Tuesday, May 29, 2007

Chapman Capital Discloses 7.4% Stake in Building Materials (BLG), Urges Sale

In a 13D filing after the close Friday on Building Materials Holding (NYSE: BLG), Chapman Capital disclosed a 7.4% stake in the company and recommended the company engage financial advisors to explore the complete or divisional sale of the Company.

Chapman Capital's Robert L. Chapman, Jr. said, "Having recently made personal contact with BMHC’s peers and leveraged consolidators of the building supply industry, I can convey an extremely high level of interest from both private equity and strategic building supply players in the acquisition of the Company."
Chapman concluded, "it was with much appreciation that Chapman Capital has become familiar with you and other senior management of BMHC. Moreover, I was gratified to discover during our meeting earlier this week the tight compatibility between Chapman Capital’s strategic goals for the Company and those of you, Mr. Smartt and apparently BMHC’s Board. The stock market is ascribing virtually no value to SelectBuild, making it imperative that BMHC management and the Board rectify this deficiency both via operating margin improvement and subsequent change-of-control premium offered for BMHC or its divisions by financial or strategic acquirers. Given Lehman Brothers’ current engagement to maximize the value of HD Supply, we strongly recommend that the Board engage it or an equally qualified advisor to begin discussions with prospective acquirers in earnest."
A Copy of the Letter:
Dear Mr. Mellor (and the BMHC Board of Directors):
Chap-Cap Partners II and Chap-Cap Activist Partners (the “Chapman Funds”), advised by Chapman Capital L.L.C., own approximately 2.2 million common shares, or just over 7.4%, of Building Materials Holding Corporation (“BMHC”, the “Company”). To put this ownership stake (the “Chapman Ownership Stake”) into perspective, the Chapman Funds’ financial interest in BMHC now exceeds that of the entirety of BMHC’s management and Board of Directors (“the Board”; together, the “Insiders”) by a nearly four-to-one ratio.11 At the risk of implying that this statistic on its own is not reason for concern, even more disconcerting is our estimation that nearly 100% of the Insider Stake was granted free of cost to the Insiders, and is residual of the exercise-and-sale of free stock option grants that have flooded your personal coffers with millions of dollars in the last six months alone.12 This followed Mr. Mellor being San Francisco’s own “$6 Million Man” in 2006, with his total compensation coming in at a whopping $6,236,182.13 The balance of BMHC’s senior management team also seems to have a disconnect between stock ownership and compensation, with Chief Financial Officer William M. Smartt hitting $2,201,114 in 2006 total compensation despite his mere 20,000 BMHC share ownership, SelectBuild CEO Michael D. Mahre stacking up $2,696,251 despite his small 22,000 BMHC share stake, BMC West CEO Stanley M. Wilson adding $2,199,728 despite his 45,234 BMHC shareholding, and General Counsel Paul S. Street accumulating $1,676,489 despite 82,944 of BMHC share ownership.14
Despite this asymmetry, it is our sincere intention for this initial written communication with you and the balance of the Board to be considered amicable and productive, rather than invective or, as past activist targets have claimed, viscerally scurrilous. Uncharacteristically, Chapman Capital is not taking this approach because May flowers have intoxicated me with unalloyed happiness or inexplicable tolerance for excessive “agency issues” in BMHC’s corporate governance. Instead, our behavior is the direct response to your responsible, accountable, fiduciary-duty cognizant reception to Chapman Capital’s initial accosting of, and ensuing dialog with, you and Mr. Smartt. In fact, you could provide a public service by calling and educating the corporate cretins in respective management and director positions at Entertainment Distribution Company/EDCI (Clarke H. Bailey - (212) 333-8478; and James M. Caparro - (917) 974-4061), Vitesse Semiconductor (James A. (Hole)/Cole - (805) 497-3222) and FSI International (Donald S. Mitchell - (858) 759-7783; and Benno G. Sand - (612) 840-5702). Hopefully, this letter will be viewed as yet another in a steady stream of constructive communications, the aim of which is to remedy the undervaluation of BMHC due in large part to its bloated cost structure and depressed operating margins within its SelectBuild construction services division (“SelectBuild”).
Nobody can blame BMHC’s management team for the steep correction of the U.S. homebuilding market, though the Board’s granting you generous financial rewards during its 2004-2006 boom years should not be ignored. Boom or bust, shallow or deep, the ups and downs of the homebuilding industry unfortunately are out your control (as compared to the self-inflicted shareholder immolation of the EDC/Vitesse/FSI miscreants named above). Auspiciously, sales of new homes rose 16% last month as homebuilder price concessions enticed buyers with a shot at median home prices down nearly 11%.15 Thus, it appears that the clearance of excess regional home inventory (the creation of which benefited BMHC by essentially pulling revenues from 2007-2008 into prior years) can be catalyzed with “couponing” and other marketing techniques designed to capitalize on the elastic nature of your customers’ newly built homes.
