Sometimes business combinations are about growth and sometimes they are about survival ... and every once in a while they can be both. There's no questioning that the current market environment for aggregates (a catch-all for crushed stone, sand, and gravel) is pretty poor as construction and large-scale infrastructure projects have evaporated. Consequently, while Martin Marietta's (NYSE:MLM) bid for Vulcan Materials (NYSE:VMC) may seem at least a little opportunistic, it does take some risk out for both companies and leaves both investor groups with a lot of upside.
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The Proposed Deal
Although proxy materials from Martin Marietta suggest that these two companies have been talking about a deal for something like 18 months, Martin Marietta has apparently tired of waiting and debating. The company has launched a hostile stock-for-stock offer for its larger rival Vulcan.
Under the deal, Vulcan shareholders would get one-half share of Martin Marietta for each share of Vulcan they own - a deal that valued Vulcan at a roughly 10% premium based on the companies' closing prices prior to the deal. If the deal is accepted at this ratio, Vulcan shareholders would own over half of the combined entity. (For related reading, see Analyzing An Acquisition Announcement.)
Why Would Either Side Want This Deal?
What's interesting about this hostile offer is that Martin Marietta arguably needs this deal less than Vulcan. MLM has a somewhat stronger balance sheet, a better cost position and arguably a better geographical footprint. MLM has a good exposure to Texas, where the economy has been somewhat stronger and demand for hydraulic fracturing has given some support to aggregates, while Vulcan is more exposed to the weaker Sunbelt region.
It's also worth noting that MLM has a small (but not insignificant) specialty aggregates business. This business chips in about 10% of revenue, but carries higher margins on products used in areas like steel-making and flue gas remediation.
Still, one of the driving factors of this deal has to be operating efficiency. MLM believes that the combined companies could save between $200 million and $250 million in operating costs which is significant given the trailing EBITDAs of $352 million and $307 million, respectively. What's more, the combined entity would have an appealing geographical reach, roughly 15% market share and solid positioning for the eventual rebound in construction and road-building.
Not a Bad Deal for Either Side
Curiously, both stocks have been solid since the announcement of the offer - a positive sign given that most acquirers see their stock drop on such an announcement. This may actually in fact be one of those win-win deals for each shareholder base.
The shares of both companies are currently undervalued, as the market gives little thought to the idea that both are likely to survive, the country will continue to need roads, and this is an industry with huge regional moats to competition. While Vulcan shareholders may want to hold out for a slightly sweetened offer, the reality is that a stock-for-stock deal does give them a small premium today and the potential to share the upside from the combined company.
The Bottom Line
Investors waiting on a construction turnaround had best get comfy and be prepared for the long haul. Simply put, there's just not much going on at companies like Cemex (NYSE:CX), Eagle Materials (NYSE:EXP), USG (NYSE: USG), Louisiana-Pacific (NYSE:LPX), Texas Industries (NYSE:TXI), or the major contractors that points to a near-term turnaround in residential or infrastructure construction. Instead, companies are still looking to keep costs to a minimum, shutter excess capacity, and find deals aimed at driving more costs out of the operation.
Deal or no, both Martin Marietta and Vulcan are names worth watching for that eventual turnaround, but it is hard to argue that the combined entity wouldn't be a more appealing prospect. In the meantime, risk-tolerant investors can shop around in the aggregates, cement, and building materials space in search of bargains, but they would do well to mind the debt and liquidity numbers and confine their bets to those companies with real staying power should this slump stretch on even further. (For related reading on liquidity, see Understanding Financial Liquidity.)
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.