Monday, April 8, 2013

The Power of True Alignment of Interest: Ply Gem Holdings

The Power of True Alignment of Interest: Ply Gem Holdings

Another one of our local companies, headquartered in Cary, North Carolina, has filed to go public.  Ply Gem Holdings is a manufacturer of exterior housing products and is seeking to raise $300 million.  The company first filed to go public three years ago, and apparently found that the market wasn’t yet ready to acquire shares of a highly leveraged company that had been battered by the housing down turn.

At first, Ply Gem looked to me like just one more private equity deal seeking to exit via an IPO.  As I read the prospectus, I began to realize that this investment bears deep scars from the housing downturn, and that the private equity owner, CI Capital, is not a conventional firm.  When CI Capital first made the investment in 2004 by buying the business from Nortek[1] for $883 million, the housing market was booming. Indeed, CI Capital’s first full year of ownership, 2005, was very successful, as revenue and operating income grew rapidly.  In 2006, CI Capital began to make significant acquisitions by acquiring two businesses for $394 million.  Clearly, CI Capital intended to use Ply Gem as a platform to build scale in both the windows and siding segments.[2]

Residential Real Estate (2005)

However, already in 2006 the housing boom was losing momentum.  While the company’s revenues jumped from $839 million in 2005 to $1.1 billion, almost all the increase was due to the two acquisitions, and operating income dropped slightly.[3]  While CI Capital made two more small acquisitions in 2007 and 2008, the good times were over.  Revenues and operating income peaked at $1.4 billion and $104 million respectively in 2007, but the increase was the result of the acquisitions rather than internal growth.  By 2008, revenue was below $1.2 billion, and operating income was a mere $20 million.

At the end of 2008, Ply Gem, which had originally been acquired, in part, with $671 million in debt, was straining under $1.1 billion in debt.  It is hard to tell how close Ply Gem came to filing for bankruptcy, but it is clear from the company’s financial filings that CI Capital had to scramble to stabilize the company.[4]  Plants were closed and some assets were sold. CI Capital put more equity into the company and also acquired a large chunk of the company’s debt (some $281 million worth at face value, but presumably acquired at a big discount).  Meanwhile, the management team remained remarkably stable[5], although the regulatory filings show that CI Capital entered into a series of retention agreements with key officers, and made it worth their while to stay through the severe downturn.[6] However, times were not so easy for Ply Gem’s employees.  Employment peaked at 6,300 in 2006 and bottomed out at 4,129 at the end of 2011.  Headcount is back up to 4,992.

As the company prepares to go public, its revenues are back at $1.1 billion and operating income is $70 million, which is a vast improvement over 2007, but still below 2005-2006 levels.  Meanwhile, debt is down to $964 million.  If the IPO is successful, the proceeds will be used to pay down some of the debt.

I mentioned at the outset that CI Capital is not a conventional PE firm, which I believe explains a lot about why Ply Gem survived.   Until 2011, CI Capital was essentially managing money for Caxton, a large hedge fund, and a group of partners.  In other words, the investment in Ply Gem wasn’t third-party capital (e.g., pensions and endowments).  Basically, the partners had $200 million of their own money at risk.  Thus if the business failed, Bruce Kovner, the founder of Caxton, along with the principals of CI Capital would have lost a lot of their own capital. 

Unlike many other deals where the PE is able to get its capital out via large dividends and distributions, CI Capital never managed this feat.  However, they did charge Ply Gem a boatload of fees, so there were some rewards along the way.  Since acquiring the company, CI Capital has received $50 million in fees consisting of $21.5 million in management fees, $15.7 million in acquisition fees, and $12.8 million in debt issuance fees.  And, they’ll get another chunk of change from a termination fee if the company goes public.  By the way, the banks have extracted $76 million in fees for financing and refinancing Ply Gem on multiple occasions.

There’s no question that CI Capital has had to work extremely hard to keep Ply Gem afloat.  Even if the IPO is successful, it will be some time before they can count their profits.  In the end, this deal demonstrates the value of having a lot of the private equity sponsor’s capital tied up in a deal.  When things go wrong, there’s nothing better than having a general partner that’s at risk.  Conversely, most private equity managers only have a small amount of their own capital at stake, and thus they don’t feel the kind of pain that must have afflicted CI Capital.

[1] Kelso, another PE firm, bought out Nortek, Ply Gem’s parent company.
[2] CI Capital claims expertise in building business platforms and integrating acquisitions.
[3] Revenue increased from $839 million to $1,054 million, but $194 million of the increase was due to the inclusion of the results of Alenco (windows and doors) and AHE (siding).
[4] Ply Gem, despite being a private company, consistently filed 10-Ks with the SEC because it had registered debt.  Those 10-Ks tell the story.
[5] In October 2006, Ply Gem replaced Lee Meyer as President with Gary Robinette, who had been COO for Stock Building Supply.  The rest of the team, including executives from acquired companies, has remained with Ply Gem.
[6] For example in 2008 the company entered into a retention agreement with Mr. Robinette, who received a $3 million payment in 2011 as part of that agreement.  His total compensation in 2011 was $10.2 million, and he signed another retention agreement.  Curiously in late 2011, the company repurchased, Mr. Robinette’s stock for $12.4 million and issued him new stock options.  None of the other managers had their stock repurchased.

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