Story Stocks^®

Dick's Sporting Goods (DKS) is selling off sharply, while Foot Locker (FL) is soaring after DKS announced its intention to acquire FL for approximately $2.4 bln, or $24 per share, marking a significant move in the athletic retail sector. This opposing movement is typical in acquisitions, where the acquiring company's stock declines due to perceived risks, but the hefty 87% premium over yesterday's closing price for FL is undoubtedly contributing to DKS's sell-off as investors assess the deal's valuation.

Separately, DKS also issued upside Q1 EPS guidance of $3.37 with solid comps of +4.5%, while FL issued downside Q1 EPS guidance of $(0.07) and weak comps of -2.6%, reflecting its ongoing challenges. This contrast in performance is not a new development as DKS has benefitted from market share gains and its diversified merchandise assortment, while FL has faced sluggish consumer spending and fierce competition.

• This deal potentially involves DKS issuing common stock since FL shareholders will have the option to receive either $24.00 in cash or 0.1168 shares of DKS common stock for each FL share they own. The total number of new shares issued will depend on the election choices made by FL's shareholders, but the possibility of DKS issuing common stock is one reason why shares are trading lower today. Another primary reason is the belief that DKS may be overpaying for FL.
• The transaction implies an enterprise value of approximately $2.5 bln for FL. DKS stated this represents an acquisition multiple of approximately 6.1x FL's adjusted EBITDA in FY24. Prior to the acquisition, FL was trading with a P/Adjusted EBITDA of approximately 3.5x, which reflected the company's struggles and weak financial performance, including yr/yr revenue declines in nine of the past eleven quarters. Given the poor results, investors could argue that FL doesn't warrant a P/Adjusted EBITDA of 6.1x, even though that looks relatively cheap on the surface.
• From a strategic standpoint, DKS's acquisition is motivated by its desire to expand its footwear business -- a critical growth area. FL, with over 2,000 stores globally and a focus on athletic footwear, complements DKS's broader sporting goods portfolio. Despite FL's struggles, DKS believes it can turn around FL's business. This turnaround strategy includes leveraging DKS's operational strengths and its strong brand relationships with NIKE (NKE) and Adidas. However, FL's smaller store layout may not align perfectly with DKS's success in large formats, potentially requiring reformatting or repurposing.
• There is also risk of sales cannibalization as both companies operate in overlapping markets, but DKS anticipates synergies, such as cost savings and cross-selling opportunities, will offset this. The integration plan involves maintaining FL as a standalone business while leveraging DKS's scale for improved purchasing power and operational efficiency, potentially mitigating cannibalization risks.
• DKS expects the transaction to be accretive to EPS in the first full fiscal year post-close, projected for FY26, driven by cost synergies such as reduced overhead and improved margins from combined operations. Factors supporting accretion include FL's potential for turnaround under DKS's management and increased market reach, potentially boosting revenue. However, financial risks include issuing new debt to finance the deal, and integration and execution risks are also significant as merging operations could disrupt DKS's momentum.

The market's unfavorable reaction to DKS's acquisition of FL reflects concerns about the high premium and integration risks. While the strategic fit is strong, with potential for footwear expansion, the execution challenges and risks of disrupting an already strong business have investors questioning the deal.