October 2016 A report by UNITE HERE Contact: Elliott Mallen (312) 656-5807 [email protected] Shaky foundations at Forterra: Lone Star Funds’ foray into the building materials industry “How will the debt-laden company [Forterra] be received on the stock exchange?” –Global Water Intel, July 20161 Texas-based Lone Star Funds has invested heavily in the United States housing sector. Caliber Home Loans, a Lone Star affiliate, reportedly oversees a portfolio of $93 billion in mortgages. Lone Star has purchased thousands of distressed loans from the Federal Housing Finance Authority.2 And in late September, Lone Star reportedly purchased American Bath Group for $750 million.3 As the firm plans an IPO of building materials manufacturer Forterra, will outside investors benefit from Lone Star’s continuing ownership? Key Points: • Forterra’s private equity legacy has increased its long-term debt relative to its peers. • Forterra’s long-term debt to EBITDA ratio has doubled since Lone Star purchased the company. • The oil price crash has affected the home construction market in Texas, the source of 37% of Forterra’s net sales in 2015. • Lone Star will own 71% of Forterra stock following the IPO and control seven of the eleven board seats. Outside investors will not have a significant say in the direction of Forterra. Background Forterra, Inc., previously known as Hanson Building Products, is a Texas-based building materials manufacturing company.4 In March 2015, Lone Star Fund IX purchased Forterra from HeidelbergCement for $1.4 billion. Heidelberg had previously pursued an IPO before selling to Lone Star.5 Bloomberg described Heidelberg’s motives for the sale as a move to “cut debt”.6 In July 2016, Lone Star filed for an IPO for Forterra but has since reportedly been looking for a potential buyer.7 Ballooning Debt Under Lone Star In its S-1 filing, Forterra acknowledged that it carried “substantial debt and may incur additional debt.” As of June 2016, Forterra had approximately $1.2 billion of long-term debt – more than triple the amount its predecessor carried 21 months prior.8 Global Water Intel, a water industry publication, described Forterra in an article about the July 2016 IPO filing as “debt-laden”.9 Donovan Jones of VentureDeal.com summarized Forterra’s financials as “high total debt”.10 1 Forterra’s Ballooning Debt Pre- and Post- Lone Star LBO Source: Forterra Form S-1; Hanson Building Products Form S-1 Forterra11 Hanson Building Products12 (As of June 30, 2016) (As of September 30, 2014) Long Term Debt $1,239,777 $343,182 Total Liabilities $1,830,643 $342,589 Total Assets $2,034,110 $1,317,613 Adjusted EBITDA (pro-forma for 12 months ending 12/31/2015 and 9/30/2014, respectively) $187,100 $145,419 Long Term Debt to EBITDA Ratio 6.62 2.36 Long Term Debt To Total Assets Ratio 0.61 0.26 Forterra’s debt increased significantly since its purchase by Lone Star. Forterra’s long-term debt to total assets ratio and long-term debt to EBITDA ratio more than doubled since Lone Star took ownership. Forterra’s Debt Higher than Peers Forterra vs. Competitors identified in early draft of its Form S-113 Source: Forterra S-1, Ibstock 2015 annual report, Boral 2015 Annual Report Forterra14 Ibstock plc15 Boral Ltd16 (As of December (As of end of June (As of June 30, 2016), 31, 2015), pounds in 30, 2016), dollars in dollars in thousands thousands thousands Long Term Debt $1,239,777 ₤144,700 $1,345,000 Total Liabilities $1,830,643 ₤328,152 $2,294,200 Total Assets $2,034,110 ₤566,236 $5,800,500 $187,100 (pro-forma for 12 Adjusted EBITDA months ending 12/31/2015) ₤107,014 $645,000 Long Term Debt to EBITDA Ratio 6.62 1.35 2.09 Long Term Debt To Total Assets Ratio 0.61 0.26 0.23 Note: Forterra’s Oct. 7 2016 Form S-1 did not identify Forterra competitors 2 Forterra carried more debt (relative to EBITDA and assets) than the competitors identified in its original S-1 filing. Forterra’s long-term debt to EBITDA ratio and long-term debt to total assets ratio are all higher than that of its competitors Ibstock plc and Boral Ltd. Forterra said that plans to use funds raised by an IPO to pay down its debt.17 Overexposure to Weak Texas Building Markets In 2015, Texas comprised 37% of Forterra’s net sales, and the company admitted in its S-1 filing that any declines in Texas home construction “could have a material adverse effect on our business, financial condition and results of operations.”16 Recent declines in oil prices have drastically reduced housing construction in Texas. In January 2016, the Wall Street Journal reported that home-construction permits in Houston had dropped 26% from a year earlier.19 Business Insider described the oil crash as “crushing” Texas’ housing markets.20 The Texas A&M University Real Estate Center reported a