Tuesday, 28 August 2007

The real lesson of HD's salvaged sale

The market reacted positively to the news that Home Depot (HD) managed to get the sale of it's supply division done. Rumors have it that the company agreed to an 18% discount to the original asking price of $10.3 billion to walk away with $8.5 billion in cash and retain a 12.5% stake in business.

At the end of the day the market along with Home Depot was happy just to get the deal done. For Home Depot it means they can institute their previously announced capital initiatives, however that may have to be reduced a little given the terms of the new deal.

For the market it means that M&A activity is still alive, however it is far from well. The Home Depot deal sounds like the desperate last gasp of a dying animal....a bull perhaps?

Minyanville's 'five things you need to know' hit on the implications of the revamped HD deal:

Any Love is Good Love for Home Depot

Home Depot (HD) agreed to sell its construction-supply unit for $8.5 billion, cutting the price by $1.8 billion, or 18%, according to Bloomberg.

  • The original buyers, Bain Capital LLC, Carlyle Group and Clayton Dubilier & Rice, negotiated a reduced price from the original $10.3 billion price tag Home Depot sought just two months ago, according to Bloomberg.
  • So here's a question: How did Home Depot's construction-supply unit lose nearly $2 billion in value in less than two months?
  • The answer is, it didn't.
  • What HD's construction-supply unit lost was buyers with access to formerly cheap credit.
  • Wait a minute, wouldn't that mean the previously agreed-to price was more a function of psychology than "value"?
  • Yes, it would.
  • Ok then, so what is Home Depot going to use the sales proceeds for? To pay down debt? Re-invest in their business? Expand?
  • Nah, they're going to buy stock with it. Seriously.
  • "Home Depot planned to use the sale proceeds to help fund a $22.5 billion stock buyback," Bloomberg reported.
The points in bold are the most important. It is symptomatic in an M&A frenzy for buyers to pay over the top. Value goes out the window and psychology takes over. Forget about the quality of the deal, more is better.

The private equity dealers that usually put these deals together aren't interested in making better run more profitable businesses. They are opportunists taking advantage of market conditions to get the highest price possible and therefore reap the largest fees possible.

However the the private equity boys have had their run, they made hay while the sun shone but now it's getting very overcast.