Description

The share class trading differential in the stock of Eagle Materials (EXP/B) offers the opportunity to make a reasonable annualized return (greater than 10%) with a defined timeframe (less than 9 months) and with limited risk. This coming end of January marks the 2-year anniversary of the spin-off completion of Eagle Materials from the homebuilder Centex. Since the dual class structure was designed simply to preserve the tax-free nature of the spin-off (the original class A shares were created through a carve-out IPO of Centex Construction Products in 1994) and tax counsel believes 2 years is a reasonable timeframe to wait to alter the corporate structure, a collapse of the share classes is likely to occur in the near term. With roughly half the shares outstanding in each class, it clearly would make sense for the company to collapse the structure and simplify its equity capital base – more importantly, the company agrees that it makes no sense to maintain dual classes once they are confident that the collapse would not generate tax implications to their former parent. The company claims to be actively investigating the mechanics of collapsing the shares but will not make any public commitments until after January. The spread has narrowed in the past few weeks after reaching an all-time high in late October.

Company description
Eagle Materials, Inc. engages in the manufacture and sale of basic building materials used primarily in commercial and residential construction, and public construction projects in the United States. The company engages in the mining of gypsum and limestone; manufacture and sale of gypsum wallboard; and in the manufacture, production, distribution, and sale of portland cement. It also manufactures and sells recycled paperboard to the gypsum wallboard industry and other paperboard converters; and sells readymix concrete, as well as engages in the mining and sale of aggregates, such as crushed stone, sand, and gravel. The company’s products are used primarily in construction projects and projects to build, expand, and repair roads and highways. Eagle Materials offers its cement products in Texas, northern Illinois, the Rocky Mountains, northern Nevada, and northern California; and gypsum wallboard and recycled paperboard in the continental United States. The company also provides concrete and aggregates to local readymix producers and paving contractors in the Austin, Texas area and northern California. Eagle Materials was founded in 1963. It was formerly known as Centex Construction Products, Inc. and changed its name to Eagle Materials, Inc. in 2004. The company is based in Dallas, Texas.

Returns summary
EXP 8-Dec
class A $120.04
class B $115.00
Spread $5.04
Gross return 4.4%
Ann'lized Collapse Days to
Return Date Collapse
29.5% 1-Feb 54
19.4% 1-Mar 82
14.1% 1-Apr 113
11.2% 1-May 143
9.2% 1-Jun 174
7.8% 1-Jul 204
6.8% 1-Aug 235
6.0% 1-Sep 266

Timing
The company plans to pursue a shareholder vote in order to effect the share class collapse. Using the 2-year timeframe as a reference point and a shareholder vote process taking about 1 month, the earliest feasible collapse date would be about March 1st – leading to a return of about 20% annualized. A more conservative estimate would be in the April to June timeframe which yields a return of 9-14%. A potential worst case outcome would be for the company to roll the vote into their annual shareholder meeting to minimize the work involved with the process, which would imply an early September close and a 6% return. This year, the annual shareholder meeting was August 4th – the year before, it was held on July 27th.

Share class description
The economic interest of the A and B shares is identical. Each share class currently pays a $0.30/share quarterly dividend. Voting rights for the 2 share classes are also the same, except B shares are given the extra voting rights to elect board members. Given the additional rights for B shareholders, it could be argued that the B shares deserve to trade at a slight premium to A shares instead of the sizeable discount. As of November 4th, there are 9,519,459 common shares outstanding (or ‘class A’) and 8,225,584 class B shares. There were 2.8 million EXP (A) shares short, implying a short interest ratio of over 10.

Background from the last proxy:
“Our outstanding capital stock consists of Class A Common Stock and Class B Common Stock. The holders of Class B Common Stock are entitled to elect the Class B Directors, who represent at least 85% of our board of directors. The holders of our Class A Common Stock are entitled to elect the Class A Director or Directors, who represent the remainder of our board of directors. There is currently one Class A Director whose term expires at the Annual Meeting in 2007. The minimum number of members of our board of directors is set at seven so that the holders of our Class A Common Stock will always be entitled to elect at least one director. As to all matters other than as to the election of directors, the rights of the holders of Class A Common Stock and Class B Common Stock are substantially the same.”
“Our two classes of Common Stock were created in connection with the spin-off (the “Spin-off”) of the Company from its former parent corporation, Centex Corporation (“Centex”), which was completed on January 30, 2004. Prior to the Spin-off, we had only one class of common stock and Centex owned approximately 65% of the outstanding shares of such class. Given the nature of Centex’s ownership interest in the Company, in order for the Spin-off to be tax-free to Centex and its stockholders, Centex determined that it must own, at the time of the Spin-off, capital stock of the Company having the right to elect at least 85% of the members of our board of directors. In order to enable Centex to meet this requirement, we agreed to reclassify our capital stock immediately prior to the Spin-off so that it consisted of Class A Common Stock and Class B Common Stock. Our stockholders approved this reclassification. Centex then distributed all of the shares of Common Stock owned by it to its stockholders in a single transaction.”
“Members of our board of directors are divided into three classes based on their term of office (Class I, II and III). The directors in each such class generally hold office for staggered terms of three years each. At present, we have three Class I directors, two Class II directors and three Class III directors. As described above, our board of directors is also divided into Class A Directors and Class B Directors. Class A Directors are elected by the holders of Class A Common Stock and Class B Directors are elected by the holders of Class B Common Stock. Currently we have one Class A Director and seven Class B Directors.”

