If you were surprised by last Monday evenings announcement regarding the Dicks Sporting Goods acquisition of Galyans Trading Company, you probably have not been reading between the lines (or BOSS) for the last six months.
After Dicks failed in its attempt to quickly capture real estate in the Northeast in the Bobs deal, and then Galyans announced that they would be exiting some of the outdoor business in favor of athletics and moving to more single story formats, and Dicks started to move to more two-story formats, the question really became one of timing and opportunity.
Galyans only needed a one last hefty push over the falls to make this all happen and that came when Dicks entered Indianapolis in April with all the subtlety of General Norman Schwartzkopf in Desert Storm.
The deal will result in a new quasi-national chain that will see 239 Dicks Sporting Goods stores in 33 states from Maine to Las Vegas by year-end 2004. The combined entity had 216 stores in 32 states generating income of $56 million on sales in excess of $2.2 billion at fiscal 2003 year-end.
The conversion to the Dicks format is expected to be completed in the first half 2005. The deal puts Dicks in the catbird seat in the East as their largest big-box rival attempts to re-build the TSA chain in the East from Denver while growing the former Gart business in the West. The deal also pits the two solidly against each other in the Sportmart territory and gives Dicks stores in Texas to compete with Oshmans and even lands them in the backyard of their chief rival. The deal now gives them a solid foothold in Chicago, Atlanta, Minneapolis, Dallas and Denver.
Dicks is acquiring Galyans at $16.75 per share, or $305 million in cash, and approximately $57 million net debt for a total deal value of $362 million. DKS said Galyans generated $719 million in sales over the last 12 months ended in April. The purchase price, which is a 53% premium over the GLYN closing price last Friday, represents a valuation that is 10.6x last 12 months EBITDA of $34.2 million, but Dicks sees the value closer to 6.7x EBITDA when factoring in $29 million in anticipated savings and synergies.
Dicks will fund the deal with cash on hand, which totaled approximately $173 million on May 1, and borrowings under a new $350 million credit facility they expect. They have a bridge loan in place just in case.
The deal is expected to be completed in October 2004. The affiliate of Freeman Spogli & Co. and Limited Brands, Inc. that own 55% of GLYN common shares have already agreed to tender their shares to Dick's.
The B.O.S.S. Report quipped back in March (BOSS_0410) that this would be a real estate play after new Galyans CEO Ed Holman said he didnt see them as much of a fit for anyone from a merchandising perspective.
Dicks is all about real estate and putting their strong operational model in place, a strategy that should see the former Galyans stores start to produce better results sooner rather than later. Yes, the merchandising mix will need to be re-vamped, and there is surely too much overlap of real estate in some locations, but the quaint little operation born in Binghamton, NY and entered adulthood in Pittsburgh, PA, has a clear head and a sound plan that is expected to help push DKS earnings up more than 30% next year.
“Combining the financial discipline, operating metrics, and innovative store design of Dick's that have led to our industry-leading financial performance, with the people, real estate, and distribution infrastructure of Galyan's creates a compelling rationale for this transaction,” said Ed Stack, chairman and CEO of Dick's Sporting Goods. “The Dick's Sporting Goods and Galyan's store locations are complementary, and the combination of the Galyan's store design, customer service and premium locations with Dick's emphasis on execution and inventory management make for a best in class shopping experience.” He went on to say that real estate was the primary driver in the acquisition.
Dicks said they feel they now have more comfort with the two-story formats that dominate the Galyans real estate portfolio. Stack said their experience with their five current two-story stores gives them reason to believe they can produce economic returns “equivalent” to the single-story format.
Dicks said that the two-story format gives them more opportunity to broaden the women's apparel area. They said it also enables them to increase the hardlines offering, especially in the team sports category. Stack also said the current two-story Dicks stores see more cross-shopping by customers and are “very pleased” with performance from an average ticket standpoint. Stack reiterated that he still anticipated that the majority of stores going forward would be the single-level stores and also said the occupancy costs associated with a Galyans store versus his is “very similar”.
As for the larger format Galyans stores, those in excess of 140,000 square feet or so, management said they “will not merchandise the stores to the square footage, we will merchandise and inventory the stores to the sales number.” They said they may have to make some of those stores look fuller than they really are, either with the addition of a service desk or setting up more tents to take up the space. They said they will not be loading up inventory just to load up space.
The new Galyans headquarters in Plainfield, IN is expected to be shuttered, which has angered the Plainfield town government after they just floated a $7 million bond to build the brand new headquarters, but the Galyans DC will be retained to service the combined entities stores in the West.
Stack also said he sees Dicks “increasing overall bench strength” by adding “many” of the Galyans people to the Dicks team. The last year has already seen a merger of sorts as personnel from Galyans systematically started the move over to Dicks as the writing on the wall became all the more apparent in Indianapolis. Not that Interstate 70 started to look like a column of ants after a dropped piece of food at a picnic, but Dicks has certainly secured some key people in some core positions, most notably Denny Feldman, who now heads up the Lodge business for DKS after running Outdoor for Galyans for years.
