HD Supply: In Trump We Trust?
Donald Trump may be able to do more to create value at HD Supply Holdings Inc. than Jana Partners can.
Jana, the activist hedge fund founded by Barry Rosenstein, disclosed an 8.1 percent stake in the supplier of sewer pipes, construction tools and maintenance-repair products in October and said it may pursue options to create shareholder value. The stock rose about 2 percent that day -- but it's climbed about 28 percent since the U.S. election as investors piled into a company that stands to be one of the biggest beneficiaries of corporate tax reform, infrastructure investment and an inflation revival under a President Trump.
As unpredictable as Trump is, the benefits from his policies appear more concrete than strategic alternatives. One potential path is a takeover, and according to dealReporter, HD Supply is working with Goldman Sachs Group Inc. to gauge interest from peers such as W.W. Grainger Inc., as well as private-equity firms. But a takeover just doesn't make a lot of sense.
With an enterprise value of about $12.6 billion, HD Supply would be one of the biggest U.S. buyout targets since the financial crisis even before adding a premium. The only larger deals to get done of late have required financial assistance from billionaires. Jana Partners could in theory contribute its stake to a deal, but to what end? HD Supply is also still saddled with a decent debt load from the last time it was a private-equity target 1 and with a valuation of more than 14 times its Ebitda, it's on the expensive side for buyout deals.
As for Grainger, it would likely have to sacrifice its credit ratings to swallow a takeover of HD Supply that would cost more than $15 billion with a typical premium. There are ways to make a deal at that price add to Grainger's earnings, but it wouldn't be a cheap use of capital.
Arguably, Grainger is better off investing that money in a defense against Amazon.com Inc.'s foray into industrial distribution. A purchase of just HD Supply's facilities-maintenance business would help because its specialized repair offerings can't be easily as easily commoditized. It would also be a smaller and more palatable deal. But why would HD Supply want to give one of its more defensible business to its rival?
Beyond that, one of the main motivators for selling a company in pieces is that the sum of its parts surpasses the value the market is assigning to the company as a whole. That's just not the case for HD Supply. Estimates from RBC analyst Deane Dray and Bloomberg Intelligence analyst Christopher Ciolino show there's little to no upside for the company in a breakup situation. There is, however, money to be made from simply allowing the stock to continue its Trump-driven rise.
Dray estimates that HD Supply could see a 19 percent boost in its 2018 earnings per share, the highest among his coverage group, in connection with Trump's policies. In particular, reflation will help the company and other industrial distributors pass on price increases to customers, something that they've struggled to do in the low-inflation environment of the past few years. Dray is now calling for HD Supply shares to reach $50 over the next year, about 16 percent higher than where the stock was trading on Wednesday morning. He's not alone. Of the 13 analysts that have price targets on the company, 11 have raised their estimates this month.
HD Supply isn't perfect. Execution missteps at the facilities-maintenance business caused an out-of-character quarterly earnings miss over the summer. It's worth Jana Partners keeping a close eye on management and making sure it follows through with pledges to fix inventory miscalculations. But beyond that, the investor should sit back and enjoy the ride.
Carlyle Group, Bain Capital and Clayton Dubilier & Rice acquired the company from Home Depot Inc. in 2007 for $8.5 billion (after a price cut).
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