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Lowe's Looks to Improve, Picks Orchard

NEW YORK ( TheStreet) -- Last week, I wrote about the divergence that exists between rivals Lowe's (LOW - Get Report) and Home Depot (HD - Get Report).

Lowe's, which has been struggling for some time due to (among other things) lack of a merchandising strategy, was coming off a disappointing first quarter, for which management blamed the weather. Meanwhile, Home Depot post better-than-expected first-quarter results and raised guidance.

I warned that if Lowe's was serious about narrowing the gap with Home Depot that it needed to adhere to its own slogan and "never stop improving."

On Monday, the company revealed its plans by offering $205 million in cash for Orchard Supply (OSH).

One of my biggest criticisms of Lowe's had been the company's lack of a store-expansion strategy and management's unwillingness to take risks.

Even though Orchard, which filed for Chapter 11 bankruptcy protection, might also be struggling, this is a good move for Lowe's, which is looking to capitalize on the California housing recovery. But it's not as easy as it seems.

The fact that Orchard is under bankruptcy protection introduces complications to Lowe's bid. And "bid" is the right term to use here because Orchard's assets will be up for auction. Meanwhile, Lowe's offer will essentially become the "stalking horse," which will protect Orchard from low-ball offers. For Lowe's, though, this process is still far from a slam dunk. This is even though competing bids must be at least $12 million.

Given how badly Lowes wants/needs this deal to happen, I don't believe it will allow anyone else to step in and outbid it. I say this because $205 million is a pretty significant premium for Orchard. It values the company's shares at close to 20% more than their closing level of $1.88 on Friday. Plus, given Orchard's debt situation and less-than-appealing balance sheet, one can argue Lowe's is overspending.

Lowe's, which already has 110 stores in California, wants 60 of Orchard's 91 stores, which are considered to be located in "prime" areas. Orchard's stores are about one-third the size of Lowe's, which average about 113,000 square feet. Assuming that this deal goes through (I can't imagine why it wouldn't), Lowe's will also have smaller stores that rival the likes of Ace Hardware.
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