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Rock Solid?

Hanson Plc hopes its bolt-on acquisition strategy will cement its U.S. presence.

1Jul

Launched in the 1960s by a pair of British entrepreneurs who squired Audrey Hepburn and Joan Collins around London, Hanson Plc has come back to earth. Gone is the glitzy $20 billion conglomeration of companies that once captivated growth investors. The focus today is on mundane businesses that produce, for the most part, bricks, mortar, and concrete.


In May, the firm closed its biggest deal since setting a new strategic course in February 1997--the $2.5 billion acquisition of the global aggregates enterprise Pioneer International Ltd. of Australia. Meanwhile, a combined $135.9 million price tag for two U.S. companies, Joelson Taylor and Cincinnati Pipe, capped a three- year period in which Hanson spent a total $1 billion on stone and concrete businesses in the United States, in addition to deals in Europe and Asia.


The former owner of Durkee's Famous Foods and Glidden Paints, among many other companies, Hanson has embarked on a new growth strategy. Instead of buying underperforming assets with an eye to boosting their sagging price-earnings ratios, the key to success in an earlier era, managers claim this time to be after the real thing: building the business for the long term.


"We're managing a single- sector business now, focusing on heavy side building materials. Unlike the old Hanson, we now have a strategy to grow this business," says Alan Murray, the CEO of Hanson Building Materials America who had been the companywide CFO until two years ago. The U.S. division of Hanson accounted for about 55 percent of the company's 1999 sales, which totaled $3.1 billion and provided about 60 percent of the $524.2 million in profits. Already this year, Hanson has announced another $135 million in U.S.-based purchases, part of the company's continuing game- plan.


"The bolt-on acquisition strategy has accelerated, increasing our leverage and reducing our interest coverage to about five times," points out Hanson's current CFO, Jonathan Nicholls, nodding to S&P's concerns. "Maybe even a little lower than five times initially."


Along with interest coverage, credit-rating agencies are also keeping a sharp eye on the ratio between funds from operations and net debt, which slipped to about 35 percent after the Pioneer transaction. Standard & Poor's had expected that ratio to fall to the 55 to 60 percent range. Current debt is about $1 billion. S&P then bumped the company's long-term debt rating down one notch to BBB+.


While acknowledging that "the acquisition has clear merits from a business perspective," S&P's April downgrade cited "the deterioration in [Hanson's] financial profile that will result from the transaction." That profile, at year-end 1999, included net debt of around $194 million. The company is now testing the limits on two fundamental notions: first, the financial viability of the "bolt-on acquisition" strategy; and second, the durability of what is already the longest expansion to date of the U.S. economy.


"We intend to spend $300 million a year over the next three years," says CFO Nicholls, to pursue the bolt-on acquisition strategy. For this year, that includes $135 million for the substantial U.S. concrete pipe acquisition that was announced in May at the time of the Pioneer purchase closing. And even though the acquisition strategy will absorb Hanson's cash flow, S&P opines that Hanson will have "substantial leeway" to complete the program, "as long as the ratio of funds from operations to debt remains above 30 percent."



Short-Term Boost

Thus, a critical question for Hanson: Can it continue to increase operating margins in its newly acquired divisions--thanks to cost-cutting measures--and then build on those gains in successive years? The first part of the answer has been a relative softball, one that can be hit out of the park pretty easily, leading London-based Merrill Lynch construction industry analyst Kevin Cammack to rate Hanson's stock a "near- term neutral." The second part is harder, determined not only by management's expertise but also by the macro-economy.


Here's the explanation of the short-term kicker that Hanson is getting from its acquisitions. The U.S. market is significantly more fragmented than the U.K.'s. The top four U.K. aggregates companies claim 70 percent of the U.K. market, while the top three U.S. producers control only 18 percent. In addition to Hanson, with about 4.8 percent market share, Birmingham, Alabama-based Vulcan Materials holds 7.3 percent of the market, while Raleigh, North Carolina­ based Martin Marietta Materials Inc. claims a 6.3 percent share.


Most of the remaining 80 percent of the U.S. market are family-owned businesses. "We're taking out [the costs of] what the families are paying themselves and what they were buying through the business," explains C. Howard Nye, president of Hanson Aggregates East, who previously oversaw the acquisition strategy in the eastern United States. That savings in overhead, says analyst Cammack, represents "a quick and easy return--somewhere between a 1 percent and a 3 percent improvement on operating margins."


There's still some running room in the U.S. marketplace, given its fragmentation. "For the United States to reach the level of concentration that exists now in the U.K. will probably take another 20 years," forecasts Murray.


But why should family-owned stone quarries be run any differently in the 21st century than they were in the 20th? Hanson's Murray points to increasingly cumbersome planning and environmental regulations, which pose a bigger hurdle for small operators than for larger ones.


Emblematic of those obstacles, and of the unwillingness of small managers to invest, is the U.S. government's new specifications for stones in aggregate for federal building projects. According to Robert Donald, a building-materials and construction-industry analyst with Schroders, Uncle Sam consumes about 35 percent of the aggregates market in total, and accounts for about 45 percent of Hanson's U.S. profits.


This regulatory change was minor, squeezing the size range of stones from between one-quarter inch and one-half inch, to between three-eighths inch and one-half inch. Nonetheless, "the need to change equipment posed capital
requirements that made it harder for the small player to stay in business," explains Larry Quinlivan, vice president, marketing, at the National Stone Association.


If buying family-owned businesses in the United States represents an ongoing opportunity for Hanson, the tougher job will be managing the cyclic nature of the U.S. economy. Despite overall GDP growth of more than 5 percent in the past two quarters, the construction industry is already slowing down, with housing starts off by about 10 percent since February. Murray says he is tracking this closely, watching the industry's most sensitive forecasts by county and state, and claims that his operations, which are now running at peak capacity, can reduce their output cost effectively to accommodate declining demand.


Murray also points to two factors that will buffer Hanson in a downturn. First is the demographics of the Sunbelt regions, where operations are concentrated--Texas, California, the Carolinas, and Georgia. Second is the U.S. government's $200+ billion highway spending program, the Transportation Equity Act for the 21st Century (TEA21).


These two factors are not unrelated. Because the demographic winds are shifting from the north and northeast of the United States, this transportation program has a notable absence of funds for public transit, focusing resources instead on highways for the Sunbelt. And with these federal funds hitting the market in this year's second quarter, Hanson competitor Martin Marietta Materials forecasts that the growing demand for aggregates will outstrip GDP growth rates by about 200 basis points.


Hanson demurs on such expectations. "In evaluating acquisitions, we've been careful in our forecasts to project volume increases only by historical amounts, and we don't expect price increases at any rates higher than historical patterns," insists Murray. Nonetheless, he adds, "TEA21 will underpin our growth in the near term."


In other words, for Hanson, the alchemy of turning bricks and mortar into profits hinges on the fate of the economy at large.

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