OID: Sounds like a reasonable enough concern.
    Nygren: It has our attention. So the concern now is that as these other companies file for bankruptcy, the plaintiff's bar will next focus on the healthy companies and try to extract more from them.

OID: Sort of like the "Survivor" series in reverse…
    Nygren: It is. But I think that outcome is unlikely. For example, Owens Corning has a very healthy business. Free of debt and asbestos claims, it would have a very strong value in the marketplace.
    And I think the likely resolution is that a company like Owens Corning comes back as a public equity similar to Manville - where the majority of its equity is owned by the asbestos trust for both existing and future claims - and that potential asbestos claimants will continue to have a claim on a newly emerged Owens Corning rather than having to try to extract more from the surviving companies, including USG.
    But even though logic leads me to that conclusion, I'm far less comfortable guessing the range of outcomes on asbestos than I am in guessing how USG's EBITDA will be effected by changing wallboard prices. I think most of us in the financial analyst community are weaker on litigation outcomes than we are on business fundamentals.

OID: In part, I imagine, because it's unknowable.
    Nygren: It is. Then again, everything's unpredictable. But this is a different kind of unpredictable that doesn't follow logical thought like rational economics usually does.

OID: Oh?
    Nygren: But from whatever angle I view it, I conclude that the asbestos problem is being grossly over-discounted for USG. I think it's going to be a difficult environment - because the news environment on asbestos will continue to be onerous. There are other overleveraged companies in the building products sector with asbestos problems for whom a bankruptcy filing would be a reasonable outcome. And in an environment in which more of these companies are filing for bankruptcy, there's always going to be a "Who's next?" mentality. They just see that one by one, these companies are getting picked off and going bankrupt.
    But I think USG's in a much better position than most asbestos defendants. The ones that have gotten in trouble have two characteristics - weak balance sheets and abnormally high asbestos exposure. And not many people are doing the work at the claims level trying to estimate what the reserve would need to be to cover this problem.

OID: And presumably you have?
    Nygren: We have. And it turns out that USG only pays about 1/6th as much per claim as Owens Corning's had to pay - given the length of time it produced products and the type it produced. Owens Corning has paid around $10,000 per claim - as has their fiber board subsidiary. Somebody like an Armstrong World is down around $5,000 per claim. Well, USG is between $1,500 and $2,000 per claimant because their exposure is rated much less as the cause of the health problems that asbestos has created.

OID: Is it possible to give us a thumbnail version of what we're talking about liability-wise for USG?
    Nygren: I've always included an asbestos liability in my valuation work on USG. However, I've never been terribly troubled because USG's been so conservative in its accounting for asbestos. Armstrong's taken big, onetime charges and discouraged the analysts from considering any ongoing asbestos costs. By comparison, USG has run its annual costs for settling asbestos claims through the income statement. There's about $100 million above the line going through their income statement each year.
    And when we tax-effect that figure and divide the resulting amount by its roughly 40 million shares outstanding, we wind up with about $1.50 per share after tax that we assume is already reducing its reported income. In other words, my earnings estimates of $3-10 - or $0-7 depending on what you assume for energy prices - are after an allowance for settling asbestos claims.

OID: Gotcha.
    Nygren: And even though asbestos claims have continued to come in at a rate that's somewhat higher than the decline curves had predicted, I felt quite comfortable that penalizing USG via the income statement was far more onerous than a onetime charge would be.
    When we make a guess as to future charges based on information out of Armstrong's bankruptcy filing - when we apply the same logic to USG - we figure that they might have to take a onetime charge of $400-500 million. But then they'd be done with it. Therefore, instead of running $100 million of asbestos settlement costs through their income statement each year based on the lawsuits as they receive them, they'd be expensing $40-50 million of interest expense on a pool they set aside for future claims. So I figure that they'd actually be adding 50-75¢ per share to their reported earnings.

OID: That doesn't sound so bad.
    Nygren: We don't think so.