Shaw and US Floors, Unilin patent battle: Strategic Exchange - Nov 2016

By Kemp Harr

What has happened to the U.S. economy in the last 15 years? From 1950 to 2000, the U.S. economy grew at an average rate of 3.5% annually. But since 2000, the average growth rate per year has been 1.76%.

Some would argue that the lack of the next big invention or productivity tool is the issue. During the 20th century, the U.S. enjoyed productivity gains from increased infrastructure, mass production, mechanization, enhanced communications, chemical developments and automation. And some theorists look back on the last 15 years and blame our current Keynesian economic thinking, which has lead to an oversized government resulting in deficit spending, no taxation reform and more and more regulations.

Clear examples can be found in counter intuitive government entitlement programs that reduce the incentive for people to get out and be more productive. Take food stamps, for example. Today, 45 million Americans receive nutrition aid even though unemployment is at 5%. Compare that to April 2008, the last time unemployment was at 5%, and there were 28 million Americans using food stamps.

Mandatory wage rates are another example. Why should a worker do what it takes to get promoted when the government has raised the bar on what an entry level person must be paid—which narrows the gap between pay levels and disincentivizes the type of hard work and dedication it takes to get promoted to the next level?

A third theory, and another deterrent to worker productivity, is stagnant wage growth, with some pundits claiming that it has actually been on the decline since 2000. Others would argue that wage growth is more of a symptom than a root cause. In a free market economy where true unemployment is in balance, wages start to go up as worker availability thins out—unless, of course, you have an unlimited supply of workers due to an unfettered immigration policy.

One thing is certain, we can’t expect gains in productivity unless we make root changes in the role government should play as it relates to our well being. Should it protect us from all enemies, both foreign and domestic? Yes. Should it provide for our education? Yes, but it needs to teach us to fish rather than give us a meal—unless of course, we are truly disabled. And that’s when it should provide for our welfare.

PLANNING FOR NEXT YEAR
As we pointed out in our Viewpoint column, the good news is that growth in the flooring business is outpacing GDP, and barring some unforeseen catastrophe, we should see the same level of growth next year and might even see a slight uptick. Household formation will continue to drive the housing market, and with the election behind us, consumer sentiment should stabilize. In the commercial sector, it has been discouraging to see the American Institute of Architecture billing index drop below 50 for the last two months, but that’s more of a reflection of what 2018 should see rather than what happens next year. Robert Dietz, the chief economist with the National Association of Home Builders, recently told me that the first two years of a U.S. president’s first term is usually filled with economic stimulating programs that could bolster certain sectors within the commercial market.

One of the biggest deterrents for growth next year lies in how currency exchange rates will impact the import/export markets. With the strong dollar versus the British pound, thanks to Brexit, and versus the Chinese yuan, thanks to the Chinese government’s efforts to revive its export volume, American produced goods will be in lower demand overseas. In addition, domestically produced flooring will have to compete with cheaper imports. This shouldn’t affect the carpet market as much as it will the tile, LVT and laminate markets.

SHAW’S DECISION TO BUY US FLOORS
While Shaw Industries has been making sizable investments in upgrading its hardwood capacity, building a new carpet tile plant and converting its rug factory into an LVT plant, it hasn’t made a sizable acquisition since it bought Anderson Hardwood back in 2007—nine years ago. There are several similarities that can be drawn from that acquisition and this most recent news about US Floors.

At the time of that 2007 acquisition, Anderson, another privately held organization, was doing just under $200 million in annual sales, according to our estimates. Shaw had already entered the hardwood flooring business, but not in a big way, and just a few weeks prior, Mohawk announced that it was acquiring Columbia’s engineered hardwood business.

Looking back even further, you might recall that the reason that Berkshire Hathaway owns Shaw today was because several Shaw executives had approached Warren Buffet about the feasibility of Shaw buying Armstrong and to see if Shaw could insulate itself from Armstrong’s asbestos claim issues with some type of insurance policy. Mr. Buffet was so impressed with Shaw’s business that he decided to buy it after that initial meeting. I bring this up because it shows that Shaw Industries had been toying with entering the hardwood and resilient flooring markets for years prior to it actually happening.

As you may recall from our last annual report issue back in May, Shaw is now the second largest player in the hardwood flooring business behind Armstrong. Shaw earned this share of the business by first converting a yarn facility in South Pittsburg, Tennessee to an engineered hardwood plant, and then by purchasing Anderson, followed by Zickgraf and Stuart—which were both solid hardwood flooring producers. With each acquisition, they were able to bring on more expertise, which they integrated into their hardwood business. While I can’t name all the talent that joined Shaw’s team as a result of these acquisitions, I do know that Don Finkell and Jeff Sills came from the Anderson acquisition and Drew Hash came from Zickgraf.

