BUSINESS

Lowe's bid for California chain could be used as model in Canada: analyst

06/17/2013 02:34 EDT | Updated 08/17/2013 05:12 EDT
MONTREAL - The addition of a California chain of hardware stores could be a model for how Lowe's Companies tackles the Canadian market, an industry observer said Monday.

Lowe's is offering US$205 million for the assets of Orchard Supply Hardware Stores, which has locations about one-third the size of Lowe's typical big box stores — about 3,200 square metres of selling space versus about 10,200 square metres for Lowe's.

"It is conceivable that Lowe’s might test an Orchard Supply store format in Canada, operated under the Lowe’s brand," Keith Howlett, an analyst at Desjardins Capital Markets, said Monday after the Lowe's announcement.

A similar strategy of operating multiple formats has been used for years by Canada's largest home improvement retailer, Rona Inc. (TSX:RON), which rejected a takeover overture from Lowe's last year.

Rona's big box stores range from 6,000 to 14,900 square metres, but it also has affiliated locations under various banners operating mid-sized building centres ranging from 460 to 5,600 square metres and smaller hardware stores with less than 1,000 square metres.

Orchard Supply filed a voluntary Chapter 11 bankruptcy petition on Monday, so the offer from Lowe's will become the "stalking horse" bid for an auction. Such a bid sets the floor for an auction process that lets competitors make better offers.

The Lowe's bid must survive the auction and receive bankruptcy court approval. The companies expect the deal to close in about three months.

Lowe's (NYSE:LOW), which operates primarily big box stores, already runs 110 stores in California and expects to add at least 60 of Orchard's locations in that state.

It plans to have Orchard operate as a separate, stand alone business, retaining the Orchard brand. Lowe's chairman and CEO Robert Niblock said in a statement that Orchard's business has potential but also has been burdened with high debt.

"Strategically, the acquisition will provide us with immediate access to Orchard's high density, prime locations in attractive markets in California, where Lowe's is currently underpenetrated, and will enable us to participate more fully in California's economic recovery," Niblock said.

Lowe's, which is No. 2 to Home Depot (NYSE:HD) in the United States and globally, attempted to greatly expand its operations in Canada last year by acquiring Rona of Boucherville, Que., which has more than 800 locations of various size. The company operates more than 1,750 stores in North America, including almost three dozen in Canada, most in Ontario and Alberta.

Lowe's unofficially bid $1.8-billion bid for Rona but backed away after it met stiff resistance from Rona's board, Quebec politicians and the independent dealership owners that operate under Rona's brands.

Since then, Rona's shares have fallen below the $14.50 per share that Lowe's had indicated it would pay. Rona shares are currently worth about $10 per share after trading as low as $9.25 last fall.

Under a new CEO, Rona (TSX:RON) is focused on improving its efficiency but Howlett says a transaction of some type, including an asset sale or joint venture with Lowe's, remains a "distinct possibility."

"We remain of the opinion that home improvement square footage in Canada requires rationalization and/or co-ordination," Howlett wrote Monday.

One potential roadblock to a new offer could be Rona's network of independent merchants, many of whom opposed Lowe's interest in Rona last August. A spokesman for the Rona affiliates couldn't be reached Monday for comment.

Rona itself said it wouldn't comment on its competitor's activities or strategies. "We remain focused on our strategic priorities and on maximizing the performance of our operations across Canada," Valerie Lamarre wrote in an email.

Scot Ciccarelli of RBC Capital Markets supported Lowe's plans to use Orchard to expand its presence in metro areas in California where its penetration lags Home Depot.

"We view this acquisition as a modest positive for Lowe’s given our view that one of the key reasons for its underperformance relative to Home Depot is the differences in real estate locations between the two retailers, and our belief that the majority of professional contractor business occurs in major metros areas," the analyst wrote.

Orchard's EBITDA margin is about 3.6 per cent compared with about 10.5 per cent for Lower's.

Ciccarelli doesn't believe Home Depot will submit a competing bid because it indicated only last week that it was focused on improving the productivity of its current stores instead of acquisitions or adding new store formats.

Orchard Supply filed its bankruptcy petition in the U.S. Bankruptcy Court for the District of Delaware.

Mooresville, N.C.-based Lowe's Cos. Inc. said Monday it will acquire at least 60 of Orchard's 91 stores, and alternative bids must top Lowe's offer by at least $12 million. Lowe's also will assume responsibility for money owed to nearly all of Orchard's suppliers.

San Jose-based Orchard was spun off from Sears Holdings Corp. in January 2012, and most of its locations are in densely populated California markets.

— With files from The Associated Press