Though stipulating that homebuilding cycles are beyond BMHC’s control, corporate and divisional overhead can be restrained by a realistic, practical management team. In a market where U.S. single family building permits (the industry’s standard 30-day leading indicator) are falling nearly 30% year/year,16 BMHC must take drastic action to rationalize its expense base to fit today’s reduced base level of homebuilding. This is especially true given that BMHC’s outsized exposure to boom/bust markets (such as San Diego and Phoenix) have experienced single family building permit declines approaching 40% in recent months.17 Simply stated, intense focus is required immediately on SG&A expense reduction in Mike Mahre’s SelectBuild division in order to navigate effectively this cyclical downturn. Moreover, in order to regain a more favorable public market valuation, BMHC must demonstrate that it can stabilize operating margins and cash flow despite prospectively sustained weak housing conditions. SelectBuild has invested an estimated $700 million into 17 acquisitions and five greenfield operations over the past five years;18 accordingly, there is no reason that its estimated real-time $1.3-1.4 billion in revenues should not receive a minimum valuation of 50% of such sales,19 which happens to coincide with its $700 million “cost basis.”
Chapman Capital, on behalf of what it believes is a significant percentage of BMHC’s owners, strongly recommends that the Company engage financial advisors to explore the complete or divisional sale of the Company. The building materials sector arguably is in the third or fourth inning of a consolidation wave, somewhat akin to where SelectBuild’s primary customers, the national homebuilders, found themselves a decade ago. To proclaim that the $400 billion building supply sector is undergoing consolidation would be a masterpiece of understatement. HD Supply, Home Depot, Inc.’s professional building supply subsidiary that a) in 2006 engaged in M&A estimated at $4.4 billion20 spread over one dozen targets,21 and b) is in the final stages of being consolidated itself for an estimated $9-11 billion.22 Even Masco Corporation, the $12 billion (in market capitalization and revenues) manufacturer and marketer of home improvement and building products, recently exhibited appreciation for the advantages of vertical integration within the building materials supply chain.23 Having recently made personal contact with BMHC’s peers and leveraged consolidators of the building supply industry, I can convey an extremely high level of interest from both private equity24 and strategic building supply players in the acquisition of the Company. Chapman Capital recognizes the unique value of BMHC’s assets, the years and efforts required to assemble and integrate them. As a result, we are not encouraging an inopportune, undervalued sale, but instead a methodical auction timed to consummate into the inevitable cyclical recovery.
In conclusion, it was with much appreciation that Chapman Capital has become familiar with you and other senior management of BMHC. Moreover, I was gratified to discover during our meeting earlier this week the tight compatibility between Chapman Capital’s strategic goals for the Company and those of you, Mr. Smartt and apparently BMHC’s Board. The stock market is ascribing virtually no value to SelectBuild, making it imperative that BMHC management and the Board rectify this deficiency both via operating margin improvement and subsequent change-of-control premium offered for BMHC or its divisions by financial or strategic acquirers. Given Lehman Brothers’ current engagement to maximize the value of HD Supply, we strongly recommend that the Board engage it or an equally qualified advisor to begin discussions with prospective acquirers in earnest.
Sincerely,
Robert L. Chapman, Jr.
Footnotes:
1 Robert E. Mellor ownership stake: precisely 254,370 (vs.154,354 year/year) shares per BMHC 2007 Proxy Statement. Total outstanding share count of 29,170,793 as of March 7, 2007.
