Why Lowe’s Pulled Its Bid For Canadian Home Improvement Retailer Rona

Lowe’s (NYSE:LOW) has pulled its $1.8 billion bid to buy out Canada’s largest home improvement retailer, Rona, which is based in the Quebec province. Lowe’s withdrew its unsolicited proposal in the face of rejection from Rona’s board and stiff opposition by local politicians. The proposed takeover had generated nationalist sentiment and had become an election issue in Quebec. The leaders feared that  jobs would be cut despite assurances by Lowe’s to the contrary. Lowe’s even hired Robert Evershed of Prospectus Associates to lobby the federal government on its behalf. His goal was to work on gaining approval from the Minister of Industry for Lowe’s acquisition of Rona. ((Lowe’s hires Canadian lobbyist for Rona deal, Reuters))

Lowe’s is based in Mooresville, North Carolina, with 1,745 stores in the U.S., Canada and Mexico. Rona runs approximately 800 stores and 14 hardware and construction material distribution centers in Canada. ((Lowe’s Withdraws $1.8 Billion Proposal to Acquire Rona, Bloomberg))

Markets reacted negatively to the news and Rona’s shares tumbled by 12% to C$11.29 at the close in Toronto, the biggest decline since its 2002 initial public offering. Lowe’s shares slipped by 0.6% to close at $29.23 in New York.

See our complete analysis of Lowe’s here

What Went Wrong For Lowe’s

Lowe’s caused a political firestorm in July with its unsolicited $1.8 billion bid for Rona. Politicians, cutting across party lines, vociferously protested the proposed takeover. Also, Rona’s Board of Directors rejected Lowe’s $14.50 per share offer towards end of July, saying that the takeover offer was not in the best interests of the company or its shareholders.

It was later revealed that Rona as well as Richard Bachand, the Finance Minister of Quebec, had been anticipating such an offer and that the latter had already apprised the federal government of Quebec’s stand over the issue. Mr. Bachand’s office released a statement opposing the takeover idea because of Rona’s pivotal status as a major employer and key buyer of local goods. He mandated the government’s investment arm Investissement Quebec to weigh action to counter the offer, just as underscoring the strong local factor, Quebec’s largest pension fund Caisse de dépôt et placement du Québec announced that it had boosted its stake in Rona to 14% from 12.18%. Bachand has been calling Rona a “strategic asset” that shouldn’t fall into foreign hands. ((Quebec’s move to shield Rona from Lowe’s takeover could end badly, Financial Post))

The Quebec government had stressed Rona’s importance to the domestic economy by claiming that almost half of Rona’s purchases are made in Quebec, and almost 85% in Canada. Rona’s retail sales, including franchised, affiliated and other independent stores that make purchases from Rona, total in excess of $6 billion per year. Purchases from its suppliers amount to more than $2 billion a year in Quebec and more than $3.3 billion in Canada. ((Rona’s rejection won’t end takeover bid, Lowe’s says, CBC News)) In fact, the deal was also opposed by some of Rona’s dealers, who even threatened to cut ties with Rona if it moved forward with the deal.

There was also the issue of impending elections which amplified the rhetoric over the proposed deal. Once politicians from the opposition who espoused an extreme version of economic nationalism went ballistic in protesting Lowe’s proposal in public, the ruling party followed suit. The latter couldn’t afford to hand over a highly emotive issue to the opposition to milk to its advantage.

What Next?

We think that it was a bit of an overreaction to call what is essentially a hardware store, a strategic asset. We think that if the ruling party had won the elections, political opposition would have tapered off after some time. Although the principal opposition party, Parti Québécois, didn’t win an outright majority, it managed to oust the ruling party and form a minority government. We think that this discouraged Lowe’s from pursuing further with its efforts.

Lowe’s started in Canada with 7 stores in 2007 and has since then scaled up to 31 but still lags Home Depot, its biggest rival in the States, which has 180 stores there. We think that Lowe’s saw Rona’s 800 stores and 14 hardware and construction distribution centers as an attractive opportunity to grow inorganically and improve profitability. ((Lowe’s withdraws buyout bid for Canadian home-improvement retailer Rona, Washington Post))

Its business in the US has been facing trouble for some time now, given lack of focus on its pricing strategy. Lowe’s adopted a discounts-and-sales business model which came back to bite the company and has now shifted back to its original “everyday low prices” model, even though it hasn’t helped business owing to changed customer expectations. It has a range of initiatives underway to close the gap with Home Depot.

Also, Rona has a complex, differentiated network of small and big stores which bear little resemblance to the uniform big-box stores that Lowe’s already operates in North America. It would have taken time for Lowe’s to figure out how to operate in this format effectively. In view of this, we think that Lowe’s can derive some positives out of the whole affair. The most pressing issue for Lowe’s is competition in the United States and it can go back to focusing its efforts on that. ((Lowe’s Will Not Be Expanding in Canada, Wall St. Cheat Sheet))

Lowe’s earned $747 million in Q2 2012. That’s down from $830 million a year ago by nearly 10%, and reinforces our stand that the U.S. market needs to be paid attention to.