Construction LBO Bargain Seen at Owens Corning: Real M&A

Homes Under Construction
Contractors work on a housing development in San Ramon, California. With U.S. construction spending at the highest in four years, analysts project Owens Corning will generate positive free cash flow this year for the first time since 2010. Photographer: David Paul Morris/Bloomberg

Owens Corning, the largest U.S. producer of insulation, may prove to be a bargain for private-equity firms betting on an improvement in the construction market.

The $4.55 billion maker of roof shingles trades at a lower multiple of revenue than all but one similar-sized North American building materials company, according to data compiled by Bloomberg. Buyout firms may consider Owens Corning undervalued and be drawn to a takeover before a U.S. real-estate recovery spurs a jump in free cash flow, CL King & Associates said.

With U.S. construction spending at the highest in four years, analysts project Owens Corning will generate positive free cash flow this year for the first time since 2010 and bring in $476 million by 2015. That represents a potential windfall for private-equity suitors, who could tie the company more strongly to the construction market by spinning off the unit that makes glass fiber for golf clubs and cars, BB&T Corp. said. Owens Corning could fetch $48 a share in a leveraged buyout for a premium of 25 percent, Royal Bank of Canada said.

“If housing starts to accelerate, Owens Corning will make a lot more money,” Bob Wetenhall, a New York-based analyst at RBC, said in a phone interview. “It should generate lots of free cash flow, which could be used to pay down debt in an LBO. This could work really well for someone.”

Matt Schroder, a spokesman for Owens Corning, said the Toledo, Ohio-based company doesn’t comment on speculation when asked about the possibility of a sale or breakup.

Pink Panther

Owens Corning, which features the Pink Panther cartoon character to market its insulation products, emerged from bankruptcy in 2006. It has two primary businesses: a building materials unit that makes insulation and roof shingles, and a composites division that makes glass fiber used to manufacture those construction products as well as airplane parts and kayaks.

The shares had climbed 3.5 percent this year through yesterday, about a fourth of the gain for the Russell 1000 Materials & Processing Index, after the company missed analysts’ earnings estimates in two of the last three quarters.

“They’re a company with volatile businesses that have lots of ups and downs,” Keith Hughes, an Atlanta-based analyst at SunTrust Banks Inc., said in a phone interview. “They’re prone to international trends in composites and they’re prone to the weather -- wind and hail and other storm damage in roofing.”

Cheaper Valuation

The decline left Owens Corning trading yesterday at 0.88 times its $5.1 billion in revenue in the last 12 months. That’s the cheapest price-sales ratio after USG Corp. among North American construction materials makers valued at more than $1 billion, according to data compiled by Bloomberg.

Today, Owens Corning shares rose 0.3 percent to $38.39 at 10:06 a.m. New York time.

The company’s low valuation could attract private-equity suitors willing to wager on an improvement in the construction market that would lead to a surge in free cash flow, said Jim Barrett, a New York-based analyst and director of research at CL King.

U.S. construction spending rose in July to a $900.8 billion annual rate, the highest level since June 2009, according to the Commerce Department. A report on August construction spending that was scheduled for Oct. 1 wasn’t released because of the partial government shutdown.

Improving conditions will help Owens Corning generate $173 million in free cash flow in 2013, according to analysts’ estimates compiled by Bloomberg. By 2015, the company is expected to bring in about $476 million, the most since its bankruptcy exit.

Housing Recovery

A private-equity buyer would have “a real opportunity here to ride the recovery and generate quite a bit of cash,” Jack Kasprzak, a Richmond-based analyst at BB&T, said in a phone interview. “We don’t think we’ve seen the best of the U.S. housing recovery yet and the benefit of that on their businesses.”

While Owens Corning management likely prefers to keep the company together, a buyer may split the composites unit from the roofing and insulation business to try to unlock value, Kasprzak said. Doing so would focus the company more on the U.S. construction market.

A breakup may be difficult because the businesses are integrated, with the roofing division accounting for about 10 percent of revenue for the composites unit, Wetenhall of RBC said. Without a split, there’s still value in a takeover, he said.

Takeover Premium

A private-equity firm could pay $48 a share for Owens Corning, 6.8 percent more than the company’s post-bankruptcy high, and generate an internal rate of return of 20 percent over five years, Wetenhall estimated in an Oct. 8 report. The shares closed yesterday at $38.29.

“You have enough money coming in that you could afford to borrow money along with your own equity to buy the company at a large premium and still have confidence that you can make your payments to lenders,” he said.

Hughes of SunTrust said Owens Corning’s valuation is too rich to support an additional premium in an LBO given the volatility in the company’s businesses. The shares are up more than 50 percent in the last two years, and the company had $2.3 billion in debt and $72 million of cash as of June 30.

“The math around that is very difficult at current prices,” Hughes said. “You would have to assume that all three of these businesses get to peak results at the same time. I don’t think you can build an investment case on that, public or private.”

Even so, the promise of a boom in free cash flow could be enough to lure private-equity suitors, Kasprzak of BB&T said.

“If housing were to continue to improve, obviously those businesses should improve and generate quite a bit of cash,” he said. “Opportunistically, that setup is probably fairly attractive.”