As far as long-term investors go, Warren Buffett is considered one of the best. Berkshire Hathaway, Buffett’s holding company, currently has large positions in companies like American Express and Coca-Cola. They also own a number of businesses outright, including Burlington Northern Santa Fe railroad and Geico.
Buffett has a long-term track record of outperforming the stock market. That’s why so many professional investors pay close attention to Berkshire Hathaway’s stock positions and business acquisitions. Since Berkshire Hathaway has increased their stake in USG Corporation, all appearances show that investors are also going to follow Buffett and Berkshire Hathaway into this company. It also seems likely that the investment conglomerate will absorb this business.
USG Corporation: A Brief History
Formally known as United States Gypsum Corporation, USG Corp. is actually one of the United States’ biggest producers of drywall – otherwise known as wallboard – and they also produce a number of other products in the home building industry. USG sells their wallboard under its trademarked brand name, otherwise known as sheetrock. This name is so well recognized that it has become synonymous with the product, much in the same vein as Coke is synonymous with cola and Kleenex is synonymous with tissues. USG is also the leading seller of ceiling tile that is predominately used in commercial construction projects.
Just like every other construction company at this time, it’s easy to imagine that a company like USG had a difficult time navigating the real estate fallout due to the subprime lending crisis. In truth, the company has had it rough for over a decade. Back in 2001, the business filed Chapter 11 bankruptcy as a way to resolve a legacy asbestos liability stemming strictly from the use of a particular carcinogen that the company has been no longer using for decades.
Even with the bankruptcy and asbestos issues hanging over their head, and a rough real estate market over the last five years, the company managed to have a number of prosperous years throughout the entire Chapter 11 proceedings. The bankruptcy was completed in 2006, and shareholders completely retained their equity within the company and all creditors were repaid. USG even established a $3.95 billion trust in order to permanently resolve all of the liability related to current and future potential asbestos claims.
After successfully navigating Chapter 11 bankruptcy, Warren Buffett had high praise for this business, claiming that it was “the most successful managerial performance in bankruptcy that I’ve ever seen.” At the time, Buffett was an interested party and much more than just a keen observer. During the fourth quarter of 2000, Buffett and Berkshire Hathaway purchased 6.5 million shares of USG, and did so during a particularly volatile quarter. The shares traded between $14 and $32 per share at this time.
As part of the Chapter 11 settlement obligation arranged by the bankruptcy court, USG was required to raise cash as part of the asbestos trust, and they did so by selling stock through a specific offering. Buffett stepped up and put his complete faith in this business. He agreed to buy any of the necessary stock that did not get purchased through that offering. Because of this declaration, Berkshire Hathaway ended up purchasing an additional 6,969,274 shares of the business. They even took it a step further and bought more stock on the open market at a value of $45 per share. All in all, this brought Berkshire Hathaway’s share total to about 17 million shares, and they owned roughly 15% of the company.
Post Chapter 11: The Real Estate Collapse Years
USG had an excellent performance for the most part during the first half of 2006, but as the housing market began to soften, shares started to fall rapidly from $114 in April, to the mid July price of roughly $45. Over the next year, the USG share price was able to stabilize, but then the second half of 2008 hit – in the beginning of the credit crisis – and share prices declined once again along with the overall broader market.
When USG exited its bankruptcy, it still had a $1.065 billion short-term debt as well as $1.439 billion in long-term debt. At the time, the debt did not seem like a sizable problem because the pricing was never higher and demand for sheetrock was never stronger. By the ending of the year 2009, the short-term debt was paid off, but long-term debt had increased to about $2 billion. A big part of the reason why the debt was transferred from short-term to long-term was that during the end of 2008, the company sold $400 million worth of 10 year notes to Fairfax Financial and Berkshire Hathaway.
Berkshire Hathaway actually purchased $300 million worth of the convertible senior notes that 10%. They will mature in 2018. The notes were noncallable until December 2013, and at that time they could be converted into 26.4 million shares at a share price of $11.40 per share. USG use the exact same terms and sold $100 million worth of these notes to Fairfax Financial. This company is run by Prem Watsa, otherwise known as the Canadian Warren Buffett. Just like Berkshire Hathaway, Fairfax also has large positions in many publicly traded companies, but it also creates a generous amount of revenue from its casualty insurance business and its primary property.
