Will Wesfarmers Ltd (ASX: WES) expand into the United Kingdom in 2016?

Wesfarmers, Australia’s leading conglomerate with ownership of names like Coles, Bunnings Warehouse, Officeworks, Kmart and more, today announced it has made an offer to acquire UK’s Homebase for £340 million ($699 million).

Homebase is the UK’s second-largest home improvement and garden retailer, with 265 stores and reported revenue of £1,461.2 million last financial year. Wesfarmers said it has made a conditional offer to Home Retail Group Plc, the owner of Homebase, following months of confidential due diligence.

“Wesfarmers and Home Retail Group began discussions in September 2015 and due diligence work commenced under a confidentiality agreement in October 2015,” Wesfarmers’ ASX announcement read. “An exclusivity agreement was signed in early December 2015 and confirmatory due diligence has now been completed. Transaction documentation is advanced and in the process of being finalised.”

Wesfarmers says there is no guarantee the deal will go ahead, but the deal appears to have plenty of strategic rationale. It says the UK home and garden market is attractive and growing, the Homebase platform is scalable and low-cost, and it provides the first step in a program that could see Wesfarmers rebrand the core Homebase stores into Bunnings Warehouses.

Data sourced from S&P Capital IQ

Data sourced from S&P Capital IQ

The offer price, which represents just 23% of annual sales, will appear very cheap if Wesfarmers can ‘do a Coles’ and turn the Homebase business around. However, without a turnaround strategy, Wesfarmers would be buying the business at a price-to-operating earnings ratio of around 17x – which isn’t exactly a ‘bargain’.

Data sourced from S&P Capital IQ

Data sourced from S&P Capital IQ

As can be seen above, the Bunnings business appears much more profitable than Homebase. However, it should be noted that for simplicity the Bunnings EBIT margins include the contribution from Officeworks (Wesfarmers reports Bunnings and Officeworks together in their financial statements). However, Wesfarmers said Bunnings achieved a 33% return on capital employed in 2014, which suggests those margins above may even be somewhat conservative.

Nonetheless, if Wesfarmers can turn Homebase’s margins around, and more towards those of Bunnings, it’ll prove to be a very savvy investment. There are risks, of course, but Wesfarmers is a well run business, with capable management and an enviable track record for big purchases, a la the Coles Group acquisition in 2007.

The deal is subject to approval from Home Retail Group shareholders, but Home Retail Group shareholders will likely be happy knowing one of their businesses is the subject of takeover activity following continual share price declines throughout 2015. The company’s share price is down 45% year-over-year.

Foolish takeaway

Provided the deal goes through, if Wesfarmers can turn the Homebase ship around, it could prove to be a very savvy investment. However, I can recall many instances of Australian companies venturing overseas only to come home with their tales between their legs and hundreds of millions of dollars the poorer.

Nonetheless, if I were a Wesfarmers shareholder (I’m not), I’d be pleased with my company’s decision.

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Motley Fool writer/analyst Owen Raszkiewicz has no position in any stocks mentioned. Owen welcomes your feedback on Google plus (see below), LinkedIn or you can follow him on Twitter @ASXinvest.

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.