There are a variety of important factors driving M&A activity at any given time. However, the effect that some of these factors have is not always what would be anticipated. Global M&A activity continued at a record-setting pace throughout 2015, surpassing the previous record set in 2007, and nowhere is it more evident that we are in a fertile time for M&A than in the LBM segment. In the current market, the largest companies in the industry are combining or being acquired. Regional businesses, attractive single yards, and specialized dealers all are being sought by buyers.
At the recent NLBMDA conference, Dr. David Crowe of the National Association of Home Builders shared his prediction that housing starts would continue to grow through 2019. This would mean significant growth and near-term profits for LBM companies. Business owners often contemplate holding on during a good period like this and waiting to sell in three or four years.
However, if Crowe’s prediction is correct, owners of LBM businesses approaching the market in several years will be doing so at a time when the future growth outlook will likely be much lower than it is now. Any increase in EBITDA (earnings before interest, taxes, depreciation, and amortization) by that time could be muted or reversed by even a modest drop in the EBITDA multiple being paid for their company. This is a uniquely good time to sell an LBM business—we are undeniably into the recovery but there is still enough growth ahead to entice buyers and result in strong valuations.
Oil prices are another economic factor with a counterintuitive effect on M&A activity. As of early November, NYMEX crude was trading just below $50 per barrel. In the short term, falling oil prices create additional profits at an LBM company; delivery surcharges tend to fall more slowly than oil prices, creating additional profits as oil prices drop. Also, consumers tend to spend more money on housing and other goods when the cost of their basic necessities, such as gasoline, decrease. However, it is difficult to imagine a consumer deciding to buy a home because gas has become cheaper. Consumers simply don’t spend a large enough portion of their income on gasoline for it to drive many economic decisions.
One group that does make immediate economic decisions in response to oil prices is oil producers themselves. Many of the oil wells in the U.S. that rely upon fracking to produce profitably are not viable when oil prices drop below $50 per barrel. The owners of such marginal wells shut them down immediately when oil prices drop. An estimated 2.4 million energy-related jobs have been created since 2003.
Unlike gasoline prices, there is a direct line between an individual having a job and deciding to buy a home. Thus, the LBM industry would be better off to have oil prices somewhat higher than they are currently. Much of the additional shipping expense incurred could eventually be passed along to the customer, and companies would benefit from operating in a stronger economy with better growth. These are key elements in the non-company specific factors that drive the EBITDA multiples that buyers are willing to pay for an LBM business.
Another economic factor that does not impact M&A activity in the way that might be anticipated is interest rates. Rates are undoubtedly going to rise in the future, but the pace and timing of increases remains to be seen. Crowe recently predicted that average mortgage rates would rise from 3.9% in 2015 to 4.5% and 5.5% in 2016 and 2017, respectively. However, mortgage rates will only rise as a result of the economy improving, which could be expected to produce as many or more potential home buyers as are chased away by rising interest rates.
As Crowe points out, a complex web of factors influence home buying, not just mortgage rates. Indeed, if interest rates were the determining factor in housing activity, we would already be in the midst of the greatest housing boom of modern times. The good news is that other important factors, such as GDP and job growth, are also pointed in the right direction.