Quanex Building Products Stock: Assessing Tyman’s Strategic Purchase (NYSE:NX)

April 22nd ended up being a really interesting day for shareholders of Quanex Building Products (NYSE:NX). This is because the company, which focuses on the production and sale of components for OEMs (original equipment manufacturers) in the building products industry announced a rather major acquisition. This move will significantly increase the size of the business, coming very close to doubling it. It’s also expected to result in some rather meaningful synergies. Whether or not the transaction actually makes sense is something that only time will tell. Management seems fairly confident in their projection of cost savings that are on the table. And if those can come to fruition, I would argue that the deal would have been quite nice. Even without the synergies, the transaction doesn’t look bad. But it doesn’t look great either.

Clearly, the market was not particularly pleased with this development. Shares of the company dropped nearly 3% in response to the news. However, that doesn’t change the fact that things are going quite well for those who have been following my work on it. Even with this decline, the stock is up 11.8% compared to when I last rated it a ‘buy’ in January of this year. That’s almost double the 6.5% rise seen by the S&P 500. And since my first ‘buy’ rating back in September of 2022, shares are up a whopping 86.9% compared to the 37.1% increase seen by the broader market. Even with all of this upside and even in the face of a questionable purchase and some fundamental deterioration, I would argue that further upside still exists. Because of this, I’ve decided to keep the company rated a soft ‘buy’ for now.

An interesting deal

According to a press release issued on April 22nd, the management team at Quanex Building Products has decided to acquire a company called Tyman plc (TYMN). This is being done in a cash and stock deal at an enterprise value of $1.1 billion. But this is not as straightforward A transaction as it appears. Each share of Tyman is being valued at 400 pence. At current exchange rates, that translates to about $4.93. However, shareholders of Tyman have the option, to an extent, of how much of this consideration is being done in the form of stock and how much is being done in the form of cash. The default option seems to be 240 pence in the form of cash and 0.05715 of a share of Quanex Building Products in exchange for each share of Tyman owned. However, they can choose to do an all-stock deal at 0.14288 of a share of Quanex Building Products for each share of Tyman they currently have.

There is a limitation to this, however. If more than 25% of the outstanding shares of Tyman elect to receive the all-stock transaction, the amount of stock received by them will ultimately be prorated. This helps to minimize dilution for shareholders of Quanex Building Products. At the end of the day though, this would translate to shareholders of Tyman receiving between 30% and 32% of the combined company. All combined though, at current prices, this translates trade premium of 35.1% over what shares of Tyman close that on April 19th. And it is 40.5% higher than the six-month volume weighted average price of Tyman stock leading up to and including April 19th. Of course, the amount of upside received will vary based on how shares of Quanex Building Products fluctuate between now and the close of the transaction. In the table above, you can see what this would look like for somebody selecting the default option. And in the table below, you can see what kind of volatility would be experienced for somebody who ends up receiving the all-stock deal. In the chart below, you can see the different volatility profiles investors receive depending on the option they select. All of this is based on Tyman’s closing share price on April 22nd of $4.89 with the current exchange rate in place. It is worth noting that, in addition to this consideration, shareholders of Tyman are still receiving 9.5 pence in the form of a final dividend that was declared by the business on March 7th. So that’s a little extra consideration that’s mixed in.

Operationally speaking, it makes sense for Quanex Building Products to want to acquire Tyman. First and foremost, using data from 2023, this transaction helps Quanex Building Products to diversify its revenue stream. Last year, the company generated $834.5 million, or 73.8%, of its revenue from the us. By comparison, only $244.6 million, or 21.6%, worth of revenue came from Europe. Tyman, by comparison, generated only about 66% of its revenue from North America as a whole. This compares to 76.1% for Quanex Building Products when we lump Canada into the mix for it. Another 15% of revenue coming from Tyman is attributable to the UK and Ireland, while 19% comes from other international markets. And 15% of that 19% comes from EMEA (Europe, Middle East, and Africa) nations.

Acquiring Tyman also allows Quanex Building Products to diversify its product line. This might be even more significant than the geographic focus. Today, about 47% of revenue generated by Quanex Building Products comes from vinyl profiles and spacers. That number will shrink to 27% as a result of this purchase. Screens and accessories will fall from 27% of sales to 15%. And cabinet components will drop from 19% down to 11%. In exchange, Tyman generates about 72% of its revenue from window and door hardware. The combined company will get about 31% of its revenue from these sources. And because of the 16% of revenue generated by seals and extrusions by Tyman, about 7% of the combined company will involve those types of products. These are complementary products that should help to create cost savings and the opportunity to generate even additional revenue by serving as more of a one stop shop for OEMs.

