It turns out that money for solid companies in the construction industry is more available than people think. The secret is knowing where to look for it.
Everyone knows that the contractors and suppliers are hurting. Falling demand has squeezed budgets. Some companies are on the verge of failure. Others have maintained profits, but to do it they had to abandon programs to expand and diversify.
Cutting out initiatives like buying other companies and developing new products are especially frustrating. The assets and people to carry out the plans are available and are available cheap. There is simply no money to pay for them. So the opportunities go unpursued, and they may soon disappear.
The solution of course is to get financing. But how? One distinctive feature of the current economic downturn is the extreme lack of bank financing. After all, overlending helped bring the recession on in the first place. In response to their mistake and the losses that followed, lenders have severely reduced lending.
Equity investors, who trade their dollars for an ownership stake in companies, pulled back as well. Why? Partly because they were suddenly as scared about investing as the rest of us. But there is another important reason. Equity investors depend on the companies they fund to also get some bank financing. If the bank also puts in some money, this “leverages” their investment so they get a higher return on their money. When bank lending became less available, investors suddenly could not get their investments leveraged. So they held on to their money instead of use it for less-profitable investments.
But something critical has shifted. Equity investors—the people who buy companies or buy parts of them—don’t want their money to sit in low-return bonds and bank accounts any longer. It doesn’t make sense to spend another year waiting for sales to improve and lending to become available. It’s better to invest now and take modest gains for the next year instead of leaving money in the bank and taking very small gains.
This shift is even more pronounced for investment funds. They are run by managers who get paid based on how much they invest and how much profit their investments return. If they fail to invest their money within a certain period of time, it goes back to the investors who gave it to the fund in the first place. That means no investments and no profits and no bonuses. So it’s better to get the money into an okay deal than lose it.
But there is one other reason the investors are starting to buy into construction and construction products companies again. They are starting to consider construction as a growth industry.
I have been asked by several investment funds to find construction-related companies that might be interested in investment, even though housing starts in 2009 are the lowest they have been since 1940.
Why? Because there is no way to go but up. By all accounts, construction will be up in 2010. By some accounts, it could be up over 20%. It is irrelevant that current sales are dismally low. If they can invest in a $50 million company at a price you’d expect to pay for a $50 company, and next year it will be a $70 million company and you can get the price you’d expect to get for a $70 million company, you’ve done well. It doesn’t matter that four years ago the company was a $100 million firm.
This does not mean that any company can get funding. For one, right now bigger is better. Local individual investors are still putting some money into small companies. But the funds want to put a large sum into each company they invest in. They are behind schedule in investing. They need to commit a large amount each time to catch back up.
The “ideal investment” seems to be a company with sales of $50-200 million. However some very good funds are investing in firms with sales as low as $30 million, and a few are putting money into $10 million companies.
Profitability is very valuable. If a company is profitable, there is little risk for the investors. Even if growth does not materialize, the company is making some money and the investors make at least a small return. Some funds require that the cash flow (or so-called “EBITDA”) be at least 10% of sales. Some require 15%. A few funds specialize in getting money to “distressed firms.”
Good growth prospects are immensely valuable. If their money is going to developing a hot product, adding distribution, or securing lucrative government projects, investors get excited. If it is going simply to keeping the boat afloat, they are less eager. But beware: they are smart enough to tell the difference between reliable growth strategies and wishful thinking.
Many investors are willing to receive either minority or majority ownership of the companies they invest in. They will expect to get some amount of say in the big decisions since they’re putting up the dollars. But the funds we have dealt with want the current management to stay in place to run things day-to-day. If the owners want to sell out and leave the business, that can be fine, but they will either have to stay in management for a couple of years or help find a good replacement.
When it comes to getting money for construction industry companies, things are looking up. And it’s for a reason: they are up.
Next issue: The New Energy Reality
President of Building Works, Inc., a consulting company that helps companies with new construction products. He can be reached at email@example.com, and his company at www.buildingworks.com.