The James Hardie and Azek merger makes no strategic sense
In what universe does the James Hardie and its merger with Azek make any strategic sense? The reasons given are spurious at best and read like something out of comedian Rob Sitch’s television show Utopia. Every cliché has been rolled from cultural alignment to revenue synergies.
The best companies – the good to great ones – almost always focus on one industry, or one niche product group within an industry, and are relentless in developing and protecting their competitive advantage. They focus on one space and own it. From the Coca-Cola Company to Cochlear it is sticking to your knitting and staying within your core area of competence that is the hallmark of most great and enduring companies, the companies that deliver excellent long-term compounding returns for shareholders.
James Hardie was one company doing just that. It owns the cement sheeting or siding category, also known as fibro, with a market share of 90 per cent. Not only is its cement sheeting or “HardiePlank” a great product, but ongoing research and development, continuous product improvement and operational excellence have allowed James Hardie to continue to win market share. This is particularly the case in the siding market in the US where the Hardie offering is superior to vinyl and wood.
James Hardie has been such a favourite with long-term investors, including superannuation funds, because of its strong market share and customer ratings and also delivery of top decile returns on capital. They are unmatched in the building product space. It is also why the level of outrage among investors about the deal with Azek, a US-based company, is so palpable.
Let’s look at Azek. It makes primarily outdoor decking, railings and trim made from PVC and a range of composite materials. It is a very different industry and a highly fragmented and competitive one. Azek is one of many players in this space, all of whom claim they are developing a range of new and innovative products out of composite and recycled materials.
Azek’s own annual report lists nine major competitors, including Trex Company Inc, Fiberon, a subsidiary of Fortune Brands Innovations, Dekorators, a subsidiary of UFP Industries, Oldcastel APG Inc and Westlake Corporation. The competitive position of Azek relative to James Hardie is chalk and cheese.
The most spurious reason given for the merger is growth. This is infuriating because the current and previous management teams have continued to tell shareholders of the long run growth runway in front of James Hardie. This is through ongoing market share gains in the siding market, new product extensions, strategic alliances with building companies, and most importantly, taking their product suite global and building on their 2018 European acquisition of Fermacell.
Rolling out the Hardie product suite and developing the European market is still in its infancy. The global runway for Hardie is very long indeed and this is where strategy 101 would say management should stay focused.
Azek operates only in the US, and Hardie management is trying to argue that becoming more US-centric is a good thing in the wake of US President Donald Trump’s tariff agenda. This is short-term and reactive management at its worst.
All acquisitions come with risk and make no mistake, this acquisition is high risk on so many fronts.
The lowest-risk acquisitions tend to be bolt-on small acquisitions in the same industry, improving a company’s competitive positioning. The highest-risk acquisitions are those where a company enters a new space and a new industry. The risk is compounded when the acquisition is large and funded by debt.
Azek is a large acquisition. At the time of writing James Hardie had a market capitalisation of $16.5 billion, while Azek’s was $US7.4 billion ($11.5 billion). The cash component of the deal is funded by debt, and leverage will increase to levels above previously stated preferred ranges. This is never a good idea in a cyclical business. Nor is overpaying. Analyst consensus is that James Hardie is paying a very full price if not overpaying for Azek.
Australia has produced many great building product companies throughout history, which is a testament to our ingenuity in developing products to suit our vast nation and harsh climate. Far too many went down the “diworsification” route, fragmenting themselves in the Australian market only to fail globally, and be swallowed up by larger stronger international players. James Hardie is the last standing for those reasons.
The only consolation, given the underlying strength and quality of the James Hardie business, is that the merger is unlikely to be fatal. Still, returns for shareholders are likely to be lower because on any financial or strategic metric Azek is an inferior business.
At some time in the future, when James Hardie’s current management team and board are gone, it is likely the next team will spout that in the interests of shareholders they have decided to stick to their knitting, sell off non-core businesses and go back to what they do best. We’ve seen this happen with other companies. And the only winners will be the investment bankers.
Jennifer Mead’s career has spanned corporate advice, funds management, superannuation and wealth advice. She owns James Hardie shares.
