An investment fund that holds 14.9% of Builders FirstSource (BFS) shares warned the building material dealer's board it could take legal action to fight a planned $205 million common stock rights offering that would be used in part to pay off IOUs due in 2012.

Thursday's letter from Stadium Capital Management (SCM) of Bend, Ore., revealed today in an SEC filing, challenges a plan that it says would unduly benefit BFS' two largest shareholders, JLL Partners Fund and Warburg Pincus Equity, which together own more than 82% of the second priority senior debt notes that come due in 2012.

"We remain deeply disappointed that the Special Committee has elected to support the recapitalization, which is unfair to current unaffiliated BLDR shareholders," SCM wrote, referring to BFS by its stock-trading abbreviation. "In fact, only a director who could both protect an equity position by participating in the rights offering AND who owns BLDR Second Priority Senior Floating Rate Notes purchased at a discount, would have the economic rationale to approve the recapitalization."

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. The day before they made their proposal, BFS shares had reached $7.64, but in the four days after the news came out, BFS' share price shrank to $4.44. (It closed on Thursday at $4.15.) That prompted several law firms to announce they would conduct investigations for suspected violations of fiduciary duty.

SCM noted that there's a potential that the shareholder lawsuits will be settled, but it may keep fighting. "The situation here, however, continues to cause us profound concerns," SCM wrote, "and we are considering our options, including without limitation intervening in the pending litigation and asserting objections to the potential settlement of shareholder lawsuits."

SCM's protest challenges suggestions by BFS that it needs the money. During a call with analysts last week, BFS CEO Floyd Sherman revealed the company lost 8% of its market share during the third quarter 2009 due to an "extremely competitive pricing environment." The Dallas-based dealer had reported earlier a net loss of $15.9 million for the third quarter on a 29% drop in net sales to $188.9 million.

SCM noted that existing home sales nationwide are up, median prices are down, and the inventory of unsold homes is at its lowest level since March 2007. "All these data points support an improvement in the overall housing market since mid-summer, not a deterioration," it wrote to the BFS board. It also quoted Sherman's statement to analysts that bad weather could have caused the recent market problems he reported during the conference call, and that it's possible 2010 will be better than 2009.

SCM also took note that BFS management planned to use $75 million of the rights issue to maintain operations. During the analysts' call, CFO Charles Horn said the major reason for doing so is that, other than $92 million in usable cash, BFS didn't have any other borrowing ability. "If BLDR's board is, as it claimed, focused on maintaining the company's financial flexibility, BLDR should keep the cash processed from a rights offering so they will be available to fulfill corporate obligations and/or preserve opportunities as they present themselves."

Late in the letter, SCM complained that JLL and Warburg representatives occupy six of BFS' 10 board seats. "In order to restore stockholder confidence in BLDR's board of directors, we believe that BLDR's board of directors should be reconfigured to include at least two truly independent shareholder representatives," SCM wrote.

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.