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Home Depot May Shed Wholesale Unit to Focus on Stores

AP
Monday, 12 Feb 2007 | 4:24 PM ET

Home Depot said Monday it was considering a sale, spin-off or initial public offering of its professional supply business to focus on its retail stores, reversing a controversial policy of former CEO Robert Nardelli to expand the unit.

Wall Street has criticized the wholesale distribution unit with its lower profit margins, saying it diverted resources from retail stores as competition from Lowe's intensified. Home Depot Supply accounts for some 15% of the company's total sales, while retail stores account for 85% of revenue.

Home Depot Supply sells building materials, wastewater and utility products to municipalities and contractors in the United States and Canada.

"With annual revenues of approximately $12 billion, HD Supply is a healthy, growing and vibrant business," CEO Frank Blake said in a statement. "We are undertaking this evaluation to determine whether there are strategic alternatives with respect to HD Supply that would optimize shareholder value."

The company said it has retained Lehman Brothers as its financial advisor to assist in the process.

Launched in 1997

Home Depot launched the supply business in 1997 and grew it by acquiring companies like National Waterworks Holdings, a water and sewer products supplier. The unit continued to expand under Nardelli, who joined the company in 2000, and last year the company bought Hughes Supply for $3.2 billion.

Home Depot has been under intense pressure from investors because of weakening sales and profits. It also faces a regulatory probe into its stock options award practices.

Donald Trott, a retail analyst with Jefferies, told CNBC that he believes Home Depot could get about $10 billion from the sale of the supply business.

The division was seen as a big opportunity for growth by former CEO Nardelli, who resigned in early January after six years at the helm of Home Depot amid shareholder unrest regarding his compensation and the company's modest share-price gains during his tenure.

Nardelli had said repeatedly that he believed the company's strategy under his watch did not need changing. But earlier this month, the company said it is giving a seat on its board to an investment group that wants the company to consider, among other things, a leveraged buyout as a way to generate shareholder value.

The group, Relational Investors, had threatened a proxy fight over the home-improvement company's strategic direction, part of an undercurrent that led to Nardelli's resignation.

Jefferies' Trott said that investors have been concerned about the return on invested capital in the business--currently about 13% to 14% compared with 23% to 24% for the overall company --which would drag down total returns.

"It's Been a Negative"

"Psychologically, it's been a negative," Trott told CNBC. But, he added, the deal was financed by debt that carries a 5.75% interest rate. "I would do that all day long: borrow at 5.75% if I could get (a double-digit return on capital)."

"Quite frankly, I'm in the minority," he added. "I think Home Depot Supply does represent an interesting opportunity for the company."

Blake said Monday's announcement regarding Home Depot Supply was part of a strategic review the company conducted in November. The announcement comes just a couple of weeks before Home Depot's annual analyst meeting.

"The company will have no further comment until they have completed their strategic review therefore they’ve defused the possibility of this being a contentious issue at the upcoming meeting," Trott told CNBC.

Trott said he believes Home Depot would use the proceeds from a sale to repurchase shares or improvements at its retail outlets.

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HD supply has annual revenues of approximately $12 billion, has nearly 1,000 locations nationwide and in Canada, and employs more than 26,000 associates, the company said.

Home Depot has retained the investment firm Lehman Brothers as its financial adviser to assist in this process.

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