decline in single-family housing construction permits. The Texas Residential Business Cycle Coincident Index, the measure of current construction activity, declined as inflation-adjusted total wages paid and employment in residential construction fell, indicating a slowdown in housing construction in Texas.21 When Lone Star took Forterra’s U.K. sibling company public in April 2016, the firm’s valuation fell short of its target by £90 million following a slowdown in the U.K. housing construction market.22 Dispute with Heidelberg Cement Could Threaten Supply Chain As of October 7, 2016, Forterra was in a dispute with its former parent company, HeidelbergCement, regarding an earn-out provision in the acquisition agreement. Heidelberg claims it is owed $100 million by Forterra. Forterra explains in its S-1 that paying $100 million would require the company to take on additional debt.23 In addition, this poses a unique concern to Forterra, as Heidelberg is its main supplier of cement. Though the term of the supply agreement extends to March 2020, beginning on January 1, 2017, Heidelberg could, for any reason and with only 180 days’ notice, reduce the amount of cement it supplies or terminate the supply agreement altogether.24 3 “The interests of Lone Star may not always coincide with our interests as a company or the interests of other stockholders” Under the proposed IPO, outside investors will not have a significant say in the direction of Forterra—a matter of particular importance, given Lone Star’s role in increasing Forterra’s indebtedness. Lone Star will own 71% of the stock, effectively controlling all matters submitted to stockholders for approval, including director elections. Seven of the eleven Forterra board members will be employees of Lone Star or its affiliates. In its S-1 filing, Forterra wrote, “the interests of Lone Star may not always coincide with our interests as a company or the interests of other stockholders. Accordingly, Lone Star could cause us to enter into transactions or agreements of which you would not approve or make decisions with which you would disagree. This concentration of ownership may also adversely affect our share price.”25 Forterra’s debt and the impact of the oil price slump on building materials manufacturers pose big questions for the future of the company. Under the proposed IPO, outside investors will have little say in how Forterra responds. Questions for Potential Investors • What impact will Forterra’s debt have on its ability to compete with its less-indebted peers? • When does Forterra expect to resolve its dispute with Heidelberg Cement? • How does Forterra’s debt related to Lone Star’s acquisition benefit potential IPO participants? Endnotes 1 July 2016. “Forterra seeks US IPO in a bid to supply the last mile of pipe.” Global Water Intelligence. https://www. globalwaterintel.com/global-water-intelligence-magazine/17/7/general/forterra-seeks-us-ipo-in-a-bid-to-supply- the-last-mile-of-pipe 2 Matthew Goldstein. September 7, 2016. “Caliber Home Loans Embraces Borrowers with Spotty Credit.” New York Times. http://www.nytimes.com/2016/09/08/business/dealbook/caliber-home-loans-embraces-borrowers-with- spotty-credit.html 3 Luisa Beltran. September 30, 2016. “Sterling Group exits American Bath Group in $750 mln sale: source.” The PE Hub Network. https://www.pehub.com/2016/09/sterling-group-to-make-4x-its-money-with-american-bath-group- sale/ 4 Forterra. http://forterrabp.com/ 5 Ludwig Burger. December 24, 2014. “HeidelbergCement sells building products arm to Lone Star.” Reuters. http:// www.reuters.com/article/hansonbuilding-ma-lone-star-idUSL6N0U80LT20141224 4 6 Andrew Noel and Alex Webb. December 25, 2014. “Lone Star Buys HeidelbergCement Bricks Unit for $1.4 Billion.” Bloomberg. http://www.bloomberg.com/news/articles/2014-12-24/heidelbergcement-sells-hanson-unit-to- lone-star-for-1-4-billion 7 Dana Mattioli. August 10, 2016. “Jeld-Wen, Forterra Exploring Sales After Filing for IPOs.” The Wall Street Journal. http://www.wsj.com/articles/jeld-wen-forterra-exploring-sales-after-filing-for-ipos-1470838934 8 Forterra. October 7, 2016. “Amendment No. 4 to Form S-1 Registration Statement.” Pages 39-40. https://www.sec. gov/Archives/edgar/data/1678463/000119312516733238/d267135ds1a.htm 9 July 2016. “Forterra seeks US IPO in a bid to supply the last mile of pipe.” Global Water Intelligence. https://www. globalwaterintel.com/global-water-intelligence-magazine/17/7/general/forterra-seeks-us-ipo-in-a-bid-to-supply- the-last-mile-of-pipe 10 Donovan Jones. October 11, 2016. “Forterra IPO Is A North America Water Infrastructure Play.” Seeking Alpha. http://seekingalpha.com/article/4011563-forterra-ipo-north-america-water-infrastructure-play 11 Numbers obtained from Forterra, Inc.