Over the past several years, there has been a heightened level of transaction activity within the construction materials industry. When relative valuations peaked in 2021 and early 2022, investment grade companies could borrow money at less than 2.0%, leading to a flurry of transaction activity.
High quality aggregate-based transactions traded north of 15x EBITDA in 2021, as evidenced by Martin Marietta’s acquisition of Heidelberg Materials’ (formerly Lehigh Hanson) business in California and Arizona. However, since July 2022, interest rates for investment grade borrowers have seen rates topping 5.8%. As such, similar transactions, if executed today, would trade at a much lower multiple of EBITDA simply because of the higher cost of capital.
Given these market dynamics, buyers are looking for alternative capital sources to fund acquisitions. One such source is Silver Creek Aggregate Reserves Fund I (SCARF), a fund that was established to provide low-cost equity capital to the construction materials industry.
Rock Products reached out to Tim Oitzman, founder of Greystone Group, a firm that has deep experience structuring reserve transactions with many of the largest aggregate producers, including Vulcan Materials Co., CRH Americas Materials and CalPortland Co., who had teamed up with Tom Lindquist, former president of Plum Creek Timber, to form Greystone Capital Partners in 2018. They joined forces with Silver Creek Advisory Partners, a Seattle-based investment management firm with $8.5 billion in committed capital, to raise SCARF.
According to Oitzman, the idea for a new capital source for the industry came during the Great Recession when a client wanted to engage his investment bank to divest an operating business to pay down debt. At the same time, industry earnings were at an all-time low and there were very few buyers with capital for acquisitions.
Oitzman convinced the client to monetize a portion of its long-term reserves to generate capital rather than selling the operating business that would later prove to generate substantial cashflow when the market recovered. A point of emphasis included that sourcing capital from the reserves represented an opportunity to highlight the reserves that were undervalued on the company’s balance sheet.
It was that positive experience that led to the launch of the Silver Creek Aggregates Reserve Fund I, which is co-managed by Greystone and Silver Creek. Today SCARF has $830 million in commitments raised primarily from a handful of state pension funds.
“We have seen a significant increase in the number of inbound calls from aggregate companies looking for capital to fund acquisitions,” said Oitzman.
SCARF aims to be a flexible and low-cost solution for aggregate producers looking to grow through acquisition, fund large capital projects, or buy out a family member in the case of multi-generational family businesses. In essence, the capital is used by operating companies to monetize economically dormant long-term reserves which can be immediately redeployed in higher returning operating businesses.
For example, an aggregate producer could monetize a portion of its reserves with SCARF at roughly 20x year one cash royalty and likely reinvest that capital in acquisitions at less than 10-13x EBITDA, making the transaction cashflow accretive.
The aggregates industry has traditionally leased reserves from third parties in a royalty agreement, but rarely has thought about using its existing reserves to fund acquisitions or capital expenditures through the same kind of royalty structure. The proposed contract structures for existing reserves can be very tax efficient and use a common royalty payment structure.
The operator could maintain land ownership and retain 100% control over the aggregate operations throughout the life of the mine. The operator would be simply monetizing a portion of the reserves to fund profitable corporate growth: a win-win.
SCARF has also partnered alongside materials producers in the acquisition of aggregate-based construction materials businesses, with SCARF acquiring the target’s reserves simultaneously with the producer’s acquisition of the operating business. SCARF and the aggregate producer entered into a life-of-mine lease so that the producer maintains full control of the aggregate operations throughout the life of the reserves.
This type of transaction was structured as a traditional royalty arrangement or mineral lease and has efficient accounting and tax treatment. This structure has the ability to reduce the amount of equity an operator needs to acquire the business, improve accretion, and improve the rates of return on the acquisition.
Oitzman attributes the increased activity to higher cost of traditional capital, while still trying to grow their business at this time of the business cycle.
“For most aggregate producers, even those with strong balance sheets, using our capital increases the return on invested capital (ROIC) while allowing them to maintain a strong balance sheet position,” Oitzman noted.
In addition to funding growth, several global aggregate producers believe there is an opportunity to highlight significant value in their long-term reserve assets that the investment community has not recognized in their stock price assessments. By structuring a reserve transaction, the value of the reserves embedded in their balance sheet can be highlighted, and at the same time, free-up capital to fund growth. Another win-win.
Greystone expects to fully deploy SCARF’s available capital in the next 12 months.