This combination is expected to result in significant cost savings amounting to roughly $30 million on an annual run rate basis. About half of these savings will be achieved in the first full year after the transaction closes. The rest will occur over the second year. About 40% of these synergies will involve product consolidation and getting rid of overlapping functions and activities across the organizations. Another 30% will involve economies of scale and consolidation of overlapping spending activities when it comes to procurement. And the final 30% will come on the corporate side by rationalizing certain executive functions. Of course, this won’t be cheap. All combined, the company expects one-time costs of $35 million in order to achieve these savings in the long run. It’s also worth noting that none of this includes additional revenue synergies that are expected to come as a result of cross selling like I alluded to already.

All combined, the company will be quite large. Like I said already, Quanex Building Products generated $1.13 billion in revenue last year. By comparison, Tyman generated $818 million. That will result in a company that generates about $1.95 billion worth of sales. As you can see in the image below, they also bring with them some rather attractive EBITDA. Tyman, for instance, generates about $120 million. And Quanex Building Products generates $160 million. All combined, this should be $310 million if we factor in cost savings. But for the purpose of evaluating the attractiveness of the deal, I would like to see what things look like without these savings.

Without the purchase, we are looking at Tyman being acquired at an EV to EBITDA multiple of 9.2. But if synergies do come into effect, then we are looking at a more reasonable multiple of 7.3. If we use data from 2023, Quanex Building Products is currently trading at an EV to EBITDA multiple of 7.3 as well. The picture does look a bit different if we use the EV to adjusted operating cash flow multiple. Using the 2023 figures, Quanex Building Products is trading at a multiple of 8.6. It may seem odd that I’m using the EV to adjusted operating cash flow multiple as opposed to the price to adjusted operating cash flow multiple.

However, the significant amount of debt that Quanex Building Products is having to take on in order to complete the deal makes the picture complicated otherwise. For instance, should be used only the component of the deal that would be stock based compensation sense taking on additional debt to complete the transaction would be akin to purchasing a highly leveraged business at a lower purchase price? To keep things simple, I’m sticking with the EV to adjusted operating cash flow approach. In this case, without synergies, Tyman is being purchased from multiple of 20. And with synergies, it’s being purchased for a multiple of 14. The good news is that, combined, and assuming that shareholders of Tyman walk away with a 31% ownership the combined firm, we are looking at a price to adjusted operating cash flow multiple for the company of 8.7 without synergies and 7.7 with. The EV to EBITDA multiple, meanwhile, should be 8.7 without synergies and 7.8 with. That’s still quite attractive in the grand scheme of things.

When it comes to the adjusted operating cash flow, I assumed a 21% corporate tax rate. I also assumed, on the $750 million worth of debt that Quanex Building Products is tapping into, an interest rate of 6.69%. That’s the interest rate on its credit facility as of the end of January of this year. In this case, the stock does look pricey relative to Quanex Building Products. It will also result in the combined company having a net leverage ratio of 2.1. However, management does feel confident that they can reduce this down to about 1.5 in the medium term. What exactly this timeframe is anybody’s guess.

It is worth noting that, regardless of your opinion of the deal, Quanex Building Products itself is facing some weakness. The $1.13 billion that the company generated in revenue in 2023 was actually down from the $1.22 billion generated one year earlier. As you can see in the chart above, while cash flows were either flat or higher year over year, net profits were also down. But in the chart below, you can see continued mixed performance covering the first quarter of the 2024 fiscal year compared to the same time last year. The decline in revenue was driven mostly by an $11.5 million drop associated with the firm’s North American cabinet components business. That drop, about 21% year over year, was thanks to a $6.4 million decline associated with volumes caused by softer market demand that resulted from weaker consumer confidence. The other $5.1 million drop was a decrease in raw material prices. And much of that decline was passed on to customers.

In all likelihood, weakness for Quanex Building Products will continue for at least this year. Without factoring in the acquisition, management is forecasting revenue of $1.1 billion. They expect EBITDA to be between $145 million and $150 million. That’s down from the $160 million reported for last year. Using the estimates provided by management, I figured that net income should be around $76 million, while adjusted operating cash flow should be somewhere around $125 million. In the chart below, you can see what shares should look like on a forward basis relative to what we get using data from 2023. However, I don’t believe that the pain will last much more than 2024. As I highlighted in another article recently, the homebuilding market that Quanex Building Products relies on is showing some strong signs of turning around.

Takeaway

Fundamentally speaking, I think that we are looking at a rather interesting transaction. When we ignore things like debt, the deal looks to be good to decent, depending on your opinion of synergies. But when you factor in the amount of debt involved in this transaction, the picture becomes somewhat less attractive. The good news is that shares look attractive on a combined basis. Yes, we are seeing some weakness from Quanex Building Products as well. However, the space that it is connected to, which is the home building market, is one that I am quite bullish on as I stated in another article recently. So all combined, I would say that additional upside is probably still on the table. However, I do think that a good chunk of the easy money has already been made. That’s why, instead of a solid ‘buy’, I am assigning it a soft ‘buy’ at this time.