Two law firms from Pennsylvania and one from New York, suspecting violations of fiduciary duty, have announced they will investigate a proposal by the two biggest shareholders in Builders FirstSource to recapitalize America's eighth-largest LBM operation by having issues of new common stock, rights to buy future shares, and new IOUs replace existing debt.

The announcements by Barrack, Rodos & Bacine of Philadelphia and the offices of Howard G. Smith of Bensalem, Pa., both came within days after the proposal emerged on Sept. 1 from JLL Partners and Warburg Pincus JLC. By that point, BFS' share price had sank from $7.64 late Aug. 31 to $4.44 at the end of Sept. 4. Tripp Levy PLLC of New York followed up on Sept. 8, by which time the stock was at $4.93.

The JLL/Warburg announcement described the two equity funds as together owning 49.9% of BFS. They also hold $98 million of BFS' roughly $319 million in long-term debt, and six of 10 seats on Dallas-based BFS' board of directors.

BFS management has formed a committee of independent and disinterested directors to evaluate the proposal. BFS gave no timeline for when the committee would report its findings. On Sept. 8, it announced the hiring of legal and financial advisers to assist the committee.

Aside from possible violations of fiduciary duty, the law firms said they also would look into violations of state law related to the proposal.

JLL and Warburg proposed:

  • A rights issue (giving investors the right to buy shares at a future date) of $2 per share, intended to raise $75 million. JLL and Warburg would backstop the offering.
  • Exchanging the debt notes held by JLL and Warburg for common stock worth $2 per share.
  • Offering to exchange at least 85% of the remaining notes, broken into $1,000 increments, into either new notes paying LIBOR plus 7.5 percentage points and due in 2017, or in equity worth $2 per share, or any combination of the two so long as between $20 million and $40 million of new common stock gets issued.

The bulk of BFS' current long-term debt consists of a $275 million second priority senior secured note issued in 2005 and due in 2012. Its rate floats quarterly and is based on LIBOR plus 4.25 percentage points. The transactions would cut BFS' total debt by $150 million to $172 million and raise about $75 million in cash, JLL and Warburg said.
JLL, which formed BFS in 1988, and Warburg, which began putting money into the dealer in 2006, have seen their investments rise and fall dramatically in recent years. In the first quarter of 2007, BFS stock traded for as much as $19.88 per share. By the fourth quarter of 2008, it was down to 82 cents a share.

In their letter, JLL and Warburg said they expected their plan would increase the number of shares outstanding--currently 36.1 million--by about 10%. They stressed that they "are committed to remain substantial investors in the company and are not interested in selling our shares at this time, including as part of any change in control transaction."

BFS stood at No. 8 on the 2009 ProSales 100 with sales last year of $1.04 billion. Its 33.7% drop in sales from 2007 was the eighth-worst on the entire ProSales 100.