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Residence Depot’s $18 Billion Acquisition: Genius Transfer or Waste of Cash?

Home Depot just made its biggest acquisition ever.

Home Depot (HD -0.85%) isn’t known as a prolific acquirer, but every once in a while, the company makes a needle-moving acquisition. In 2020, it acquired HD Supply, a supplier in the maintenance, repair, and operations field, for $8 billion, and last year it bought Temco Logistics and International Designs Group for an undisclosed amount.

The company just announced its biggest acquisition ever, taking over SRS Distribution for $18.25 billion, including SRS’s debt. Home Depot said the deal would expand its addressable market by around $50 billion, and CEO Ted Decker called SRS “An industry leader with a proven track record of profitable growth across verticals.”

Investor reaction to the acquisition has been underwhelming thus far. The stock slipped 0.3% last Thursday and then fell 4.1% on Monday even as Wall Street’s response to the news has generally been positive.

So is the SRS purchase a smart move or is this another example of “diworsification,” as famed money manager Peter Lynch used to call it? Let’s take a look at what SRS does and see what makes it appealing for Home Depot before answering that question.

A Home Depot employee in an aisle.

Image source: Home Depot.

What is SRS Distribution?

SRS Distribution is one of the nation’s largest building materials distributors, focused on roofing materials and building products. It was founded in 2008 and has grown to cover more than 760 locations across 47 states. It also has more than 4,000 delivery trucks and over 2,500 sales representatives.

The company is known in particular for its strength in roofing, a large category with appealing unit economics. In fact, home services marketplace Angi made a play for the roofing market with its 2021 acquisition of Total Home Roofing, though it ended up selling it.

SRS started out as a seller of roofing and building products in 2008 before entering landscaping products in 2019 and the pool products market in 2021. SRS brought in $10 billion in revenue in 2023 and $1.1 billion in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), meaning the deal values SRS at approximately 16 times adjusted EBITDA.

Home Depot’s justification

Home Depot has long seen the pro market as a significant growth opportunity and a way to differentiate itself from rival Lowe’s. The retailer aims to gain market share in the professional market and sees SRS’ model as being complementary to Home Depot’s pro ecosystem, giving it a significantly deeper product assortment and penetration in areas like roofing and pool supplies.

SRS will operate under Home Depot and retain its current leadership. The retailer will pay for SRS with a mixture of cash on hand, commercial paper, and new unsecured notes. It expects its debt-to-EBITDA leverage ratio to reach 2.5x at closing, and plans to deleverage over the next two years, pausing share buybacks to bring its leverage ratio down to 2.

Will the SRS deal pay off for Home Depot?

The logic for the acquisition makes sense, but it’s also true that Home Depot is paying a fairly steep price for SRS, which has a slightly higher EBITDA multiple than Home Depot stock based on the acquisition price. Investors are also likely disappointed in the two-year pause in Home Depot’s share buybacks, which had been a reliable source of capital returns.

However, the acquisition looks like a smart move for long-term growth. Home Depot has essentially stopped opening stores, and its ability to grow within its current business model is somewhat limited as the Home Depot brand only serves one corner of the home improvement market.

From that perspective, expanding the business through acquisitions makes sense, and SRS looks like a rock-solid, profitable business that can bring something new to Home Depot.

It may take time for the business to deliver results for Home Depot, but expanding downstream in the pro market with SRS should pay off for Home Depot. Investors should trust management here.

Jeremy Bowman has positions in Angi. The Motley Fool has positions in and recommends Home Depot. The Motley Fool recommends Lowe’s Companies. The Motley Fool has a disclosure policy.

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