or suppliers. In some cases, these groups will represent your only buyers.

For owners who think of business as a win-lose endgame, this can be a mental obstacle. Jack Welch, former chairman and CEO of GE, once said, “Buy or bury the competition.” Obviously, you want to sell your business to a qualified bidder at the best price. However, what are you to do if an in-market player gains access to sensitive information but fails to consummate a deal? How do you keep yourself from getting buried?

Know what you need to protect

The release of highly confidential information can be damaging. As such, it’s only natural for sellers to want to protect sensitive data, including:

  • Sales volume
  • Customer lists
  • Pricing (by product and/or customer)
  • Materials costs (for ready mix or asphalt producers)
  • Margins

There are numerous risks of this data becoming public. For instance, while sales volume can be estimated, if your business has a high but under-the-radar sales volume you can attract unwanted attention from competitors. In addition, revealed customer lists can also attract more competition, and details about pricing, costs and margins can disrupt the market, bring vendor relationships under scrutiny and rock the boat with customers who do not receive equal discounts and/or feel gouged.

Install a “seller-friendly” confidentiality agreement

Not all confidentiality agreements (CAs) are created equal, and while the right CA can protect your business in this situation, the wrong CA can leave you vulnerable.  Standard CAs rarely include the provisions necessary to protect sellers in these situations, and CAs generated by buyers often protect the buyers more than the sellers.

For example, a seller-friendly CA can limit the use of confidential information only for the purposes of evaluating the potential acquisition, and it may even restrict specific personnel from seeing confidential information.  A standard CA certainly won’t do that.

Other common restrictions and provisions in seller-friendly CAs include:

  • Establishing a length of agreement term sufficient to make confidential information outdated by the expiration of the term.
  • Prohibiting the buyer from soliciting your employees and customers.
  • Treating all information, in any form (oral, written, etc.), as confidential.
  • Requiring the return or destruction of all confidential information, analyses or other pertinent documents.
  • Prohibiting the buyer from disclosing it is negotiating to acquire your business.
  • Making it easy for you to protect your sensitive information in the event of a breach.

Control the flow of information as discussions progress

It is also beneficial to control and limit the flow of information. That is, release what you need to release but only when you need to or are obligated to release it. Essentially, you want to limit the amount of sensitive information you share with a buyer to only what they need to evaluate your business or conduct due diligence.  For example, you might initially limit information to sales, earnings, assets, etc., and require the buyer having to make an offer based on that information. If a conceptual agreement is reached, more detailed information can then be shared. In this instance, information sharing can again be limited to certain designated personnel.

The release of information is inevitable…but an advisor can help you control it

If you are going to consummate a transaction, there is no getting around these two facts: one, you will need to reveal sensitive information to prospective purchasers, and two, you will be exposed to risk. This is less of a concern when dealing with out-of-market buyers, but in an industry in which buyers are often in-market, these are real and serious issues. The key is to minimize your risk exposure. Delineate what information is critical at various stages of the sale process and determine what thresholds a buyer must clear before you share more sensitive information. If this is an area in which you lack comfort or expertise, consider working with an advisor. A qualified advisor will have experience both buying and selling construction materials businesses and can help you navigate these and other risks while maximizing the value in a sale.

Understanding When It Is the Right Time to Sell Your Construction Materials Business

Market conditions and a favorable outcome should outweigh perfect timing

In 1991, Hurricane Grace collided with a low pressure system off the New England coast to create a meteorological rarity—two historic storms clashing together in perfect conditions to create the storm of the 20th century. Author Sebastian Junger, who immortalized the storm in a bestselling book The Perfect Storm, wrote: “The waves generated by the storm were so huge that they literally shook the earth; seismographs in Alaska picked up their impact 5,000 miles away.”

Business also has its stories of perfect storms, when market conditions and business strategy intersect at just the precise moment to maximize value and return. However, they are equally rare and hard to document. The reason: business is cyclical, and even the best economic forecasters do not know when a market is at its top or bottom. This is especially true in the construction materials industry.

According to National Ready Mix Concrete Association (NRMCA) the construction materials industry experienced four complete up and down cycles between 1975 and 2010.The four expansion periods ranged from three to ten years, with an average duration of 5.6 years. The four contraction periods ranged from one to five years, with an average duration of 3 years.

Today, the industry has been in an expansion period that has persisted since 2011, a period of 5.7 years. This is greater than the average expansion period of the past four cycles, so the question is not if the current expansion will reverse but rather when will it reverse…and whether or not trying to perfectly time the sale of your business is a sound strategy.

Are we already seeing signs of slowing growth?

Industry economists at organizations like Portland Cement Association (PCA) and McGraw-Hill (formerly known as FW Dodge) are indeed beginning to issue forecasts that show slowing growth and/or outright contraction of shipments in the industry. However, current conditions in many U.S. markets remain strong, with volumes, sales and profits up in 2016.

The last time we experienced such inconsistency between forecasts and a scarcity of markers that indicated an imminent slowdown was a decade ago. At that time, industry economists began forecasting a notable pullback, as producers were enjoying the final leg of an unprecedented building boom. Many producers, including several in my home state of Florida, ignored those economic forecasts and continued to ride the boom, spurning exit opportunities from 2005 through 2007.

Unfortunately for those who missed the peak, the Great Recession followed, triggering a five-year downturn in the ready mix industry that ultimately caused the demise of many independent ready mix producers.

Is it time to consider an exit?

If you’re wondering if the timing is right to sell, the answer is maybe. Remember, perfect is elusive. So the more relevant question to ask is, “what conditions need to be present to attract buyers and investors interested in ready mix?”

The following are three things to look for:

  1. Significant equity and debt capital available to fund acquisitions at favorable rates.
  2. Current market conditions need to be strong.
  3. 18 months of visibility into future market growth potential.

