PGTI - Masonite And PGT Innovations: Slamming The Door Following A Big And Expensive Deal

2023-12-19 11:00:41 ET

Summary

• Masonite International Corporation has announced a $3 billion deal to acquire PGT Innovations, Inc., raising questions about the company's growth strategy.
• The deal will make Masonite the undisputed leader in the field of patio doors and premium window solutions.
• The premium offered, ambitious synergy targets, and high leverage create uncertainty and make the deal less compelling on a risk-reward basis.

As recently as early November, I concluded that I was slowly opening the door for Masonite International Corporation ( DOOR ) . The company was facing a tougher 2023 amidst the impact of higher interest rates on the housing market, with the company resorting to price hikes and M&A efforts to grow sales and earnings (at the expense of added debt).

This gradual organic and inorganic growth profile is now completely turned upside down, as Masonite has announced not only a very large deal, but an expensive one as well, raising real questions here.

Walking Through Walls

Masonite is a near $3 billion business which produced and sold over 30 million doors in 2022, with 10,000 workers operating in a pure-play and vertically integrated operation. The integration of activities allows the business to post EBITDA margins in the mid-teens.

The business is mostly focused on North American operations, with exposure split pretty evenly between new construction, renovation and remodeling, as the company has smaller European and architectural activities as well.

Perhaps viewed as a commodity, the role of doors is getting more important for safety, energy efficiency reasons, and smart home applications, among others. While wood is still responsible for half of sales, other materials such as composites, steel, glass and other materials are often used as well.

For the year 2022, the company posted a solid 11% increase in revenues to $2.89 billion. GAAP earnings of $214 million came in at $9.41 per share, making an $80 stock early in November look cheap, but there were some caveats. The first was that net debt would rise over a billion (pro forma, by the end of 2022) for a roughly 2 times leverage ratio.

Moreover, high interest rates were the driver behind a decline from highs around $130 in 2021 to the $80 mark as earnings were expected to come under pressure. The effect of higher interest rates was clearly seen in the 2023 guidance. Full year sales were seen between flat and minus 5%, with organic sales declines seen at 7-12%. Earnings power was expected to fall to $7.75 per share, based on a $430 million EBITDA number. This came following the cocktail of higher interest rates hurting demand, while inflationary pressures hurt margins.

Despite the tougher year, Masonite announced another deal this fall, with a $285 million deal for Fleetwood Aluminum Products, a premium manufacturer of innovative glass products. This business was valued at a premium, although it posted higher margins as well, with pro forma net debt of $1.1 billion translates into a 2.5 times leverage ratio.

At 10 times earnings, valuation multiples looked reasonable, as leverage inched up a bit following the dealmaking spree, as some greater prudence with leverage would be welcomed.

A Rally Reverses

As I concluded to look for a dip in the $70s in November, shares started on a big rally from the $80 mark to highs of $104 per share in recent trading days. This was in part driven by resilient third quarter results, as released early in November.

Revenues fell 4% to $702 million, but margin pressure flattened off. Pro forma net debt fell to just over a billion as 22 million shares value equity of the business at close to $1.8 billion, for a $2.8 billion enterprise valuation.

This was equal to about 1 times sales, all with EBITDA margins coming in around 15%, and after-tax margins seen at 6%.

A Huge Deal

This all changed overnight, as Masonite made a massive deal with the announced $3.0 billion purchase of PGT Innovations, Inc. ( PGTI ) . The designer and manufacturer of patio door and premium window solutions will be added to Masonite, in order to create the undisputed leader in the field.

Investors in PGT stand to receive $41 for their shares, a 24% premium compared to recent trading action. PGT´s investors are set to receive $33.50 per share in cash and $7.50 per share in shares of Masonite, which will give PGT´s investors a combined 16% equity stake in the new business.

PGT generates about $1.5 billion in sales on a trailing basis, being valued at 2 times sales (while the own business is at valued around 1 times sales). This can be explained by the stronger growth of PGT Innovations and superior EBITDA margins of 18% (coming in about 3% higher than Masonite), but it still marks a big premium nonetheless. If we adjust for this, PGT is valued at 11 times EBITDA, while Masonite trades around 7 times EBITDA in the lower $80s.

This higher multiple comes at a premium (relative to Masonite) as the company justifies the deal by pointing towards $100 million in anticipated annual synergies. On top of these uncertain and ambitious synergies (equal to nearly 7% of PGT´s sales!), investors furthermore have to deal with a pro forma leverage ratio of 4.1 times EBITDA.

Shares fell some $17 to $85 per share upon the deal announcement, as the 22 million shares outstanding (including the newly to be issued shares) lost nearly half a billion dollars of value upon the deal announcement. Quite frankly, that does not surprise me given the premium offered, the ambitious synergy targets, but moreover, the leverage taken on.

What Now? Uncertainty Prevails

Pro forma EBITDA is seen at $700 million upon closing, set to rise to $800 million over time. That is about all the good news. Subtracting an estimated $125 million in depreciation charges, and $35 million in stock-based compensation expenses, I peg adjusted EBIT at $540 million.

With a pro forma net debt load of around $3.5 billion and about $175 million in interest costs (at 5% rates), net earnings could come in at $275 million after a 25% tax rate, for earnings close to $10 per share (including the to be issued shares). Note that these are just back of the envelope calculations, not backed up by quantified comments by management, although management indicated that accretion is expected.

That suggests very modest earnings accretion, while a great debt overhang creates a lot of uncertainty. That being said, a $100 million synergy target could boost earnings over time by close to $3 per share. This looks comforting (if achieved), as the company claims that few financial resources are required to integrate both businesses.

Not that there is a wildcard in all of this, as competing firm Miter Brands (backed by the Koch family) has been making offers for PGT as well, raising the potential for a bidding war, which is a terrifying prospect for investors in Masonite.

Given all of this, I am very cautious on Masonite here, as I only would be willing to commit to shares at these levels if a deal were not to go through. The size, premium offered, and leverage taken on by Masonite International Corporation following a potential deal for PGT Innovations simply does not look compelling on a risk-reward basis.

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