Usg Specialty Ceiling
USG specialty ceiling products at the Las Vegas Stratosphere observation deck. Image source: USG.

Warren Buffett's investing prowess is famous throughout the investing community, and many investors look closely at the companies in which Buffett has expressed the most confidence. For more than a decade, Buffett's Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) has held shares of building-materials specialist USG (NYSE:USG), and many have predicted that Berkshire will eventually buy the company in its entirety.

At first glance, USG seems like a typically unexciting Berkshire target, with its production of drywall under the well-known Sheetrock brand name being the most obvious evidence of USG's exposure to the building-materials industry. USG also makes ceiling tile and other materials for construction projects, including insulation, roofing, and construction-plaster products. Yet the story of USG is particularly interesting, as it offers an unusual look at a company whose common shareholders survived a bankruptcy filing. Moreover, USG's history reveals Buffett's thinking in dealing with distressed assets and also reflects his evolving thought process as USG's financial condition changed over time.

Stats on USG

Shares Owned by Berkshire Hathaway (% of Outstanding)

39,002,016 (27%)

Dollar Value of Berkshire Holdings of USG Stock

$1.03 billion

Rank Among Berkshire Publicly Traded Holdings, Dollar Value

14th

Revenue Growth, Past 12 Months

6.2%

Earnings Growth, Past 12 Months

135%

Source: S&P Capital IQ.

The evolution of Buffett's position in USG

Buffett first started buying USG stock in 2000, accumulating a 6.5 million share position in the company. Unfortunately, that was before the company ended up filing for bankruptcy, and for years, USG's share value languished well below its 2000 levels as the USG tried to figure out a way to resolve potentially catastrophic asbestos-related liability claims.

In 2006, though, USG emerged from bankruptcy, and unlike most bankrupt companies, USG continued to exist in its current form. The company's bankruptcy reorganization plan involved paying as much as $3.95 billion to resolve claims of asbestos liability, and Berkshire Hathaway played a key role, guaranteeing the settlement's finances through a USG stock offering. Even more remarkably, USG's debt retained an investment-grade rating after the company emerged from bankruptcy, and the shares climbed briefly above the $100 per share mark in shareholders' pre-exit speculation about how USG would be able to continue operating its business.

Usg Roofing
Source: USG.

Buffett's timing was again suspect, as the end of the housing boom sent USG shares crashing downward again. But a well-timed investment in USG corporate debt near the 2008 bottom gave Berkshire a 10% interest rate as well as the right to convert the $300 million investment into 26.4 million shares at $11.40 per share. The stock now trades at more than double that level, and with Berkshire having gone forward by converting its debt into shares early this year, Berkshire has benefited greatly from the move and has built up its stake in USG's common stock in the process.

What USG offers Buffett

USG is a great example of how Warren Buffett prefers leaders in their respective industries. The size of each respective industry doesn't matter nearly as much as whether it offers a business a sustainable and reliable profit opportunity, and with USG's products being nearly ubiquitous within residential and commercial real-estate properties across the nation, it's not surprising to have seen Buffett gravitate toward the company over the long run.

Moreover, USG has a strong management team that's aware of the cyclical nature of its business and does its best to manage it. CEO James Metcalf showed his prowess in managing USG's struggles during the housing bust, shuttering plants that couldn't operate affordably and waiting for times to turn. Once the dust had settled, USG looked at the global macroeconomic picture and concluded that entering various emerging markets would be smarter than maintaining its European business, which it sold off two years ago and took the proceeds to invest in other areas of the world.

Usg Cement Board

Source: USG.

At the same time, USG has made a surprising amount of effort at improving its products. Facing different climate conditions around the world, USG products have to fit not only their intended use but the location in which they get used, and one way that USG has stood out from competitors is by having tailored products that match up with prevailing conditions in targeted markets. Moreover, USG has expanded its scope by looking at products that go on the outside of buildings and therefore are exposed to the full brunt of the elements.

With a market capitalization of less than $4 billion, USG isn't the big elephant that Warren Buffett has been focusing his efforts on lately. Yet with such a large present commitment to the company, it's natural to expect that Buffett could make the same move he used with Burlington Northern and make a bid for what's left of the USG stock he doesn't already own. Given the ups and downs of the construction industry, USG arguably doesn't get the respect it deserves as a separate company and could thrive as yet another of Berkshire's lucrative wholly owned subsidiaries in the future.

Dan Caplinger owns shares of Berkshire Hathaway. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.