Berkshire Ruminations

Friday, December 01, 2006

USG, asbestos and Berkshire

USG shares shot up yesterday on an upgrade, so I guess it is time I got around to writing about this company.

US Gypsum, or USG as the parent company is now called, manufactures home building products such as wallboard, floor tiles, ceiling panels and the like. It is a manufacturing company that is just about as simple and understandable as they come. Unfortunately, in addition to making these products, years ago the company also manufactured, well, asbestos.

As I indicated earlier in my general discussion of bankruptcy, firms emerging from Chapter 11 can make great investments for value investors. The stock in the new company, although the old shareholders may no longer own it, is less burdened by the heavy liabilities that led the company to file in the first place. Meanwhile investor sentiment is often highly negative and can result in undervaluation – who wants to own stock in a bankrupt company anyhow?

But the USG case is in a special subset of bankruptcies. Its bankruptcy is the direct result of asbestos litigation, a trigger that has caused a superfluity of Chapter 11 cases in recent years. Other companies in similar situations to USG (and that may warrant blog postings all their own) include Owens Corning, Armstrong and Federal-Mogul.

In the early seventies, when the dangers of asbestos became widely recognized, a key ruling by a federal Appeals Court declared that victims of asbestos can sue on a product liability basis, rather than a workers compensation basis. This meant that cases could be heard by a jury which could award plaintiffs virtually unlimited damages. And so the lawsuits began. The decision was appealed to the U.S. Supreme Court and upheld, making it applicable to courts throughout the nation.

Over the years legislators tried unsuccessfully to pass various versions of what would have been the Fairness in Asbestos Litigation Injury (FAIR) Act. Such an act would create a national fund from which all future asbestos claims could be paid and which would be funded by those companies subject to asbestos litigation as well as their insurers. Additionally, the act would all but prevent any individual from filing subsequent lawsuits. For one reason or another this bill has never been passed, although a newer version still sits before the Senate.

Instead, the Bankruptcy Code was amended in 1994 to provide for alternative protection for firms. The provision is Section 524(g) and allows Chapter 11 firms to create their own private trust funds from which future liability will be paid. Thus, a firm that has emerged from bankruptcy and created such a fund will not be exposed to any additional, unforeseen asbestos liability. This has encouraged as many as sixty firms to file bankruptcy primarily for the 524(g) benefits. USG is among them.

Warren Buffett began buying USG back in 2001, shortly after the company had filed Chapter 11. He is very familiar with the economics of asbestos-litigation-plagued firms, both through his experience writing insurance policies and with companies Berkshire owns such as Shaw Industries and Johns Manville. In typical fashion, he has stuck with the stock throughout its bankruptcy, obviously aware of the prospects for the firm’s stock. He saw it rise over $100 and then fall back to the mid-$40s. Importantly, the stock survived and creditors will be repaid in full. In fact, the only real consequence of the entire five year bankruptcy is the creation of a large 524(g) fund and the relief from future asbestos liability. Clearly not a prototypical bankruptcy case.

The 524(g) trust is large, though. The company made a $900 million payment in June as it emerged from bankruptcy protection and will contribute $1.8 billion more over the next two years. This was disastrous to the company’s earnings, of course, as USG was forced to take a huge charge. At the same time, the housing industry was in a substantial downturn and makers of building materials were dragged down with it.

So the stock looked cheap back in June as the company emerged from bankruptcy protection, which is likely why Berkshire, already a large shareholder, agreed to help finance the reorganization plan by “backstopping” a stockholder rights offering. This means that, in order to raise the cash to fund the trust, shares were offered for sale to existing shareholders at $40/share and if those shareholders didn't contribute the $1.8 billion needed, Berkshire would buy the difference itself. As a result Berkshire has amassed an 18% stake in the company. Since the rights offering, the stock has risen to $54.

It will remain interesting to watch events unfold, particularly the performance of the company which by all metrics looks very good. But also how other companies with asbestos burdens fare. Perhaps we will even see the passage of a FAIR act sometime soon. Stay tuned, this should be an fun ride.

FD: I own shares of USG and of course Berkshire, but none of the other companies mentioned in this posting.


  • I think there is a bigger story here regarding Buffett. If you look at his recent deal with Lloyd's of London, that is essentially a bet on asbestos and that the reserves Lloyd's have booked are larger than the total exposure.

    Overall, I think Buffett has decided the worst of the asbestos crisis is over and he is plunging in where others are understandably reticent.

    By Anonymous Anonymous, at 04 December, 2006 04:58  

  • USG was quite upstanding in their exodus from Chapter 11. The fund they created will care for the sick and because they chose a stock offering as their means of funding, other than diluting the value, their shareholders were protected as well.

    From what I have read, it looks like Federal Mogul will not be so upstanding. From what I understand (and its not too easy to understand) it looks like they intend to cancel their current stock and new shares of Class B sold to Carl Icahn will fund the Trust. It’s my understanding Icahn will effectively take control of Federal Mogul and the current shareholders will be issued warrants at 6.5% of their current stake with an exercise cost somewhere in the $40 - $50 range. So, as I understand it, the Company which spent shareholder dollars buying up several other asbestos burdened companies will shed its liability through the trust fund, give our $4.5 billion company away to Icahn for ~$775 million and oh well for the current shareholders. With 89+ million shares outstanding, a simple equal share stock offering at $10/share would net more money for the Fund than what they are proposing while protecting the stakes of the shareholders.

    USG in its actions has proven there is a way to take care of everyone. Federal Mogul should step up to the plate and follow in kind.

    Obviuos disclosure: I own Federal Mogul stock.

    By Anonymous Anonymous, at 03 January, 2007 16:34  

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