Rona disclosed this week that its board rejected an unsolicited offer of C$1.76 billion ($1.75 billion) from Lowe’s, saying it wasn’t in the best interests of the Boucherville, Quebec-based company’s shareholders. While the July 8 bid of C$14.50 a share is 41 percent higher than Rona’s average stock price in the prior 20 days, the proposal is only 1.8 percent more than book value, a measure of the assets’ estimated price tag in a liquidation, according to data compiled by Bloomberg.
Even with Quebec vowing to help prevent a takeover of a “strategic asset” for Canada, Lowe’s of Mooresville, North Carolina said it’s still interested in a friendly deal. With a $29 billion market value, Lowe’s has room to pay as much as C$18 a share, according to Desjardins Capital Markets, and Canaccord Genuity Inc. said the retailer needs to offer at least C$16 a share to win over Rona’s investors and management. At C$16, the sweetened bid would be almost 56 percent higher than the 20-day average before July 8, the biggest premium since 2006 for a retailer of home products or building supplies, the data show.
For Lowe’s to get a hold of Rona, “it comes down to a price that’s higher,” Jonathan Brodsky, a Chicago-based portfolio manager at Advisory Research Inc., which oversees $8.5 billion including Rona shares, said in a telephone interview. “The bid where it is right now is reflective of a company in distress. That does not take into account the brand or the value of the locations and other attributes. It’s an opportunistic approach by Lowe’s.”
Doug Robinson, Lowe’s head of international operations and development, said the company was “disappointed” in Rona’s reaction to its bid and wouldn’t speculate on whether Lowe’s would raise the offer price as it continues to seek discussions with Rona’s management. Michelle Laberge, a spokeswoman for Rona, declined to comment on speculation.
Lowe’s is trying to buy Rona to gain a bigger foothold in Canada, where the U.S. chain operated just 31 of its 1,745 stores as of February, compared with Rona’s network of almost 800 lumber and hardware outlets throughout the country.
Lowe’s submitted its bid for Rona after the Canadian retailer lost half its market value in five years amid declining earnings. After posting a net loss in 2011, Rona is projected to return to profit this year and more than quadruple net income next year, according to analysts’ estimates compiled by Bloomberg.
When the bid from Lowe’s was disclosed on July 31, Rona had its biggest stock gain since the company’s initial public offering in 2002. The stock climbed as much as 22 percent to reach Lowe’s offer price before giving back some ground as Quebec’s provincial government joined the Canadian retailer in resisting the bid. Rona closed yesterday at C$13.95.
Today, the shares fell 0.4 percent to C$13.89.
Quebec’s finance minister said the Lowe’s offer “does not appear to be in the interests of either Quebec or Canada,” and the province may take steps to prevent a takeover. Though Quebec wouldn’t have the power to directly block Lowe’s bid, it can influence the federal government, which can reject takeovers unless they provide a “net benefit to the nation.”
Lowe’s says its bid involves combining its Canadian business with Rona’s headquarters in Quebec, and maintaining or increasing Rona’s Canadian headcount. Institutional shareholders representing 15 percent of Rona’s outstanding shares have indicated support for its offer, Lowe’s said.
“We believe we have a great proposal,” Lowe’s Robinson said in a phone interview yesterday. “Our goal is to sit down and have meaningful discussions, productive discussions to satisfy people’s concerns.”
Derek Dley, a Vancouver-based analyst at Canaccord, said the bid from Lowe’s may not be high enough to gain adequate support for the deal.
“That’s a bit light in my mind,” based on 2013 profit estimates for Rona and the earnings multiples paid on other Canadian transactions involving retailers, Dley said in a phone interview. “It’s going to take a bit more than that for management and shareholders to be interested in the offer. It’d have to be something closer to C$16 to C$18 a share.”
A C$16 bid would represent a 55.6 premium to the average price in the 20 days ended July 6, the highest offered on a deal valued at more than $100 million for a retailer of building products, floor coverings, garden products or home furnishings since January 2006, according to data compiled by Bloomberg.
Sachin Shah, a Jersey City, New Jersey-based special situations and merger arbitrage strategist at Tullett Prebon Plc, said C$16 to C$17 a share may be enough to overcome management and government opposition. The deal could help Rona bolster its operations and avoid job losses in Canada, he said.
Lowe’s is “trying to do something positive and actually grow the Canadian business,” Shah said in a phone interview. “This is a mutual benefit for Rona in that they are losing money, and turning around hasn’t worked.”
While Shah predicts Lowe’s will increase its bid, he said Rona’s shares aren’t trading above the offer price because of the concern about the government’s stance, which throws the timing of a deal into question.
“The market in general is betting that a deal is not going to happen in the near term,” Shah said. Rona “should be trading higher because Lowe’s can offer more and will offer more. They need to iron out the details with the politicians.”
Jeff Burchell, Toronto-based money manager at Aston Hill Financial Inc., which oversees about C$6 billion including Rona shares, said the company should sell itself to Lowe’s. While the offer price is one hurdle, Lowe’s also needs to gain political support.
“Normally, I would say it’s all about price but it’s more than just price to make this deal happen,” Burchell said. “If it’s purely economic, they should take the bid and leave, but it’s not about that. I’m not sure Lowe’s understands what they’d be dealing with buying a Quebec-based company.”
Michael Liss, a Kansas City-based portfolio manager for American Century Investments, which oversees $120 billion including shares of Lowe’s, said he would prefer that the U.S. chain focus on its existing operations rather than make an offer for Rona, one that it now will probably have to increase. Lowe’s earnings have fallen four out of the last five fiscal years as sales from Lowe’s stores open at least a year trailed rival Home Depot Inc.’s (HD) 3.4 percent growth in the latest fiscal year.
“We’re disappointed,” Liss said in a phone interview. “Diverting their attention into Canada when you don’t have your base stores where they should be, that’s very frustrating for us as investors. They are just socking it to their shareholders.”
While Lowe’s shares have fallen 5 percent since the deal was announced, the company hasn’t walked away.
Keith Howlett, an analyst at Desjardins in Montreal, said in a note this week that Lowe’s has room to increase its bid. He sees an 80 percent chance of the offer increasing to C$18 a share because of the potential for improved profit margins from lower marketing and other expenses.
Advisory Research’s Brodsky said at the right price, a deal is the best option for shareholders.
“We don’t have an interest in protecting jobs or protecting a category leader in the province of Quebec,” he said. “We are looking for the highest possible price as it relates to the takeout.”
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