Armstrong should make $2.65-2.75 in 2007 and $3.00 in 2008.  Cash EPS is greater than GAAP EPS a go forward basis as its assets were marketed up to fair value when it came out of bankruptcy.  Annual depreciation will be $25mm more than Capex.  Armstrong expects to generate $300mm in free cash flow in 2007 (Cash EPS of $5.30).

 

Armstrong has two unique assets: a large deferred tax asset and an overfunded pension.  Armstrong has a $1.6 billion NOL in the US which, starting in 2007, results in the company not paying taxes until it is fully utilized.  At the end of 2006, the company valued its deferred tax assets as $552.7mm for federal tax purposes and $45.5mm for state tax purposes. Year to date the company has deferred 45mm in taxes.  Finally the company has a $500mm overfunded pension with which a strategic buyer could fund an underfunded pension.  Not including the overfunded pension, AWI is currently trading at 5x Ebitda with commercial (2/3 of Ebit) and residential (1/3 Ebit) competitors trading at 7-8x Ebitda.

 

Armstrong World Industries, Inc. (AWI), incorporated in 1891, is in the design and manufacture of flooring products and ceiling systems which are primarily used in the construction and renovation of commercial, institutional and residential buildings. The company first began the business in 1860, and its initial business line included the production of cork. From manufacturing of cork they graduated to developing fiberboard, which eventually led to the current business of ceiling board. AWI also entered in the business of Linoleum Flooring in 1909. This eventually led the company to develop and market Vinyl flooring.

 

As of December 31, 2006, the Company owned and operated 43 manufacturing plants in 12 countries, including 26 plants located throughout the United States. Three of its plants are leased and the remaining 40 are owned. In addition, Armstrong had an interest through its two joint ventures in eight additional plants in five countries. AWI sells its products in more than 80 countries. The Company principally sells products through building materials distributors, who resell its products to retailers, builders, contractors, installers and others.

 

On December 6, 2000, AWI filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court, in order to use the court-supervised reorganization process to achieve a resolution of its asbestos liability. During the time in bankruptcy, the company continued to operate its normal day-to-day operations through debtor-in possession financing. Armstrong finally emerged from bankruptcy on October 2, 2006. The plan of reorganization resulted in cash payments of approximately $1.1 billion made to the Asbestos Trust and Unsecured Creditors, funded by cash from the balance sheet and the proceeds from Armstrong's $1.1 billion bank refinancing. The refinancing consisted of term loans of $300 million with a five-year maturity and $500 million seven-year maturity and a $300 million revolver.

 

 2006 Consolidated Net Sales by Segment

Resilient Flooring   33%

 Building Products  30%

Wood Flooring       22%

Wave                      9%

Cabinets                  6%

 

Resilient Flooring   5%

Building Products   54%

Wood Flooring      19%

Wave                    19%

Cabinets                3%

 

Reportable Segments:

 

Resilient Flooring:  It produces and sources a broad range of floor coverings primarily for homes and commercial and institutional buildings. Manufactured products in this segment include vinyl sheet, vinyl tile, linoleum flooring, luxury vinyl tile, automotive carpeting and other specialized textile floor products. In addition, Resilient Flooring segment sources and sells laminate flooring products, ceramic tile products, adhesives, installation and maintenance materials and accessories.

 

 

 

                       

Wood Flooring: It produces and sources wood flooring products for use in new residential construction and renovation, with some commercial applications in stores, restaurants and high-end offices. The product offering includes solid wood (predominantly pre-finished), pre-finished engineered wood floors in various wood species (with oak being the primary species of choice) and related accessories.

 

 

 

Building Products: It produces suspended mineral fiber, soft fiber and metal ceiling systems for use in commercial, institutional and residential settings. In addition, to Building Products segment sources complementary ceiling products. Their products are available in numerous colors, performance characteristics and designs, and offer attributes such as acoustical control, rated fire protection and aesthetic appeal. Commercial ceiling materials and accessories are sold to ceiling systems contractors and to resale distributors.

 

 

Cabinets: It produces kitchen and bathroom cabinetry and related products, which are used primarily in the U.S. residential new construction and renovation markets. Cabinets segment provides design, fabrication and installation services to single and multi-family homebuilders, remodelers and consumers.

 

 

Equity Investment:  Investments in affiliates of $294.6 million at December 31, 2006, reflected the equity interest in 50% investment in WAVE joint venture and 50% investment in Kunshan Holdings Limited.

 

Wave JV: Worthington Armstrong Venture (“WAVE”), a 50%-owned joint venture between Armstrong World Industries, Inc. and Worthington Industries, is one of three global manufacturers of suspension grid systems for concealed and lay-in panel ceilings in commercial and residential ceiling markets. WAVE operates seven facilities in five countries: Aberdeen, Maryland; Benton Harbor, Michigan; and North Las Vegas, Nevada, within the United States; Shanghai, the Peoples Republic of China; Team Valley, United Kingdom; Valenciennes, France; and Madrid, Spain. Armstrong also sells the suspension grid systems from which the ceilings hang, which are manufactured through the WAVE joint venture with Worthington Industries. The company has an EBITDA margin of 35% with the annual growth in revenues at 35% CAGR.  The Joint Venture is accounted under the equity method of accounting and hence the revenues of the company are not consolidated along with the company. Revenues of the Joint Venture in FY 05 were $307.7 Mn. with an EBITDA of $39.3 Mn.

