DWM - 2008 - February

Volume 9, Issue 2 - February 2008

trend tracker

In the Driver’s Seat
Exploring the Forces Behind Transactions and Expansions
by Michael Collins

With the housing market entering what is likely to be its third year of flat or decreasing new housing starts, it becomes important to understand the forces driving past expansions and merger and acquisition transactions in the door and window industry and their implications for the future. We have undertaken such an analysis of the number of expansions and transactions (company sales and acquisitions) relative to single-family housing starts.

Data Patterns
Single-family housing starts rose steadily from 1.2 million homes in 2000 to a recent peak of 1.7 million homes in 2005. In the last seven years, housing starts have increased in all but the last two years. Expansions, similarly, have increased steadily in six of the last seven years to a 2006 peak of 26 plant expansions. Transactions activity has fluctuated much more widely than expansions or housing starts. The number of transactions in recent years peaked at 32 in 2004, having increased in only four of the last seven years.

How it all Relates
Having assessed the patterns of each data set, we next looked at the ways in which the variables relate to one another. The line that would connect the bars representing the number of expansions each year is roughly the same shape as the line representing new housing starts, indicating there may be a relationship between the two (Note: there are commercial companies in our transaction and expansion databases, but the statistics are dominated by residential companies.) Yearly expansions have increased more quickly than housing starts, having grown thirteen-fold in number from 2000 to their 2006 peak. Housing starts per year, meanwhile, increased only 40 percent from 2000 to their peak in 2004. According to the chart, expansions appear to lag housing starts by roughly one year. In 2006, when housing starts decreased 15 percent, expansions increased by 37 percent. In 2007, when housing starts were headed for a 19-percent drop, expansions caught up, overcorrecting with a 54-percent drop versus the prior year.

Comparing the number of merger and acquisition transactions to housing starts, we see that transactions have moved less in unison with housing starts than expansions. In several recent periods, the number of transactions decreased, while housing starts increased, resulting in a very choppy and unpredictable pattern over time.

Explanation of the Data
Expansions represent one-party events that result from the decision of one company. Since it typically takes six to nine months to secure a source of significant capital, an expansion announced on any given day likely was undertaken because of optimism about the market as much as a year earlier. Thus, expansions most likely dropped precipitously during 2007 because companies contemplating expansions throughout 2006 were greeted by discouraging housing start numbers each month. They chose to forestall expansion, which found its way into the declining 2007 expansion numbers.

Transactions, unlike expansions, require the alignment of two industry participants (along with, most likely, a lender or other source of capital to finance the acquisition). While expansions presumably are only driven by enthusiasm, transactions may be initiated because of either enthusiasm or pessimism. A sale initiated by a current owner may be motivated, among other factors, by pessimism about the market. An acquisition where the buyer makes the initial approach, on the other hand, most likely is driven by enthusiasm. The motivation for transactions can exist whether the prevailing news regarding the industry is good or bad. There are a number of other factors that affect the number of transactions in an industry, including the availability of capital, among others. These factors were roughly constant during the period under consideration. In general, the number of transactions in the door and window industry appears to be constrained by the presence of willing sellers. Our conversations with industry participants tell us that there are more companies seeking to make acquisitions at any given time than there are companies for sale. Thus, given reasonable price and other expectations, when a company becomes available for sale, there likely will be a buyer for the company.

Implications for the Future
It appears that, to an extent, transactions will take care of themselves whether in an up market or a down market. There may be companies that have to lower price expectations in order to sell their company, depending on the segment in which they operate. However, all sellers are reasonably assured of finding a buyer because there are many companies focused on making acquisitions that are right for the long-term. Expansions are an area that appears to be more at risk. If we are correct and expansions are hampered or driven by the prevailing news regarding the housing market, we could be due for a one- to two-year period of little expansion. This is precisely the wrong strategy for many companies. Companies with an optimal facility that is significantly below capacity probably do not need to expand. Medium and large companies, though, with facilities near capacity or facilities that are scattered in several locations would be well-advised to consider the benefits of an expansion or rationalization of facilities. There are a number of examples of companies undertaking such moves in the current environment. When the market inevitably turns positive again, these will be the “crazy-like-a-fox” companies in the best position to take full advantage of the upswing.

Michael Collins is with Jordan, Knauff & Company, an investment banking firm that specializes in the door and window industry. He may be reached at mcollins@jordanknauff.com. Mr. Collins’ opinions are solely his own and do not necessarily reflect the views of this magazine.