July, 2007

Shark Bait

A corporate raider targets BMHC.

By Greg Brooks

Everyone’s life is a little more complex than it was this time last year, but however difficult your situation may be, you would not want to trade places with Rob Mellor, chairman of Building Materials Holding Corp. (BMHC).

You may have seen the May 30th item at Home Channel News’s web site titled, “Investor group urges BMHC to sell SelectBuild.” HCN quoted from a SEC filing by Chapman Capital L.L.C., urging BMHC to “explore the complete or divisional sale of the company” and adding that “the stock market is ascribing virtually no value to SelectBuild, making it imperative that BMHC management and the board rectify this deficiency.”

Virtually no value? SelectBuild is the crown jewel in BMHC’s portfolio. Its business model—turnkey construction services encompassing the entire dry-in shell—has been acclaimed as the future of production homebuilding. Sure, first-quarter sales were down 43%, but SelectBuild targets high-volume builders. They’re not building now, but they won’t be idle forever.

You might think that these are investors who simply don’t understand that, perfect or not, SelectBuild is arguably the most innovative idea in residential construction since tract builders came onto the scene in 1946. You would be wrong.

In a June 1st article titled “Hedge-Fund Bullies,” CFO magazine called Chapman Capital “one of a new breed of corporate raiders—hedge-fund activists who instill fear in managers of underperforming companies.” Activists don’t try to take over their targets, says CFO. Instead, they “take relatively small positions and seek to impose their will by pursuing a few seats on the board and agitating for change. Their aim is to boost the stock price by pushing for a strategic move such as a spin-off, sale of assets, a large buyback or dividend, or a change in management.”

That’s what happened to Home Depot earlier this year. An activist group called Relational Investors parlayed a 1% ownership stake into a seat on the board of directors; and appear to be trying to force Depot to abandon HD Supply, and played a role in Robert Nardelli’s firing.

Chapman Capital has reportedly conducted more than 20 such raids since 2000, earning a 20% annual return for its investors. BMHC’s 13D shows that Chapman began buying stock on March 29, 2007. By May 22nd, it held a 7.4% stake and became BMHC’s largest single investor, according to Chapman.

But Robert Chapman is famous in hedge-fund circles for using 13D filings—statements of ownership required when an investor acquires over 5% of a public company—to publicly intimidate his targets’ senior managers. Included in the 13D  were details noting that, on Friday, May 18th, Chapman placed three calls to Mellor, who was traveling. On Saturday the 19th, he emailed Mellor to accuse him of “disregard and disrespect” for not returning the calls, and to issue a threat: “Basic ‘consequential analysis’ of the situation should lead you to the logical conclusion that engaging (rather than avoiding) Chapman Capital may result in the most (mutually) beneficial outcome.” Mellor responded on Sunday the 20th.

That was the mild stuff. A letter included in the filing accuses BMHC’s senior managers of having “flooded your personal coffers with millions of dollars” through stock option grants, as well as “a disconnect between stock ownership and compensation.”

Given Chapman’s track record, odds are that BMHC’s shareholders will make money no matter how this plays out. But it illustrates another disconnect between investors’ objectives and any company’s long-range plans.

BMHC isn’t the only pro dealer doing turnkey shell construction, but its size helped give the model visibility and legitimacy. Size also enabled it to push the envelope further than most by acquiring concrete, plumbing, and roofing subs. If BMHC is sold or split up, it’s impossible to say whether the buyer would pursue that vision.

But if not, others will—as long as they have the freedom to execute their strategy.