The Home Depot, Inc. (HD), HD Supply: Is This The Next Great Spinoff?

This past Friday brought an interesting SEC filing to my attention: the offering documents for an upcoming former The Home Depot, Inc. (NYSE:HD) property, HD Supply. Since the financial crisis ended, and the housing recovery began its long, lumbering climb back to life, home-improvement stores such as Home Depot and Lowe’s Companies, Inc. (NYSE:LOW) have been some of the best-performing stocks over a five-year period. HD Supply, of which Home Depot still owns 12.5%, is a construction materials wholesaler that plays on the housing recovery and public works projects. Let’s examine how the offering will take place and what investors can expect come IPO day.

Business review
The Home Depot, Inc. (NYSE:HD) sold its wholesale construction materials arm to private equity companies in 2007 for more than $8 billion — right before the housing crash. The parent company remains HD Supply’s biggest minority owner and represents 4% of its annual sales, which were just above $8 billion in 2012.

The company operates in four segments: Facilities Maintenance, Waterworks, Power Solutions, and White Cap, which we’ll get to in a moment. HD Supply has more than 600 outlets around the U.S. and Canada and caters to contractors, government entities, maintenance companies, and all kinds of builders. 2012’s sales were 14% higher than the prior year’s, though the bottom line was negative at $1.1 billion. EBITDA growth was substantial, up 34.4%.

Facilities maintenance sells products to multifamily residences, health care and hospitality facilities, and institutional clients. Waterworks, if you can imagine, is water and wastewater products for both residential and non-residential uses. Power Solutions sells anything from electrical transmission units to smart-grid components. And finally, White Cap sells specialty tools, materials, and safety products to contractors.

Why it could win
These businesses are all benefiting from the housing recovery, but it is not just new homes that benefit (and potentially hurt) the company. If consumers take a more cautious approach to their homes in coming years and choose remodeling and repairs over new homes, HD Supply is in prime position. The Facilities Maintenance division addresses a $48 billion market and currently represents just 4% of market share, leaving plenty of room for growth. This is a tough business due to economies of scale, and HD Supply has it. Additionally, out of any of the four segments, this division has the highest gross margin, 18%.

Most of HD Supply’s competitors are smaller, sometimes local businesses. Each of its segments operates in a fragmented industry, where the company’s scale can really become useful.