2 Sara L. Beckman ownership stake: precisely 18,653 (vs. 16,890 year/year) shares per BMHC 2007 Proxy Statement.
3 Eric S. Belsky ownership stake: precisely 1,519 (vs. 0 year/year) shares per BMHC 2007 Proxy Statement.
4 James K. Jennings, Jr. ownership stake: precisely 17,100 (vs. 15,600 year/year) shares per BMHC 2007 Proxy Statement.
5 Norman J. Metcalfe ownership stake: precisely 7,519 (vs. 3,000 year/year) shares per BMHC 2007 Proxy Statement.
6 David M. Moffett ownership stake: precisely 1,500 (vs. 0 year/year) shares per BMHC 2007 Proxy Statement.
7 R. Scott Morrison, Jr. ownership stake: precisely 26,700 (vs. 24,200 year/year) shares per BMHC 2007 Proxy Statement.
8 Peter S. O’Neill ownership stake: precisely 41,996 (vs. 40,180 year/year) shares per BMHC 2007 Proxy Statement.
9 Richard G. Reiten ownership stake: precisely 32,809 (vs. 28,454 year/year) shares per BMHC 2007 Proxy Statement.
10 Norman R. Walker ownership stake: precisely 0 (vs. NA year/year) shares per BMHC 2007 Proxy Statement.
11 The Chapman Funds owned 2,189,239 as of May 24, 2007 vs. “the Insider Stake” of 572,344 shares (or 2% of the shares outstanding) owned by BMHC management and the Board as of March 7, 2007 (Source: BMHC 2007 Proxy Statement, dated April 2, 2007).
12 Mr. Mellor sold 71,491 and 28,509 BMHC shares at approximately $26/share November 17-21, 2007 for a total of $2,605,393.
13 Source: BMHC 2007 Proxy Statement.
14 Ibid.
15 The U.S. Census Bureau reported that sales of newly constructed homes rose 16.2% in April 2007 to a seasonally adjusted annual rate of 981,000 homes, the largest monthly gain in 14 years.
16 U.S. single family building permits declined 28% in March 2007 (over 2006 levels) to an annual pace of 1.1 million.
17 BMHC’s regional markets experienced a single family building permit decline of 37% (vs. a 31% national rate decline) in the three months ending February 2007.
18 SelectBuild transaction highlights include the following (Target Revenue/Acquisition Price/Acquisition Date): 27% interest in Riggs Plumbing (N/A, $10.5MM, 3/28/2007), Willis Roof Consulting ($90.0MM, N/A, 06/30/06), Davis Brothers ($110.0MM, $43.3MM, 8/1/2006), Azteca (N/A, $1.5MM, 4/1/2006), Boulder's West (N/A, $6.7MM, 4/1/2006), Benedeti Construction ($145.0MM, N/A, 1/11/2006), MWB Building Contractors ($80.0MM, $57.1MM, 1/11/2006), 20% stake in WBC Construction (N/A, $31.4MM, 1/1/2006), HnR Framing & Home Building Components ($140.0MM, $72.6MM, 10/18/2005), Campbell Companies ($200.0MM, $85.6MM, 8/31/2005), Gypsum Construction (N/A, $5.9MM, 9/1/2005), 20% stake in WBC Construction (N/A, $24.8MM, 8/1/2005), 51% interest in BBP Companies ($100.0MM, $10.4MM, 7/1/2005), 73% interest in Riggs Plumbing (N/A, $19.2MM, 4/19/2005), 51% interest in RCI Construction (N/A, $4.9MM, 1/27/2005), 51% Interest in A-1 Building Components (N/A, $2.3MM, 9/1/2004), 49% interest in KBI Norcal (N/A, $14.0MM, 8/9/2004), 67% Interest in WBC Mid-Atlantic (N/A, $5.1MM, 10/1/2003), BMC West (N/A, $5.1MM, 6/1/2006), 60% stake in WBC Construction (N/A, $24.0 MM, 1/1/2003), and 51% interest in KBI Norcal (N/A, $7.1MM, 6/24/2002).
19 Valuation Assumptions (Chapman Capital research): 14-20% (cycle trough-peak) gross margins reduced by 6-10% (cycle peak-trough) SG&A loads, capitalized at 16-17% ROI.
20 HD Supply doubled in size with its $3.5 billion acquisition of Hughes Supply Inc. in January 2006.
21 HD Supply reportedly has expended approximately $8 billion buying the estimated 39 companies in its composition, in an effort to leverage Home Depot’s $70 billion supply chain.
22 Home Depot reportedly has retained Lehman Brothers, Inc. to conduct a strategic review of HD Supply, including its sale in part or entirety.
23 Masco acquired on May 1, 2007, Erickson Construction Company (turnkey framer) and Guy Evans, Inc. (millwork, interior and exterior door, window and bath hardware installer) for an estimated .8-1.0 times a combined $200 million in anticipated 2007 revenues, roughly in line with the valuation placed on Masco 2001 acquisition BSI Holdings. In 2002, Masco acquired Service Partners LLC (insulation installer) and other smaller businesses for $1.2 billion.
24 Leonard Green & Partners, L.P. reportedly gained 2.5 times its $88 million investment for a 60% stake in White Cap Construction Supply Inc. upon its acquisition by Home Depot in 2004; Warburg Pincus, LLC and its affiliate JLL Partners are the private equity backers to Builders FirstSource, Inc. (Nasdaq: BLDR), having a 50% combined ownership stake as of March 27, 2007.

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