(By Mani) Lowe's Companies, Inc. (NYSE:LOW) has withdrawn its C$14.50 offer for Canadian rival Rona, Inc.(TSX:RON) after significant opposition from numerous stakeholders, notably Quebec politicians and Rona franchisees. Most importantly, Rona's board was steadfast in its disinterest in pursuing any sort of transaction.
A hostile bid is possible and would certainly garner some support, but it would bring much more than its fair share of criticism – from Rona supporters and Lowe's shareholders.
"While it is possible Lowe's will go this route, we believe it is unlikely, particularly given the incompatibility of each company's current operating models and corporate cultures and the firestorm of political opposition it would likely ignite," CIBC analyst Mark Petrie wrote in a note to clients.
So, the next question is what's next for Lowe's, which currently operates more than 1,745 stores in North America, including 31 stores in Canada and three in Mexico, plus an additional 16 stores as part of a joint venture in Australia.
If Lowe's doesn't buy Rona, it might face greater hurdles in trying to expand organically in Canada, and may secure inferior real estate as many of the best trade areas in Canada have already been built out. This is part of the problem that is now holding Lowe's back in the US where its store locations are inferior to Home Depot's (NYSE:HD).
While Lowe's has repeatedly voiced its commitment to continuing its growth in Canada, the losses are mounting. Housing prices are showing some signs of weakness, a recovery in big-ticket renovation spending remains in the distance, and its current network has neither the locations nor scale to deliver the required profitability.
"For the time being, new store openings will be the strategy, but we would not be surprised to see Lowe's pursue an alternative acquisition to Rona," the analyst said.
One of the interesting revelations from the Rona experience was Lowe's willingness to operate stores under a different model than its traditional corporate big-box store, which materially expands the list of potential M&A targets and also adds flexibility to Lowe's store opening plans
"The company will no longer be pinned to +100,000-square-foot boxes and 10- to 15-acre sites and we expect that Lowe's will begin to test smaller stores within the next 12 to 18 months," Petrie said.
This is bad news for Rona, as it will face additional competition in the proximity store formats, which has been its best performer. However, with 178 stores already in that size range, Rona clearly has a substantial advantage.
With a new distribution center under construction, it seems very likely that Lowe's will continue with its organic growth and search for scale.
"Assuming Lowe's decides to focus its efforts elsewhere, we see a couple potential deals that could offer meaningful benefits, albeit not on the scale that Rona would have brought," Petrie added.
Lowe's may eye Kent Building Supplies, a leading home improvement retailer in the Atlantic Provinces with 38 locations generating approximately $450 million in annual revenue. Similar to Rona, the Kent network spans a range of store sizes, with most recent efforts on the medium format stores.
At present, there are 14 traditional stores (5,000 to 45,000 square feet), 17 Warehouse stores (45,000 to 85,000 square feet) and seven big-box stores (85,000 to 100,000 square feet). The company is owned by the Irving family, which has significant holdings across various industries, including lumber and truss manufacturing.
"It is possible that the family's connection to these ancillary businesses has proved a barrier to a deal in the past, but with Rona now out, Lowe's could be back at the table as a more flexible acquirer," the analyst noted.
Canac would be another potential target with estimated annual revenues of $250 million to $300 million) and would clearly give Lowe's a presence in Quebec as it has 18 stores, mostly in the Quebec City area. It might be small enough to fly under the radar, but its Quebec roots could give rise the same political wrangling that an acquisition of Rona did.
The acquisition of a buying group would provide Lowe's with immediate distribution scale within Canada, though with much less ability to influence store offering or operations.
"Both Home Hardware and TIM-BR MART would bring meaningful volumes to the network, though we don't think Lowe's would stray this far off its model," Petrie said.
The purchase of a buying group is always delicate given the ability of store owners to move over to another banner with relative ease. BMR is another group that could be attractive given its strength and distribution infrastructure in Quebec.
Either way, any move that Lowe's makes to expand its Canadian presence and growth plans would be negative for Rona," Petrie added.