EUR 464.20 For Business Accounts Only

Accumulate Stable High-Margin Industrial Distributor Pre-Spin

HD Supply Holdings, Inc. (HDS) has a history of value creation through divesting non-core assets since its IPO in 2013, coming to its most recent move: the planned Spinoff of its Construction & Industrials distribution business. We believe the Parent will benefit from this transaction, and additional catalysts are present with the involvement of two activist investors, a director purchasing stock on the open market, and a flexible balance sheet allowing for a higher multiple.

Path from Listing to Break-Up...
Originally founded as Maintenance Warehouse in San Diego in 1974, the business was acquired by The Home Depot, Inc. (HD) in 1997, eventually renaming internally to HD Supply in 2004. HD also acquired another business (Hughes Supply) in 2006, which was integrated within HD Supply. During a CEO transition from Bob Nardelli to Frank Blake in 2007 (on the back of criticism for being over-diverse in its operations), HD Supply was sold to the private equity group made up of Bain Capital, The Carlyle Group, and Clayton, Dubilier & Rice, with the proceeds of the sale (just over $10bn) used to pay down debt and buy back stock. Each of the PE firms owned one third of the business.

The PE firms then brought HD Supply Holdings, Inc. (HDS) back to the public market with its IPO on June 27, 2013. The stock listed at $18, which was lower than anticipated (the guided range up to listing was between $22-$25). As part of HDS’ ongoing strategy for value creation through divesting non-core assets, the company announced the Spinoff of its Construction & Industrials distribution business (retaining the Facilities Maintenance segment) in September 2019 (our announcement alert can be found here).

Since its IPO in June 2013 and up to its pre-pandemic high of $43.29 (February 20, 2020), HDS provided a total +132.0% return (at a CAGR of +12.8%), outperforming the Russell 1000 Index’s return of +109.1% (at a CAGR of +11.1%) in the same period, demonstrating the company’s long-term value creation efforts.

The Edge View...
HDS will be Spinning off its lower margin and cyclical Construction & Industrial business (FY18 adjusted EBITDA margin of 11.0% Vs. overall 14.3%) into a new publicly traded company, retaining the high margin and stable Facilities Maintenance business (FY18 adjusted EBITDA margin of 17.7% Vs. overall 14.3%). HDS post-Spin will be a leading player in maintenance, repair, and operations solutions (MRO), as it mainly serves the less cyclical living-space verticals. The multifamily end-market represented about 64% of 2018 sales, followed by hospitality at 19%, health care at 8% and institutional at 7%.

Therefore, HDS (ex-Spin) seems to be the more attractive asset with stronger margins and steadier end-market demand. On the other hand, The Spinoff (comprised of the White Cap brand in the US and Brafasco in Canada) primarily serves the non-residential construction market, with a focus on concrete accessories, specialty construction and safety products. This market carries cyclical risks, especially considering the almost entire freeze on building as the pandemic continues to pressure.

ESR Action: We believe investors should accumulate HDS at current levels (see below for our valuation) to participate in the opportunity provided by the upcoming Spinoff and ongoing focus on core operations. The CEO’s track record of value creation through strategic divestitures, insider buying from a recently appointed director, and post-Spin position as a high margin stable business are all positive factors that add to our conviction in HDS’ prospects.