After months of speculation, The Home Depot has agreed to sell its wholesale division, HD Supply, and bring its focus back to the performance of its retail core. Three private equity firms will buy the $12 billion unit.
The Home Depot, Atlanta, GA, has agreed to sell HD Supply to a team of private equity firms – Bain Capital LLC, Carlyle Group and Clayton Dubilier & Rice Inc. – for $10.3 billion, or roughly 10X-12X EBITDA. The firms are splitting the investment equally.
The sale has been expected for weeks now, with a number of private equity firms rumored to have bid for the unit and several to have bowed out due to the down housing market – one of HD Supply's core customer bases. HD Supply reported a decrease in organic sales in the recent quarter.
"This was not an easy decision," HD CEO Frank Blake said. "(HD Supply chief) Joe DeAngelo and his team have built a world-class operation over the last few years. We gave careful consideration to a number of options, including holding onto the business."
Blake said that selling HD Supply in pieces, as some industry-watchers expected, would have been "timely and distracting," with the added cost of separating the businesses. An IPO, another option considered, would have resulted in a multiple discount relative to the sale of the entire business.
Industry-watchers say HD Supply's new owners will likely sell off some of HD Supply's assets almost immediately in an effort to better integrate the wholesale unit under a common platform.
CD & R's David Novak said that it is premature to say whether the private equity team will divest any of HD Supply's assets after taking full ownership. The new owners however do plan to continue building the company through acquisitions. "That we will certainly do," Novak said. "Local scale is very important for productivity and service levels."
That means that HD Supply, with $12 billion in sales in 2006, will continue as a major player in the distribution M & A market.
Little more than a month after former CEO Robert Nardelli retired, HD announced in February it would consider a potential HD Supply spin-off. Nardelli had pushed the wholesale division as a way to diversify HD's offering and spark growth to balance out a slowing retail division.
While HD had reported that some investors wanted it to stick with its HD Supply strategy, other investors were quite vocal on their dissatisfaction with the wholesale business. They called it an unnecessary diversion from the retailer's core business. This included Ralph Whitworth, an activist investor whose firm, Relational Investors, recently won a seat on HD's board of directors.
Home Depot has spent the past few years building up its wholesale unit, which originated back in the mid-1990s. It bought $5.5 billion diversified distributor Hughes Supply for $3.4 billion, or 12X EBITDA, in early 2006, and National Waterworks, at the time with $1.5 billion in annual sales, for $1.35 billion in mid-2005.
In 2004, Home Depot acquired White Cap Construction Supply, then a $500 million distributor.
The year 2005 started an acquisition frenzy, which included $400 million William Bros. Lumber, Contractors' Warehouse, the $100 million Greenwald Supply Inc. and Greenwald Industrial Products Company, fastener and industrial supplies distributor Brafasco, and catalog MRO supplier Utility Supply of America Inc.
Crown Bolt Inc., a distributor of fasteners and hardware, was acquired in 2005, as well – its primary customer is Home Depot. Blake confirmed that Crown Bolt was included in the sale of HD Supply. Home Depot has signed a seven-year supply agreement from Crown Bolt.
In 2006, HD Supply made almost $4 billion in acquisitions, starting with the Hughes buy. Its other acquisitions in the past year were quite diverse, including distributors in waterworks, electrical, concrete and
"Home Depot has finally faced the inevitable truth they could not run the collection of companies they acquired over the past five years," said Adam Fein, president of Pembroke Consulting. "The private equity firms taking over have the opportunity to build a unified common platform. But to do that, they will probably divest some of the companies that are a part of HD Supply."
In mid-May, Grainger President Jim Ryan told analysts that the new owners will have the same challenges in unifying HD Supply's diverse businesses. "The challenges in building the HD Supply business exist regardless of who owns them & hellip; It takes time, patience and a lot of money. That said, it can be done. But a change in ownership doesn't change any of this."
Impact on M & A Market
In a recent MDM audio conference, Jim Miller, who heads the distribution practice at investment banking firm Vetus Partners, said that even talk of a potential HD Supply spin-off had a slight impact on valuations in the distribution M & A marketplace.
The effect of talk of a divestment came from two areas: "One, the position of Home Depot as a competitive buyer against another bidder, or at least the perceived threat of Home Depot as a competitive buyer," Miller said.
"And two, Home Depot Supply as a potential exit opportunity. There were several private equity funds that were chasing distribution investments with the intent of buying them, holding them for a period of time and potentially flipping them to HD Supply."
The firms likely will pay closer to 12X EBITDA for HD Supply, according to Miller. "When they started this process, I believe they were touting approximately $1 billion of EBITDA from HD Supply. With the recent softening of some of their end markets, particularly the residential end market, I'm guessing that HD Supply's most recent trailing 12 months' EBITDA was closer to $800 million than it was to $1 billion.
"That's a full purchase price, but I still believe that CD & R (and the other firms) are getting a good collection of assets and the investment will be a good one over time."
Miller said that the final sale price of $10.3 billion is a "good sign" for distributors contemplating selling part or all of their businesses. Some industry-watchers expected the price to be closer to 8X EBITDA.
He says that deals of this magnitude typically "set the bar" for valuations in the sector -valuations for smaller companies are then discounted from that bar. "Even with a significant discount to this bar, valuations for smaller distributors in this sector should hold fairly well in the near term," he says.
Private Equity & Distribution
More than 100 private equity firms are targeting distribution right now, thanks to low-cost financing, high valuations and a healthy earnings environment. That has provided a "great selling opportunity for quality distribution businesses," Robert W. Baird & Co.'s Tom Lange said during the recent MDM audio conference.
Fein said private equity is being attracted by the ongoing need for wholesale distribution to end markets insulated from global competition, such as facilities maintenance, construction or health care services.
The firms buying HD Supply are no strangers to the distribution world. Clayton Dubilier & Rice invested in global electrical distributors Rexel Inc. and Wesco International, and recently sold its investment in $3.2 billion lab supplier VWR International Inc. Also, the former CEO of building materials and plumbing distributor Wolseley plc (parent of Stock Building Supply and Ferguson) is an operating partner at CD & R.
Carlyle has recently made industrial and construction investments, as well, including Goodyear Tire and Rubber Company's Engineered Products Division. It previously owned PT manufacturer Rexnord before selling it to Apollo Management.