As I wrote in a post (1/3/2007), Home Depot (HD) has been attempting to make two wrongs equal a right for sometime. The first wrong, a poorly structured (at least from a shareholder perspective) employment contract, facilitated bad relations all around. The second wrong, a reactive removal of Nardelli as the CEO left HD with difficulty executing the complex business model Nardelli had constructed.
Now, HD has struggled with refashioning itself. The basic business platform generates a likely return on capital of 12%, creating adequate cash flows to build new stores, refurbish old ones and pursue business initiatives. Left to its own devices, this would indicate a growth rate of 7% plus inflation on an unlevered basis. Not bad.
But HD is trying to refocus on this business model. It is disposing of HD Supply for about what it paid, given that HD is getting cash back of $8.5 billion, keeping a 12.5% equity stake and guaranteeing $1 billion of debt. Overall, this is not a bad outcome. The purchasers will ultimately take the stock public and HD will cash out at that time without the business having been a management distraction. Thank you, Jamie Dimon.
The aggressive area seems to be the increase of debt in order to repurchase $22.5 billion of stock. HD has been extremely fortunate to have a market downturn, reducing by at least $1.2 billion the cost of its repurchase. The total is almost 290 million shares at $37 per share for a total cost of $10.73 billion. This is roughly 14% of the shares outstanding. Most of this cost will be covered by the $8 billion of sales proceeds from HD Supply. In addition, HD will be borrowing about another $12 billion to repurchase more shares. A downturn in the stock would be welcome as it would allow HD to dramatically shrink share count.
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