Why the Lowe’s-Rona Deal Is a Smart Move

Merger-and-acquisition activity is heating up in the retail space. The latest deal is home improvement giant Lowe’s (NYSE: LOW) acquisition of  Canadian home retail giant Rona in a $2.3 billion transaction.
Rona operates more than 500 corporate-owned and independent affiliate stores. If the acquisition deal is successful, it will allow Lowe’s to instantly and forcefully expand its Canadian business. As of today, Lowe’s operates just 40 stores in Canada, a very small fraction of its more than 1,800 locations in North America. Rona, meanwhile, operates 700 stores across Canada.
The Lowe’s-Rona deal is being met with a significant amount of scrutiny from investors. The reason is because other retailers have tried – and failed – to enter Canada. But here’s why Lowe’s deal is different, and why the company has a great chance of a successful integration.

A Lesson From Target

Lowe’s attempting to expand into Canada seems like a natural fit. The neighboring nations present millions of new customers and attractive growth potential, without much of the cultural frictions that can sometimes make international expansion difficult. Lowe’s can look at Wal-Mart (NYSE: WMT) as an example of a company that has gained ground in Canada. Wal-Mart established Wal-Mart Canada in 1994 and has grown to operating nearly 400 retail units there. That suggests a precedent for American companies to succeed in breaking ground in Canada.
But more recently, investors likely recall the trouble discount retail giant Target (NYSE: TGT) had in its own Canadian expansion effort. Last year, Target closed all of its 133 Canadian stores. Initially, Target Canada was able to bring shoppers through the door because of the significant promotional activity associated with its grand opening. That initially allowed Target Canada to rack up $1.3 billion in sales in the last three quarters of its operation, which was 90% growth from the same period the year before. That was impressive, but Target Canada lost $627 million in the same period in earnings before interest and taxes.
The reason why Target couldn’t make money in Canada is because once the promotional activity ended, shoppers in Canada didn’t return to the stores. This dynamic was evident in poor same-store sales numbers — the metric that analyzes a retailer’s sales from stores that are at least one year old. In the last three quarters of its existence, Target Canada’s same-store sales declined 3.3% year over year. Making matters even more difficult is that Target management did not envision turning a profit in Canada until 2021, at the earliest.

Why the Lowe’s Acquisition Is Different

On the surface, it’s easy to dismiss the Lowe’s acquisition as a waste of time and money, given Target’s failures in Canada. But there are some important differences that separate Lowe’s strategy from Target’s. The biggest  is that Lowe’s is buying a company with a proven business model and an established brand that Canadian consumers know and like. Target tried — and failed — to bring its own brand to Canada, which consumers there were not familiar with nearly to the same extent.
This is an important distinction. Rather than trying to build its entire Canadian operation from the ground up, which would be very time-consuming and costly process, Lowe’s is simply buying an existing company there. Since they are nearly identical business models, Lowe’s will be able to squeeze out significant cost synergies from the deal. That’s why Lowe’s expects the acquisition to be accretive to earnings in the first year upon completion.
Lowe’s management undoubtedly is aware of Target’s failure. That’s why it is wisely keeping the Rona brand name. If successful, the acquisition will allow Lowe’s to overtake the Canadian unit of Home Depot (NYSE: HD) as the dominant home improvement company in the country.
Lowe’s has deep enough pockets to easily afford Rona. At the end of last quarter, Lowe’s held $1.3 billion in cash on the balance sheet. With interest rates still near zero, Lowe’s isn’t earning much at all on that money. The bottom line is that the Lowe’s acquisition makes both financial and strategic sense for Lowe’s, which is why the company deserves credit for making a good deal.

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