Flammable

If the growing ranks of distressed investors in the market are correct in betting on a severe fallout later this year and next, a good place to look for fires is in building products and home repair. Too much leverage is a common theme. In June, several PE-backed businesses saw downgrades on their debt ratings, and that's bound to make it even tougher for them to comply with financial covenants as lower-rated issuers.

Consider recent casualty Maax Corp., a Montreal bathroom products maker. Boston buyout firm J.W. Childs Associates LP, along with Canada's Borealis Capital Corp. and the Ontario Municipal Employees Retirement System, bought it in 2004 for C$640 million (then $484 million). After it defaulted on its senior debt in December, the investors tried to sell the company. Evidently finding no takers, Maax filed for protection under Canada's Companies' Creditors Arrangement Act last month while completing its sale to senior secured lender Brookfield Bridge Lending Fund Inc.

Poor Maax struggled with a staggering 16 times debt-to-Ebitda ratio. Contributing to its troubles was a triple whammy -- housing slump, rising oil prices and currency exposures. Of course, there was the little matter of a $110 million dividend recapitalization paid to J.W. Childs shortly after the buyout, which didn't help.

Pick your trouble spots. Business for Canadian doormaker Masonite International Corp. hasn't exactly been brisk since its $3.2 billion buyout by Kohlberg Kravis Roberts & Co. in 2005. Revenue, which stood at roughly $2.7 billion for fiscal 2007, has been slipping, despite Masonite's brand recognition and a strong market position globally. Net debt to trailing 12 month adjusted Ebitda has risen further, to 6.71 times as of March 31, 2008, versus 6 times at year's end.

Management's belt-tightening may not be sufficient to offset an anticipated drop in housing starts in the U.S. this year by about 33%, to 900,000, from about 1.35 million last year, with the North American business comprising about 70% of revenue. All this leaves the company, which has about $1.5 billion in debt, with little cushion under its financial covenants, says an analyst, especially since it recently borrowed aggressively under its revolver. Moody's Investors Service downgraded Masonite's corporate family debt ratings to B3, from B2, citing poor financial performance, with a greater probability of default.

Following a steep drop in shipments to construction companies, automakers and other customers, cash flows have declined. Nor is performance expected to improve anytime soon.

Several plants have been shut, but the cost-cutting moves won't immediately offset the volume declines.

Also taking some beating is United Subcontractors Inc., a Minneapolis provider of home insulation and framing services for homebuilders. Chicago private equity firm Wind Point Partners acquired the decade-old company in 2005 for $287 million. Unfortunately, its biggest market is Florida, where the housing market remains in the doghouse.

Before the buyout, the company had made nearly 50 acquisitions, including two completed just last month, but total revenue has stayed flat at about $483 million, unchanged from 2005. USI posted a $40.5 million loss last year, according to Moody's, which in June downgraded all of USI's roughly $377 million of bank debt.

In April, Aleris International Inc., a Beachwood, Ohio, aluminum product manufacturer backed by TPG Capital, was put on credit watch by both Standard & Poor's and Moody's, though neither has lowered its rating on the company's $2.5 billion of total debt.

There is one bright spot: Ply Gem Industries Inc., a Kearney, Mo., building products supplier controlled by New York buyout shop Caxton Iseman Capital Inc. CI Capital, which bet $570 million on the company in 2003, anted up an additional $30 million, earning it some goodwill from bankers as the company sought to avert tripping covenants. Ply Gem recently closed on a refinancing package, including $700 million in senior secured notes from Credit Suisse Group and UBS.

That should give Ply Gem breathing room -- or at least keep the fire from turning into a conflagration.