Today, Shaw approaches the hardwood business with an integrated strategy, and as of earlier this year, both the Shaw and Anderson brands are sold on a direct basis without the use of distributors. This shouldn’t come as a surprise when you consider Shaw’s logistics infrastructure.

So now you’re asking, what does all that have to do with Shaw buying US Floors? First off, Shaw was already in the WPC category with a product called Floorte. So in a similar fashion, buying US Floors doesn’t open the WPC category as a new market but it does give Shaw status as the undisputed marketshare leader. Secondly, this acquisition also comes with a validated U.S. patent that the firm can use to keep competitors from duplicating the way they make their products. Thirdly, it makes them instant players in the cork and bamboo markets, so it does make Shaw a player in those environmentally friendly markets. And lastly, it gives Shaw access to the foreign markets that Piet Dossche’s team has opened up in Europe, Asia and Australia for US Floors.

Since US Floors is a privately owned family business, its hard to know exactly how this acquisition compares to the Anderson acquisition, but when you add up the domestic and international Coretec business, in addition to the cork, bamboo and oiled hardwood flooring business, as well as some of the patent licensed business, it’s feasible that US Floors could be twice as big as Anderson was when Shaw acquired it nine years ago.

The next question to ponder is how Shaw will integrate this new property into its existing infrastructure. At this point, the news releases are telling us that the integration will be minimal, which was not the case when Shaw bought Anderson, though Anderson didn’t command the same share of its market as US Floors currently does with its Coretec branded WPC products. So, we could see Shaw treat US Floors much like Mohawk has treated Daltile after that acquisition back in 2002, and run it as a separate business. Regardless of the integration plan, Shaw’s acquisition of US Floors makes the firm a much bigger player in the global hard surface business.

UNLIN LOSES A EUROPEAN INTELLECTUAL PROPERTY DISPUTE OVER CLICK SYSTEM
Hardly a month goes by in floorcovering news when we don’t hear of an intellectual property dispute between suppliers in the business. One of the more active categories for patent disputes has been the rights to various click locking systems—which initially were limited to the laminate business but are also now used in the LVT, WPC and engineered hardwood. Usually, these disputes are between Unilin or Välinge and a manufacturer that has used one of their systems without paying a royalty. Hundreds of millions of dollars are spent each year licensing these systems worldwide and much of that is profit—once a patent has been declared valid.

Near the end of October, Floor Focus was sent releases almost simultaneously from two legal teams regarding a dispute between Unilin and Innovations 4 Flooring (I4F). We could tell from the timing, the language used in the releases and follow-up calls and emails from Europe that this case might be more than routine. Both firms concur that Unilin’s patent EP 1026341 has been “fully nullified” and must be regarded as having never existed by a judge in the District Court of the Hague in the Netherlands.

The disparity between the two releases comes when the two firms translate what this decision means. On one side, I4F believes this effectively releases flooring manufacturers and distributors from the obstruction created by Unilin’s patent after 19 years of invalid enforcement and unjustified payment of license fees. But according to Unilin, the decision has no effect until a final appeal decision is issued and has no invalidity effect for any country other than the Netherlands, and also has no effect on any of the 32 Dutch or European patents related to Unilin’s glueless locking patent portfolio.

At this point, its safe to say that one of Unilin’s patents has a potential issue that could be far reaching, but the firm still has over 30 other patents related to click looking systems. Stay tuned as we bring you more information on this dispute.

FIRST E-TAILERS ON OUR TOP 100 LIST
For years, the consensus among industry experts has been that floorcovering is a tactile fashion category that is difficult to purchase via a picture on a computer. Certainly, this is more so the case with carpets and rugs than it is with hard surface products.

Please take note that we’ve included Wayfair and Rugs Direct on our Focus 100 Retail list. While rugs have sold over the Internet for years, much of that business has been done by retailers with both a brick and mortar presence and an Internet presence. Now, we’ve got pure Internet companies answering the younger generations quest to ‘let me buy it my way.’ And now Wayfair is selling everything but broadloom carpet. The question now is not ‘if’ but ‘how fast.’ Another question, and one that’s previously been top of mind in the home center channel, is how does an independent retailer react to a brand that allows an e-tailer to undercut its margins by selling a similarly branded product at a much lower price? It will be interesting to see how this plays out.

If you have any comments about this month’s column, you can email me at kemp@floorfocus.com.

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