Home Retail bid rumours fail to convince

Home Retail was back in the spotlight yesterday after it emerged that a US private equity investor had bought a 4.25 per cent stake in the owner of Argos and Homebase.

Madison Dearborn Capital Partners typically invests between $100m and $600m in each holding and it has raised its stake in the general-merchandise group from 3.2 per cent in the middle of March.

Ahead of its full-year results on 20 April, the purchase lifted shares in Home Retail, partly as it rekindled persistent speculation of a takeover bid. Of the potential suitors, the Walmart-owned supermarket chain Asda was believed to have considered a bid for the group in the spring of 2010, though it decided against an aggressive non-food land grab.

While the speculation surrounding Asda or a buyout giant launching a bid has refused to go away, we are not convinced it now holds much more water than a Homebase plant pot.

This is partly because the group's profits, margins and earnings per share are set to decline over the next year and the outlook for UK consumers looks as tough as a hoodie in one of the group's Argos stores. As recently as last month, the company guided down its profits for the year to the end of February this year to between £250m and £255m.

In our view, a break-up of the group is far more likely, but not for the foreseeable future. In its defence, Home Retail has a strong management team, generates lots of cash and has completed a £150m share-buyback in the past year. Furthermore, Argos has a slick multi-channel operation and performed far better than many expected over Christmas.

But Home Retail's shares have jumped around 10 per cent this year and now trade on forward earnings multiples of 11.2 times, which is by no means a bargain.

According to Seymour Pierce, a private equity takeout model implies a valuation of around 280p a share. But with consumer spending likely to be in the doldrums for the rest of this year, we think a bid is unlikely and Home Retail is better left alone.

Source : Nikhil Kumar - The Independent