Rona’s Lowest Value Makes Canadian Firm Takeover Bait: Real M&A
Rona Inc. (RON), the home-improvement retailer with the lowest market valuation in North America, would give potential suitors the chance to profit as Canada’s economy adds new homes and jobs at the fastest pace in more than three years.
Rona, Canada’s biggest home-improvement chain, yesterday was valued at a 26 percent discount to its net assets, making it the only North American home-products retailer with a market capitalization over $500 million to trade lower than book value, according to data compiled by Bloomberg. After increasing competition sent the Boucherville, Quebec-based company’s shares down 57 percent in the last five years, Rona was also the least expensive of its rivals relative to earnings, the data show.
Lowe’s Cos. (LOW) could be interested in acquiring Rona to expand in the country and better compete with Home Depot Inc. (HD), said ABC Funds, after Canadians started work last month on the most housing units since 2008 and the economy added the most jobs in 42 months. The chain would also be attractive to private-equity buyers, said Aston Hill Financial Inc. (AHF) While the C$1.4 billion ($1.4 billion) company says it isn’t for sale, Rona would fetch C$15 a share in a takeover, or a 42 percent premium compared to yesterday’s close, ABC said.
“Rona is definitely cheap,” Richard Fortin, Calgary-based co-manager of the Bissett Small Cap Fund at Bissett Investment Management, which oversees C$13.7 billion including shares of Rona, said in a telephone interview. “If Lowe’s were to acquire Rona, it’d gain a significant presence in Canada overnight. The merger math works quite well at current prices.”
Rona’s shares climbed 2.4 percent to C$10.85 in Toronto today. The gain was the second-biggest among the 253 companies in Canada’s benchmark Standard & Poor’s/TSX Composite Index, data compiled by Bloomberg show.
Lowe’s Chief Financial Officer Robert Hull told Reuters last week that his company is open to “all options” if Rona were to put itself up for sale and called it “a very interesting company.”
“Lowe’s has stated its intention to expand in Canada to as many as 100 stores,” Julie Yenichek, a spokeswoman for Mooresville, North Carolina-based Lowe’s, said in an e-mail yesterday. “We cannot speculate about how we may choose to grow our business in Canada.”
“We are not looking to sell,” Michelle Laberge, a spokeswoman for Rona, said in a phone interview. “We haven’t been approached at this time,” by potential suitors, she said.
The company is focused on executing its 2012 business plan and will soon be updating investors on its progress, according to Laberge. Rona said on Feb. 23 that it will be introducing a new website and decreasing the size of the sales area in some of its “big-box stores” as part of its 2012 business plan.
Home Depot, Lowe’s
Rona, which sells everything from paint to power tools and flower pots at almost 800 stores across Canada, has been trying to fend off increased competition from Home Depot and Lowe’s.
Atlanta-based Home Depot, the world’s largest home- improvement retailer, has opened 180 stores in Canada since entering the market in 1994, according to its web site. Lowe’s opened its first Canadian stores in 2007 in the Toronto area and had 31 locations in the country as of this February, a filing with the U.S. Securities and Exchange Commission showed.
Rona reported a net loss of C$78 million in 2011 as its results deteriorated after four straight declines in annual profit. In the last five years, Rona’s shares slid 57 percent to C$10.60 through yesterday, the biggest drop among consumer discretionary stocks in the S&P/TSX Composite Index. (SPTSX) Home Depot rose 33 percent and Lowe’s gained 0.7 percent in the same period, data compiled by Bloomberg show.
The slump left Rona trading at 0.74 times the value of its assets minus liabilities, compared with an average price-to-book ratio of 3.5 for home product store owners in North America with market values higher than $500 million, the data show.
With its equity and net debt valued at 5.3 times earnings before interest, taxes, depreciation and amortization, Rona was also the cheapest among its competitors and valued at half the industry average, according to data compiled by Bloomberg.
“As Home Depot and Lowe’s expand their presence in Canada, they’re taking share away from Rona,” Brian Huen, a Toronto- based managing partner at Red Sky Capital Management Ltd., said. An acquirer could get Rona “at a reasonable price,” he said.