DKS sees the acquisition as “slightly accretive” to its previous guidance for fiscal 2004. Revised guidance now calls for $1.28 to 1.30 per share for 2004 excluding merger costs, but anticipates that fiscal 2005 diluted EPS could increase “more than 30%” over previous guidance to $1.70 to $1.75, based on anticipated synergies and “approximately $20 million of annualized cost savings and merchandise buying improvements that will result from the acquisition.”
The stock market apparently approved as DKS shares rose to $34.40 Tuesday before falling back to $33.43 by weeks end, a 14.5% increase for the week. Of course the Galyans stock rose to just under the tender offer, more than a 50% increase in one day.
Some analysts cautioned that the purchase price seemed high. Others downgraded the stock at the new price. Harris Nesbitt analyst Sean McGowen does not think the 35% year-over-year growth is sustainable.
Dicks did say they saw some improvement coming out of recent actions by the Galyans management team, but would help improve the metrics even further. Stack pointed to a 20% decline in inventory per square foot at Galyans at the end of Q1. As a combined entity, DKS sees fewer markdowns as they move the Galyans stores to the inventory control practices that are inherent in the DKS model.
Stack also pointed to increased leverage from the Private Label business as they expand their door count with the Galyans stores. Margins in PL are running about 800 basis points higher than the rest of the business and management still feels the target to bring Private Label up to 15% of sales is still valid.
The expansion of stores in any particular market will also help Dicks leverage advertising costs. There is some current and planned overlap, but also some complementary locations. For instance, in Georgia Dicks started their move there with a store in Macon. Galyans has three stores in the Atlanta market. Same holds true for Maryland, Virginia, and much of the Midwest, where DKS can now amortize regional ad expenses across more stores. A clear example is Galyans new store opening this fall in the Southpark Mall in Charlotte, NC as the perfect complement to the five current (and one planned) Dicks stores located on the citys perimeter. A more difficult road to expense leverage can be argued in Massachusetts, New Jersey, and the lone store at Roosevelt Fields.
Spreading real estate too broadly in expensive advertising markets was a major contributor to Galyans downfall.
The question now is how quickly Dicks will now move to backfill markets where only one or two Galyans stores exist, and how eager they are to take on TSA in their home market. The Texas question should probably weigh heaviest, since they will either need to get big there fast or risk a drain on resources. The Salt Lake City store should be a no-brainer, a store Galyans was reportedly looking to close anyway.
Dicks provided no direction on stores to be closed, but did say there would be a “minimum number” of stores closing, with both Dicks and Galyans stores on the table, based on “both overlap and on performance of the stores”.
The increase in the number of stores will also help leverage SG&A expenditures.
On the assortment side, Dicks noted that Galyans was already moving closer to their model in merchandising with more athletics, sporting goods, and hardlines and less emphasis on “lifestyle” apparel and a heavy emphasis on outdoor.
“Conversion of these stores to Dick's stores, then, is a natural extension of what's already begun,” said Stack. “So, we're just building on a transition that has already begun.”
One question may be how the Soccer Mom, Galyans primary customer, respond to the more masculine Dicks assortment.
Some areas that would be re-vamped would be items such as women's sundresses, bathrobes, blankets, towels, and “some of the-that fashion aspect of the business that doesn't fit with a Dick's store.” Management said they expect that the Galyans stores will stay in the SnowSports business, but need to talk with a number of those vendors.
Stack said the climbing walls in the Galyans stores will stay in place. The remaining walls will not be the biggest issue Dicks faces as they move to integrate this business.
Some argued that they paid too much and put them back into the high Debt to Capital situation they faced prior to the ramp up to the IPO.
DKS shareholders are pleased because they dont get diluted. GLYN shareholders are ecstatic because they got way more than they ever thought they would see again. But the fact of the matter is that they could have built these stores for a lot less than they paid for them. This move obviously accelerates their expansion plans and puts even more pressure on their primary competitor, but the market will be watching how quickly they make this work as a cohesive unit.
The other issue will obviously be culture, but both companies come from similar roots as a family-run business and perhaps, just perhaps, they yearn for the good ol days when Pat Galyan ran the business. Sometimes, people only need solid leadership to follow.
>>> It appears that Richard Leto, incoming GLYN president and CMO, made a killing on this acquisition. He began work on 6/14. Under the terms of his employment agreement, with a change in ownership Leto is entitled to a payout of his annual salary ($600K), a payout of all of his target bonus ($450K) and all of his options (250,000 @ $9.60), netting him a total gross payout of about $3 million for a week's work
>>> While we expected this to happen, we expected it to happen after Galyans was weakened a bit more and DKS could pick up the real estate cheaper. Perhaps the lessons learned in the Bobs was a key driver in this deal
>>> Will this now take the heat off of TSA in the south. Is that Academys baby now?