 

 

North American Residential: Nearly 50% of the total consolidated net sales of the company are for North American Residential use. They are the largest provider for vinyl and wood products. Industry estimates are that existing home renovation (also known as replacement / remodel) work represents approximately two-thirds of the total North American residential market opportunity. Sales of ceiling products for residential use follow the trend of existing home sales, with a lag between the two.

North American Commercial:Nearly 33% of the total consolidated sales of the company are for North American Commercial use.  Renovation work is estimated to represent approximately three-fourths of the total North American commercial market opportunity.  Most of the company’s revenue comes from office, education, retail and healthcare sector. Company believes revenue from construction sector lags behind by as much as one year from the start of new construction.

Non-North America: The Majority of the revenues outside America come from Europe and from commercial segment.

Americas      76%

Europe          20%

Pacific Rim     4%

Company sells their products in over 80 countries across the world.

 

 

They principally sell products through building materials distributors, who re-sell products to retailers, builders, contractors, installersand others. In the commercial sector, they sell to several contractors and to subcontractors’ alliances. In the North American retail channel, which sells to end-users in the residential and light commercial segments, they have important relationships with national home centers such as The Home Depot, Inc. and Lowe’s Companies, Inc. In the North American residential sector, they have important relationships with major homebuilders and buying groups.  Home Depot & Lowe’s Corporation together account for more the 22% of the receivable as of December 31, 2006

  

The Asbestos Trust is currently funded with $750 million of cash and owns roughly 37 million shares of the new common stock AWI or almost two-thirds of the stock. The Trust began paying claims in May. If this Trust is similar to others that have preceded it, the cash funds of $750 million will be fully spent within 12–18 months. The expectation therefore is that the Trust will need to liquidate a large percentage if not all of its stock at some future point in order to both diversify its investments and gain liquidity.

 

 

	FY 2006	FY 2007	FY 2008
Net Sales	3,425.9	3,503.7	3,577.3
Cost of Sales	2,689.1	2,655.2	2,707.4
Gross Profit	736.8	848.5	869.9
GM (%)	22%	24%	24%
SG&A	561	597.0	614.6
SG&A % of Sales	16%	17%	17%
Restructuring charges, net	11.7	0.1
Equity (earnings) from joint venture	-46.7	-43.5	-44.0
Operating Income	210.8	294.8	299.4
OM(%)	6%	8%	8%
Depreciation & Amortization	133.4	134.3	135.2
EBITDA	344.2	429.1	434.6
Margin (%)	10%	12%	12%
Interest expense	18.6	57.6	33
Other non-operating expenses	1.3	0.8	0
Other non-operating income	-11.5	-14	-12
Chapter 11 reorganization costs, net	-1,956	0.1	0
Earnings Before Taxes	2,157.9	250.3	278.4
EBT Margin	63%	7%	8%
Income Tax	730.4	98.3	107.3
Tax Rate (%)	34%	39%	39%
Income from Continuing Operations	1,427.5	152.0	171.1
Net Margin from Continuing Ops (%)	42%	4%	5%
(Loss) from continuing operations	-69.5	-5.8	0
Net Profit	1,358.0	146.2	171.1
Net Margin (%)	40%	4%	5%
Diluted Weighted Average Shares		56.5	56.8
EPS - Continuing		2.69	3.01

 

 

Coming out of bankruptcy the asbestos trust owns 2/3rds of the shares outstanding.  It has started to make payments to the beneficiaries of the trust, so it will likely need to liquidate at least part of its position within 12 months.  Since the current credit market reduces the odds of private equity buyer, Armstrong is left with 3 options.

 

Good

1- Begin marketing the company.  Armstrong trades at a significant discount to its peer group and once people understand the story, the stock should trade up.  Eventually the asbestos trust will sell its stock in a secondary.

 

Better

2- Sell to a strategic investor.  While Armstrong was hoping to be purchased by a private equity firm in the upper $50's, the company could now go back to a strategic buyer, such as Warren Buffett's Shaw group, and try to sell the company for $50 per share.  Armstrong should be worth more to a strategic buyer since it could use Armstrong's NOL quicker and apply $500mm to an underfunded pension.  Even without utilizing the overfunded pension, a strategic investor could pay Armstrong $50 and be paying 6x next year's Ebitda, a substantial discount to peers.

 

Best

3- Armstrong buys stock back from the Asbestos trust in a $1 billion Dutch tender at $40 per share.  The company can obtain a tax refund of either 2 or 10 years of previously paid taxes.  While a discount rate would be applied, the company should get approximately $350mm in a tax refund.  The recapitalized company would have a market cap of $1,300mm and $900mm in debt.  Even in this restrictive credit environment, the company should be able to finance the debt at 9%.  Based on consensus 2008 Ebit, this buyback would result in GAAP EPS of $4.50 and cash EPS near 5.00.  After the buyback, if Armstrong traded inline with its peers, the stock would trade in the $60s.

 

* If Armstrong used the proceeds of the tax refund and the cash on their balance sheet, then Armstrong might be able to borrow $400mm at 9% while leaving the $500mm in long-term debt it currently has on its balance sheet at a 7% avg cost.  This would reduce their interest expense by $10mm and result in EPS 19 cents higher than the estimate above.  It is unclear how the covenants of the existing debt would be impacted by raising additional debt.