Rona has grown cheaper even as Canada’s recovery from the worst global financial crisis since the 1930s strengthened.
Data this week from Ottawa-based Canada Mortgage & Housing Corp. showed the annual pace of housing starts rose 5 percent to 215,600 in March, the highest level since October 2008. The country also added 82,300 jobs last month, Statistics Canada said last week. That’s the most since September 2008, the month that New York-based Lehman Brothers Holdings Inc. collapsed.
Canadian executives are more positive on sales growth than at any time in two years, the Bank of Canada’s quarterly survey showed this week.
U.S. retailers facing saturation in their own country will increasingly search for ways to expand in Canada because of its proximity to the U.S. and the similarities in consumer behavior, according to Irwin Michael, a Toronto-based money manager at ABC Funds, which oversees about C$1 billion and owns more than 3 million shares of Rona.
“The borders are breaking down,” Michael said. “We’re seeing more and more U.S. companies come here to Canada. We basically watch the same TV, eat the same food. We’re familiar with all your stores.”
Buying Rona would help Lowe’s accomplish that by giving it a “fairly dominant position” in Quebec, and the combined company could lower costs and boost profitability, ABC Funds’ Michael said. Rona has more than 200 stores in Quebec, according to its website.
“While management has indicated the company is not for sale, the reality is that control is in the marketplace,” Michael said. “That statement by the Lowe’s CFO, whether they’re interested or not, it certainly was a catalyst to get people to say ‘Hey, this stock is cheap.’”
Rona would fetch at least C$15 a share if it were acquired, or “just slightly above” its C$14.33 in book value per share, ABC Funds estimated. That would be a 42 percent premium to yesterday’s close, data compiled by Bloomberg show.
While Lowe’s management may need to stay focused on competing with Home Depot in the U.S. right now, Rona would make sense as a target for a private-equity firm that could try to run the company better and improve margins, or break it apart and sell off pieces, said Jeff Burchell, a Toronto-based money manager at Aston Hill, which oversees about C$5.5 billion.
Rona, the only North American home products retailer with a market value of more than $500 million that was unprofitable in the last 12 months, earned less than 4 cents in operating income per dollar of its C$4.8 billion in sales in the past year, data compiled by Bloomberg show. That’s less than half the median 8.3 percent operating margin for the group, the data show.
A private-equity firm would also be getting a company that trades at 10 times its cash from operations after deducting capital expenses, the cheapest free cash flow multiple among its peers, the data show.
“Lowe’s is really focused on the internal business in the U.S.,” Burchell said. “For Lowe’s to take on the whole Rona and do a hostile takeover for it, that sucks up a lot of management time. Private equity, that would be pretty interesting. That’s where you could probably make sense of the whole thing.”
Concern that the Canadian housing market will weaken could deter potential buyers, said David Cockfield, a Toronto-based managing director at Northland Wealth Management, which oversees about C$200 million.
Policy makers, including Finance Minister Jim Flaherty, have said parts of Canada’s housing market have become overvalued as households add to record debt levels. Household spending in Canada is increasingly driven by “stimulative financing conditions” and higher home values, Bank of Canada Governor Mark Carney said in an April 2 speech. Such trends are “unsustainable over the medium term,” he said.
“The housing market is running at probably what we would consider an unsustainable high,” Northland Wealth’s Cockfield said in a telephone interview.
‘Wait and See’
While Cockfield also said it could be difficult to convince Rona to sell, the company may not have a choice if the stock continues to drop and increased competition further erodes margins, according to Sachin Shah, a special situations and merger arbitrage strategist for Tullett Prebon Plc in Jersey City, New Jersey.
Rona “saying ‘our standalone strategy is going to deliver more value than doing a deal’ is only going to work if they’re actually able to do that,” Shah said in a phone interview. “Shareholders have been waiting two years and they’re not happy. It’s just been a downward trajectory and so Lowe’s sees the intrinsic value here. We’re going to have to wait and see, but that wait and see has a limitation.”