July, 2006

Top Billing for Home Depot?

Can the LBM giant parlay its 15 minutes of fame into stardom?

By Greg Brooks

Judging by recent headlines, millions are apparently hooked on TV’s American Idol. I’d say they’re all half a bubble off plumb except for the rule about living in glass houses and throwing stones: I’m addicted to watching The Home Depot Supply.

I don’t doubt that Idol junkies would say I’m weirder than they are. But we’re all watching the same thing: top-quality amateur entertainment with a cast of characters who may be superstars one week and back at the wheel of a UPS truck the next.

And just as American Idol can knock your socks off and still leave you feeling like you’ve been watching karaoke, there is something about HD Supply that doesn’t quite ring true.

I understand the basic premise. Home Depot intends to become the marquee player not just in home improvement but in literally every phase of a building’s life cycle: infrastructure (water, sewer, and utilities), home building (concrete subcontractors’ supplies, LBM, plumbing, electrical, HVAC, and interior finish and decor), and maintenance and repair (residential and industrial).

That’s HD Supply’s mandate, and it is climbing the charts quickly. According to a presentation by EVP Joe DeAngelo at Depot’s investor/analyst meeting in January, the division is already number one in the nation in waterworks, concrete subs’ supplies, utilities, and interiors, and among the top five in MRO, plumbing, and HVAC. With its acquisition of Cox in May, HD Supply cracked the $1 billion mark in LBM, which makes it a top-10 pro dealer, as well.

Here’s where my reception gets fuzzy: HD Supply’s stated objective is to reach $25 billion by 2010. By DeAngelo’s calculations, the remaining dollars to be captured in all his target markets combined come to $369 billion, but the biggest opportunity by far is in LBM: $138 billion, or about 37% of the total.

Assuming proportional growth—and to achieve his goal of becoming a market leader—DeAngelo has to acquire $8.88 billion in LBM sales. He can’t do it with dealers the size of Williams Bros. or Cox; there are only seven in that revenue range and it’d take more than 20 of them. To make his numbers, he’ll have to buy one or maybe even two billion-dollar-plus chains.

So who might they be?

The name that keeps coming up is Fidelity Investments’ Pro-Build Holdings (Strober and Lanoga). I may be wrong (and often am), but I don’t see it. Fidelity obviously has an exit strategy, but unless Depot is willing to overpay and give it that return immediately, the only reason to bail out would be if HD Supply is perceived as a serious threat to the plan. Fidelity doesn’t seem intimidated so far.

Stock Building Supply, BMHC, and Builders FirstSource are publicly held and so in theory, vulnerable to a hostile takeover. But that usually also means overpaying with the expectation that the stock price will rise to cover your investment, and Depot shareholders are a little sensitive about that right now.

That leaves 84 Lumber and Hope Lumber & Supply. Both fit HD Supply’s low-cost provider model; 84 is also restructuring in a way that fits, closing rural stores and investing in component plants plus installed sales to target big builders in major metro markets. Still, both have done well on their own; they may not want to bail out.

This is all pure speculation, of course, but that’s what American Idol fans do, too. It’s fun—until each season ends, that is. At that point, the winners are on their own, and most are quickly forgotten.