Investment advisers for funds that collectively hold 14.9% of all Builders FirstSource (BFS) shares urged a special BFS committee to reject what the advisers called a "blatantly unfair" and "self-dealing" proposal by BFS' two biggest shareholders to recapitalize the LBM operation.

"Nothing about [BFS'] current circumstances warrants a recapitalization on terms reflecting the desperation of the Recapitalization Proposal--terms that are extraordinarily beneficial to Warburg and JLL while being commensurately punitive to the minority stockholders," Bradley Kent, a managing member of Stadium Capital Management, Bend, Ore., said in a letter sent Sept. 24 to the BFS group and included that same day in an SEC filing. Stadium Capital Management oversees funds that, all told, have purchased 14.9% of BFS' shares.

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.

Kent's letter takes aim at JLL Partners and Warburg Pincus JLC, a pair of investment funds that collectively own 49.9% of BFS, hold $98 million of BFS' roughly $319 million in long-term debt, and control six of 10 seats on Dallas-based BFS' board of directors. On Sept. 1, JLL and Warburg proposed that BFS approve:

  • 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.

JLL and Warburg estimated the moves would increase the number of BFS shares outstanding--currently about 36 million--by 10%.
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. That prompted several law firms to announce they would conduct investigations for suspected violations of fiduciary duty.

The price since then has more or less stabilized. Trading of BFS shares closed on Thursday, Sept. 24, at $4.55.

"Despite our efforts to contact the Special Committee of Independent Directors of [BFS], we have not been able to speak directly with the members," Kent's letter said. "This delay has left Stadium with no recourse but to submit this letter to highlight the serious financial, legal and ethical issues within the Recapitalization Proposal.

"To be absolutely clear, we urge the Committee to reject this self-dealing Recapitalization Proposal as wholly inappropriate and unwarranted at the present time," the letter continued. "...We believe the Recapitalization Proposal is a simple and striking attempt by Warburg and JLL to increase their ownership position substantially at the direct expense of Stadium and the other minority stockholders. We believe that these issues are so obvious, and the terms of the Recapitalization Proposal are so egregious, that we would have hoped that this letter is unnecessary. Our fear, however, is that the Committee is ignoring basic economic realities and true legal requirements and will instead make decisions based on the undue influence of Warburg and JLL, whose motives for the Recapitalization Proposal are clearly questionable."