Below is relevant language from the registration statement filed at the time of the creation of the class B shares ahead of the spin-off in January 2004:
“Company Common Stock
The Common Stock and Class B Common Stock are identical in all respects except as otherwise expressly described below.
(a) Cash Dividends. Subject to the rights and preferences of any outstanding series of Preferred Stock, the holders of shares of Company Common Stock are entitled to receive dividends out of assets legally available therefore at such times and in such per share amounts as the Board of Directors may from time to time determine. Whenever a cash dividend is paid on the Company Common Stock, the same amount shall be paid in respect of each outstanding share of Common Stock and Class B Common Stock.
(b) Stock Dividends. If at any time a dividend is to be paid in shares of Company Common Stock, such stock dividend may be declared and paid only as follows: only Common Stock may be paid to holders of Common Stock and only Class B Common Stock may be paid to holders of Class B Common Stock. Whenever a stock dividend is paid, the same number of shares shall be paid in respect of each outstanding share of Common Stock and Class B Common Stock.
(c) Property Dividends. If at any time a dividend is to be paid in rights to purchase shares of the capital stock of the Corporation (a “rights dividend”), then: (i) if the rights dividend is of rights that entitle the holder thereof to purchase shares of Common Stock (or shares of capital stock of the Corporation having voting rights equivalent to those of the Common Stock (“Equivalent Shares”)) or Class B Common Stock (or shares of capital stock of the Corporation having voting rights equivalent to those of the Class B Common Stock (“Equivalent Class B Shares”)), then only rights to acquire Common Stock or Equivalent Shares may be paid to holders of Common Stock and only rights to acquire Class B Common Stock or Equivalent Class B Shares may be paid to holders of Class B Common Stock; and (ii) if the rights dividend is of rights that entitle the holder thereof to purchase shares of capital stock of the Corporation other than Common Stock (or Equivalent Shares) or Class B Common Stock (or Equivalent Class B Shares), then the Board of Directors of the Corporation may pay such dividend of rights to the holders of shares of Common Stock and Class B Common Stock in such manner as the Board of Directors may determine. Whenever any rights dividend or dividend in the form of securities or other property (other than a cash dividend or stock dividend) is paid, the same number or amount and kind of rights, securities or other property shall be paid in respect of each outstanding share of Common Stock and Class B Common Stock.
(d) Stocks Splits, Subdivisions and Combinations. The Corporation will not subdivide, reclassify or combine stock of any class of Company Common Stock without at the same time making a proportionate subdivision, reclassification or combination of shares of the other class.
(e) Voting. The holders of shares of Common Stock and Class B Common Stock shall vote together as a single class in all matters requiring the vote of holders of Company Common Stock with each share of Common Stock and Class B Common Stock having one vote, except that (i) the holders of shares of each class shall vote as a separate class when required by law to do so and (ii) the holders of shares of Company Common Stock shall vote in respect of directors as specified below.
With respect to the election of directors, the holders of shares of Class B Common Stock, voting separately as a class (the “Voting B Shares”), will be entitled to elect a number of directors that equals 85% of the authorized number of members of the Board of Directors (or, if such 85% is not a whole number, then the nearest higher whole number) (the “Voting B Share Directors”). In the election of Voting B Share Directors, each share of Class B Common Stock shall have one vote. The holders of shares of Common Stock voting separately as a class (“Voting Shares”) will be entitled to elect the remaining members of the Board of Directors, if any (the “Voting Share Directors”). In the election of Voting Share Directors, each share of Common Stock shall have one vote. The term “Special Voting Rights” means the different voting rights of the holders of shares of Common Stock, on the one hand, and the holders of shares of Class B Common Stock, on the other hand, with respect to the election of the applicable percentages of the authorized number of members of the Board of Directors as described above….
(f) Merger or Consolidation. The Corporation shall not enter into any consolidation, merger, reorganization or other combination, unless each holder of a share of Common Stock or Class B Common Stock is entitled to receive with respect to such share the same kind and amount of shares of stock and other securities and property (including cash) receivable upon such consolidation, merger, reorganization or other combination as each other holder of a share of Common Stock and Class B Common Stock, except that in any such transaction consummated prior to the elimination of the Special Voting Rights, the holders of shares of Common Stock and Class B Common Stock may each receive different kinds of shares of stock that differ to the extent and only to the extent that the Board of Directors determines in good faith that such shares differ with respect to the rights of holders of such shares to substantially the same extent as the Common Stock and Class B Common Stock differ.
(g) Liquidation. The holders of shares of Common Stock and Class B Common Stock will participate equally per share in any liquidation, dissolution or winding up of the Corporation, without distinction between classes.”

Issues
*Management could choose to wait until their annual meeting to vote on the share class collapse, which would reduce the annualized return to about 6%.
*Liquidity in the B class shares is limited (averaging about 20,000 shares per day in the past 6 months), although the triple-digit stock price does mitigate this somewhat.
*Mark to market risk: with limited liquidity in B shares and potential for big moves in the volatile materials stocks, the spread between the classes can move around quite a bit day to day.

Catalysts
*Company announcement of time-frame for share collapse after January.
*Shareholder vote to approve share collapse.
*Investor perception of imminent collapse.

Catalyst

*Company announcement of time-frame for share collapse after January.
*Shareholder vote to approve share collapse.
*Investor perception of imminent collapse.