In November 2013, USG announced that it issued a notice of redemption in order to redeem $325 million in aggregate principal amount of the outstanding $400 million on December 16, 2013. The price will equal 5% of the total principal amount. This instance triggered conversion of a number of the notes. We aren’t certain why USG only redeemed $325 million as opposed the entire $400 million worth. It’s possible that the company decided to only redeem the amount that it can refinance comfortably, even though it would prefer to eliminate the debt entirely. It’s possible they will redeem the remainder in 2014. An attempt at acquisition is imminent if any preemptive conversion takes place.
The Current Berkshire Hathaway Position
Back on January 2, when Berkshire Hathaway filed its schedule 13 D/A, we learned that the company now owns a total of 30.5% of the USG common stock. This in effect doubles the amount of shares owned by Berkshire Hathaway. Its previous reported stake was 15.71% back in the third quarter of 2013. It’s a rarity when Berkshire Hathaway has such a high stake in a business without eventually taking over the company. This is currently the highest percentage stake that Berkshire Hathaway has in a publicly traded company at this time.
Even though the $11.40 per share conversion price was a lot lower than the current market value for USG, Berkshire also bought several million shares for roughly 50% higher than the market price at this time. It’s also highly unlikely that Berkshire Hathaway will sell off any of its shares. Fairfax will also most likely maintain its position due to the probable Berkshire Hathaway acquisition end game.
Buffett’s company has many investments in housing related businesses, so USG would fit right into the fold. They even acquired Jenkins Brick right after the subprime crisis, and merged the company with its Acme Brick subsidiary. Buffett also owns Clayton Homes, one of the leading financers and producers of manufactured homes. Some other housing related businesses are Johns Mansville, MiTek and Shaw Carpet. The business also insures real estate.
In an effort to capitalize on the eventual housing turnaround in the United States, Berkshire Hathaway has also undertaken a number of other private investments, which include a Leucadia joint venture know as Berkadia Commercial Mortgage LLC. This business is made up of assets that were bought out of bankruptcy in 2009, at least partially, and they were formally related to General Motors. When opportunities arise, companies like Fairfax financial and Leucadia will continue to take advantage of deals with Berkshire Hathaway.
Warren Buffett has a storied history of adding to positions for several years before ultimately acquiring them. As an example, Berkshire Hathaway purchased shares of Geico for decades before they ultimately acquired the entire company in 1996. They followed the same path with Burlington Northern Santa Fe Railroad, where they purchased shares for several years and owned 22.6% of the railroad before ultimately making the final bid in late 2009. Berkshire Hathaway is consolidating and increasing their position in USG, so it’s possible that we will see a similar outcome.
This company has already been an industry leader prior to the housing crisis correction, and it’s a safe bet that the company will continue to be the dominant producer of wallboard once the true housing recovery takes place. Some of the weaker competition should ultimately fail or have a difficult time meeting the demand as the increase happens.
Sheet rock is already the premium brand of wallboard, and it’s the type of intangible asset valued by Warren Buffett and Berkshire Hathaway, just like it valued Coca-Cola. USG will continue to increase and expand the sheetrock brand with differentiating and new products.
Over the last few years, the company introduced Ultralight sheet rock, which is thinner and lighter than the typical wallboard when you compare it to the traditional product. It is advantageous because it can be transported the same way as regular wallboard, but it will cost less to move, it will cost less to install and it’s easier to install as well. This will allow workers to work faster and experience less fatigue. It may even be looked upon as a greener alternative to traditional sheet rock.
As the housing market turns around, and commercial construction continues to accelerate, USG’s products will see an increase in demand over the next few years. When this occurs, you will see increasing prices for the purchase of wallboard. As of 2013, USG is seeing profitability once again and earnings growth potential seems significant over the next few years.
Although the most recent conversion of notes increases the overall share count, and this is going to put added pressure on earnings per share because of dilution, the company balance sheet is far stronger because of the removal of high yield long-term debt. By eliminating 10% of the notes the company will pay significantly less in interest expenses, and this should allow them to continue to grow revenue streams and add profit. Plus, the new shares went to shareholders that will undoubtedly hold the shares for some time, and these companies will probably even increase their stake over time, in anticipation of the future conversion of the notes that still remain.
To close things out, it is expected that Berkshire Hathaway will eventually look at this company as a potential acquisition target over the next few years. All signs point to this taking place, and if history repeats itself, Berkshire should end up owning the entire company in due time.