Dick's Sporting Goods (NYSE:DKS) is making a tough call with its proposed purchase of Galyan's Trading (NASDAQ:GLYN). Investors are cheering the move today, though, sending shares of Galyan's up 50% to $16, and shares of Dick's up more than 13% to $32.
Dick's plans to shell out almost $305 million in cash and assume $57 million in net debt to seal the deal. With low-cost behemoths such as Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) in the space, size is necessary to compete. Still, the transaction's price tag -- which represents a 53% premium over Galyan's shares as of market close on June 18 -- as well as Dick's use of cash, may trouble some investors.
Dick's has hit some bumps, but has generally demonstrated solid operating performance. Although some have remarked that Dick's hasn't been adequately rewarded for its prowess, its stock still carries a respectable 22.5 forward P/E. Given this valuation, equity would seem to be the natural currency for acquisitions. Instead, by using cash, the company will have to borrow $197 million from a new $350-million credit facility, adding to its $176 million in long-term debt.
Galyan's, meanwhile, has been less consistent, at least in the profitability department, even though many shoppers admire its stores. Nevertheless, its shares win the popularity contest. The stock carries a trailing P/E of 55 and a forward multiple of 26. Evidently, though, Dick's thinks the chain is worth every bit of its price and then some.
Dick's expects the deal to work on several levels. First, the purchase has geographic benefits, through the addition of stores in Minneapolis, Dallas, and Denver, as well as an Indianapolis distribution center that will feed Western locations. Dick's also expects it can lower its procurement costs by purchasing in greater volume and, finally, that it can bring its inventory control expertise to Galyan's sites.
The most significant hurdle may be re-branding Galyan's outdoor-equipment-focused stores. Dick's noted that the acquired sites will shift their merchandise mix to reflect Dick's greater emphasis on sporting goods. This change may help in inventory management, but Galyan's shoppers who appreciate variety could be turned off.
Even with all the challenges, Dick's is confident in the transaction's success. The firm is projecting the deal will be slightly accretive in 2004 and that earnings will grow 30% in 2005, excluding integration expenses. One thing is for sure: Dick's has grabbed investors' attention.
Fool contributor Brian Gorman is a freelance writer living in Chicago, Ill. He does not own shares of any companies mentioned here.
