Bankrupt Retailer Could Have Life

 | Jun 17, 2013 | 2:00 PM EDT
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A small West Coast retailer that has been feeding short sellers could now potentially be an interesting opportunity, given recent developments.

On the surface, it appears that equity holders are no better off, but it certainly bears watching. Orchard Supply Hardware (OSH), a small West Coast retailer with a market cap of $11 million, received a $200 million buyout from giant Lowe's (LOW). If only the upside were that lucrative; it absolutely is not, but there are some interesting dynamics that don't have me necessarily dismissing this headline altogether.

Here is a quick background. Orchard Supply was previously owned by Sears Holding (SHLD), the retailing giant that has its fair share of growing pains over the past several years. Sears spun out OSH to its shareholders and shares were dumped immediately. Shares of Orchard traded as high as $20 in the past year -- shares now trade for just under $2. The news of Lowe's sent shares skyrocketing over 70%, and now they are settling above $3. 

Orchard's balance sheet is sickly with over $250 million in indebtedness. The debt load was so burdensome that OSH recently filed for Chapter 11 bankruptcy. As a result, Lowe's $205 million bid for the assets of Orchard becomes very interesting. Because of the bankruptcy filing, Lowe's offer is a "stalking horse bid," which essentially sets a floor price on the value of Orchard's assets. Orchard now can seek superior offers to trump the $205 million. 

Lowe's wants Orchard so it can expand its footprint in the West Coast, where all of Orchard's stores are located. Orchard's smaller store size of approximately 35,000 sq. ft. is also very attractive to Lowe's which operates large 100,000 sq. ft. warehouses and wants smaller retailer boxes to better compete with the growing online market. It's easy to see why Orchard is very appealing to Lowe's. It's a very cheap way for Lowe's -- Lowe's earned over $500 million in profits in the first quarter - to add to its West Coast presence.

Whether Home Depot (HD) will be interested will be something to watch. HD could easily justify a much higher bid merely to keep its biggest rival out a key market. Wal-Mart (WMT), which is also looking to build smaller retail boxes, could sneeze out a few hundred million dollars to get these established assets. Now that a Lowe's has officially kicked off an auction process, there will surely be others that take a closer look. Whether that manifests into anything more valuable is another story. The Lowe's deal is expected to close within three months.

A technical, yet worthwhile, note to keep in mind is that over 30% Orchard's shares are in the hands of a short seller. If this stalking horse bid spooks them the run to cover, the shorted sales could create another tailwind. Regardless of the outcome, a large-cap retailer has taken an interest in a micro-cap retailer and it may be worthwhile to keep abreast of the developments.

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