Home Depot Should Keep Its Supply Operation

August 26, 2007 by Douglas A. McIntyre

Home Depot (HD) seems desperate to get rid of its HD Supply unit which handles wholesaling of its products to builders. The deal was set for private equity interests Bain Capital, Carlyle and Clayton Dubilier & Rice to buy the firm for $10.3 billion. According to the last HD 10-Q, the Home Supply business had revenue of $3.1 billion and operating income of $163 million.

Due to trouble getting banks and big institutions to put up loans for the buy-out, the private equity purchasers have asked for a lower price. And, HD seems to be willing to bring the sticker down to about $9 billion.

Now the FT writes, HD is willing to go even further to cut loose the operation–"According to people familiar with the matter, a range of solutions are possible, including the possibility that Home Depot might agree to shoulder some of the debt needed to fund the deal."

HD was hoping to use the proceeds from the sale to, among other things, have a huge share buy-back. But, why bother? The housing slump will keep the company’s shares low no matter what it does.

The operating margins at the Supply group were over 5%, according to the HD quarterly filing. HD’s retail operation had a 9% margin. If private equity interests believe that they can improve the operating performance of the Supply business, why shouldn’t Home Depot management think the same?

Home Depot would be better off improving its share price by managing through the current environment instead of selling a business that could have strategic value, especially when the housing slump begins to ease. The parent company has $11 billion in debt. But, it has an operating income run rate of $2 billion a year. If it fell the need to buy-back shares, it can clearly take on more debt.

At its current share price of $34.50, HD trades at .75x sales. It is willing to sell the Supply unit for .72x sales if the price is $9 billion. If it guarantees debt, the deal is even worse.

HD should hang onto it Supply unit. Selling it under the current terms does not make sense.

Douglas A. McIntyre