Given enough time and the right economic conditions, HD Supply’s all-encompassing business model might have succeeded. But the housing downturn, the executive pay flap and lackluster stock performance intervened, forcing a sale of the unit before it ever really got any traction. After the market bell rang on June 19, Home Depot confirmed that yes, it had settled on a buyer (three, actually) and HD Supply was being spun off to private investors for $10.3 billion.
It’s unlikely that the new owners share the same vision that Bob Nardelli, Home Depot’s deposed CEO, once held: a single company that sells industrial pipes, framing lumber, evaporative coolers and window treatments. HD Supply was designed to complement Home Depot by taking care of a builder’s every need, from groundbreaking to customer move-in, and reap the benefits from the leads generated by each division. That was the view from above the circle, an image frequently used by HD Supply to represent its synergistic approach to the market.
But can the circle remain unbroken? Without that overarching strategy, HD Supply is a collection of divergent companies, at least in terms of end users. National Waterworks sells to municipalities, Hughes Supply caters to plumbers, Williams Bros. delivers lumber and Creative Touch Interiors only sees new homeowners—with appointments.
“Home Depot seemed willing to invest whatever it took for the company to be all things to all people in the professional distribution world, whether that be LBM, plumbing, water, wastewater, electrical [or] construction tools,” said Keith Hughes, managing director, equity research for SunTrust Robinson Humphrey in Atlanta. “Now that the separate entity will have limited capital and significant debt, the strategy will have to change.”
The deal, which has already been cleared by federal antitrust regulators, is expected to close in the third quarter of 2007. Home Depot has signed a short-term agreement to help with the transition. Joe DeAngelo, the executive vp and COO of HD Supply, will remain with the division, which will be owned equally by Bain Capital, Carlyle Group and Clayton, Dubilier & Rice.
Few other details have been forthcoming about HD Supply’s future, however. (None of the three investment companies would agree to an interview for this article.) Although their joint announcement on June 19 talked of “growing these businesses,” the chatter on Wall Street revolves around which pieces of HD Supply might be coming on the market—and who the potential buyers might be.
Of special interest to the LBM industry is Williams Bros., a 19-unit pro dealer in the Atlanta metro area, and Cox Lumber, a 28-unit chain of Florida lumberyards purchased by HD Supply last year. Both are key acquisition targets, given their geographic positioning. Among the possible buyers are Builders FirstSource, a strong player in the Southeast who has already invested millions in acquisitions and organic growth efforts in Florida; BMHC, which entered the Florida market through an acquisition in 2003 and now offers shell construction throughout the state; Stock Building Supply, a division of Wolseley, which has made four Florida acquisitions over the past three years; and Pro-Build, which purchased two truss plants in Florida in April and Dunn Lumber of Daytona Beach in June.
It’s worth noting that two of the four possible suitors, Builders FirstSource and Pro-Build, are controlled by private investors. The majority shareholders for Builders FirstSource are JLL Partners and Warburg Pincus, both private equity firms who hold seats on the board of directors. Pro-Build is owned by Fidelity Capital, the private equity arm of Fidelity Investments. BMHC and Stock are both publicly held companies.
Not all of these companies are in a position to spend capital or take on debt, however. The housing downturn has taken its toll on merger and acquisition activity this year; among the industry’s main consolidators, only Pro-Build continues to consistently snap up smaller players.
“The home-building decline has spooked [investors], and we have seen very few deals,” noted analyst Hughes. “This is because the financing…is much more difficult than other non-home-building industries.”
When Home Depot announced last February that it was evaluating “strategic alternatives” for HD Supply, a number of private equity firms began kicking the tires of the company’s $12 billion wholesale distribution business. But the winning bid came from a consortium of three private investment companies who will put up equal amounts of equity into the transaction:
Bain Capital, best known for its investments in the retail, health care, finance and IT sectors, has approximately $50 billion of assets under management. Its holdings include Burger King, Ameritrade, MinuteClinic, Vonage, Sports Authority, and
The Carlyle Group is one of the world’s largest private equity firms, with more than $58 billion invested in aerospace and defense, automotive, transportation, consumer, retail, energy and power, real estate technology and media. Its portfolio includes Dunkin’ Brands and Dr. Pepper/7-Up. The firm operates offices in 15 countries.
Clayton, Dubilier & Rice, based in New York and London, manages a $4 billion fund using a hands-on approach, particularly with underperforming acquisitions. Many of its principals are former chief executives, including Jack Welch of General Electric. CD&R’s portfolio includes Rexel Group, a global distributor of electrical supplies, and Hertz Corp. In March, CD&R led a group of investors who acquired ServiceMaster, a franchise of home services providers that include lawn care maintenance, termite and pest control, home warranties, house cleaning and home inspection.
The HD Supply deal should net Home Depot $9.5 billion in cash, which the company said it intends to combine with $12 billion in borrowed notes to fund a $22.5 billion recapitalization plan. Although credit agencies didn’t like the idea of new debt—Moody’s Investors Service and Standard & Poor’s immediately warned they may downgrade the retailer’s rating—investors applauded the stock buyback plan. And wooing back shareholders is a top priority for the new Home Depot chairman, president and CEO, along with fixing whatever problems he found waiting for him in the company’s orange boxes.
“We are focusing exclusively on our retail business,” Frank Blake told analysts during a conference call the day after the HD Supply announcement. Blake has said repeatedly that he wants the company to return to its core values; he’s convinced that the path lay with improved employee morale. Indeed, Blake spent as much time talking about a new stock bonus plan for assistant store managers during the June 20 call as he did discussing leveraged buyouts or incremental SG&A.
“We want to establish an ownership mindset throughout the organization,” Blake stated.
Although Home Depot is obviously not looking in its rear view mirror, a lot of churn will follow the HD Supply transaction. The sprawling division, with more than 1,000 locations and 26,000 employees, was cobbled together from more than 35 companies acquired during a four-year buying spree. Home Depot put most of them under the HD Supply banner last year, but the branding initiative never had time to take hold, even in the businesses open to the concept of integration.
Now the various divisions, some of them relatively new to HD Supply, find themselves under new ownership again.
White Cap, a California-based distributor of specialty tools, hardware and construction supplies, was one of HD Supply’s larger acquisitions when it was purchased in 2004. Following the HD Supply playbook, White Cap spent the next three years rolling up smaller companies. It grew from 70 locations in 17 states in 2004 to its current 160 branches in 27 states. White Cap was acquiring companies up until February, when it signed an agreement to purchase GSI General Materials, a concrete accessories and rebar supplier in the Carolinas.
Peter Alexander, president and CEO of ORCO Construction Supply, was closely tracking the rumored HD Supply deal from his company headquarters in Livermore, Calif. As he sees it, the uncertainty surrounding White Cap’s future could create opportunity for ORCO, which serves the same type of contractors from 20 locations in California, Nevada and Arizona.
“We find our customers insist on predictability and consistency,” Alexander said.