Each of these conditions are met by today’s market. In fact, in the southeast and Florida, market conditions are particularly strong. Not surprisingly, more investors and buyers are seeking to acquire ready mix companies now than at any time in the past eight years.

When the above three conditions exist, seller earnings tend to be strong, and buyers tend to pay healthy multiples. However, if market conditions turn, seller earnings tend to soften and buyers tend to pay significantly lower multiples. This is why it is much better to sell six months too early than six months too late.

Is it the right time for you?

Market conditions, like weather patterns, can provide us with valuable data—data that can and should inform our decisions—but it’s impossible to forecast the perfect storm. So the question of if now is the right time to sell is very unique to your individual situation. It is a question only you can answer, and it depends largely on what you believe about the future of your market. However, know two things. First, you don’t need to go it alone. There are many qualified professionals who can help you understand the market and help you prepare your business for maximum earnings through a sale. Second, there is a penalty for being late. Don’t wait for perfect, because if you miss it, you’ll be on the wrong side of the curve.

Martin Marietta and U.S. Concrete Garner Different Market Reaction for Similar Performance

High valuations demand higher performance

During the week of November 1, construction materials industry leaders U.S. Concrete and Martin Marietta released their 3Q 2015 earnings reports. Each company delivered strong growth in both revenue and earnings, but the market response to each’s results could not have been more different.  While U.S. Concrete shares realized a 9 percent increase in pre-market trading following its earnings release, Martin Marietta’s stock dropped 8.5 percent following its announcement.

The discrepancy in market reaction directly correlates with market expectations. Martin Marietta did not deliver weak results. It grew revenue 7.9 percent and its earnings increased 119 percent year-over-year. However, what Martin Marietta failed to deliver was performance on par with its lofty valuation.

At the time of Martin Marietta’s earnings announcement, its enterprise value totaled nearly 15 times EBITDA. To use a term preferred by CNBC’s Jim Cramer, Martin Marietta’s shares were “priced for perfection,” which the company did not deliver. Further, the company reduced its earnings guidance for 2015 and 2016, stoking fear that the aggregates industry was seeing a broad slowdown and was yet another sign of a slowing economy. As a result, Martin Marietta’s shares dropped precipitously, and the share prices of most other construction materials companies were dragged down with it.

Conversely, when U.S. Concrete announced similarly strong results—49.4 percent revenue growth and 85.8 percent earnings growth year-over-year—the market responded favorably. The reason: U.S. Concrete’s performance exceeded analyst expectations.

U.S. Concrete’s enterprise value totaled approximately 12 times EBITDA at the time of the announcement, which is still high by historical standards but not as lofty as Martin Marietta’s.

Surely U.S. Concrete benefited from reduced expectations set by Martin Marietta’s results and guidance, which drove more pronounced share price gains in reaction to the earnings beat. U.S. Concrete also benefited from its geographic footprint, with operations focused in markets that showed continued strength and limited exposure to regions within the U.S. showing some weakness (notably those regions in which the economy is very energy dependent). In addition, the company got a large boost from the success of its continued acquisition program.

Still, the most important factor that drove favorable market reaction to U.S. Concrete’s earnings announcement is the fact that its valuation heading into earnings season was low relative to that of Martin Marietta, and analyst expectations were correspondingly low.

U.S. Concrete and Martin Marietta are both solid companies, led by talented management teams that are delivering strong revenue and earnings growth. Yet their respective share prices went in different directions when reporting similar performance. The reason is simple. One was priced too high, the other not high enough.  Valuation will ultimately revert back to the mean. Sure, it is great to be “priced for perfection,” but it is important for companies and shareholders to understand that performing to perfection is rarely sustainable. In the end, market expectations drive results, and when performance does not align with expectations the market will adjust and correct.

Will the largest merger in the history of the aggregates industry collapse…and what will happen if it does?

Is the largest potential deal in aggregates industry history—a merger between Swiss-based Holcim and French-based Lafarge—really at risk?

A day after reports surfaced that billionaire investor Thomas Schmidheiny, who holds a 20 percent interest in Holcim, was souring on the deal, BloombergBusiness quoted Schmidheiny spokesperson Joerg Denzler as saying that “the industrial logic of the deal is undisputed.”

At question in the merger is a growing gap in performance. Initially structured to be a 1:1 share exchange, strong performance by Holcim and currency movements have raised Holcim’s value to nearly $25 billion. Lafarge is currently valued at just over $20 billion. Accordingly, the original terms of the agreement are now less favorable to Holcim shareholders, a number of whom have been anonymously sourced as wanting more favorable terms that better reflect current market conditions.

Whether or not a change in terms is addressed, Schmidheiny’s statement eased the concerns of Lafarge investors. After shares dropped 3.1 percent, they improved by 2 percent.

Schmidheiny’s statement also acknowledges the importance of closing the deal for both Holcim and Lafarge, because if the deal fails to close, the market capitalization of each company will decrease due to anticipated cost savings not being realized.

Another company to consider is CRH. Since it was announced that CRH would acquire the assets divested by Holcim-Lafarge, CRH’s shares have risen dramatically. A failed Holcim-Lafarge merger would likely hurt CRH’s market standing. On the other hand, a failed Holcim-Lafarge merger would leave CRH, long the most acquisitive company in the industry, with a large amount of capital to invest, which could prove to be a catalyst for industry merger and acquisition activity worldwide.

According to BloombergBusiness, Holcim shareholders are expected to vote on the merger “in the first half after the company’s annual meeting due April 13.”

Inlet Capital Group wants to help you stay informed of the economic impact of COVID-19 and how it is changing the business landscape. If you have any questions about the consequences for your business or how to access relief, contact us or visit the SBA or Fed websites.