Expansion is often seen as a sign of strength and future growth for companies. However, this isn’t always the case.

Dick’s Sporting Goods (DKS) recently announced a $2.4 billion acquisition of Foot Locker (FL), offering an 80% premium over FL’s recent stock price. 

However, the market reacted negatively, sending the sporting goods company’s stock crashing down by over 12%.

The concern lies in Foot Locker’s much lower profitability compared to Dick’s Sporting Goods, raising fears that the deal will dilute the company’s overall performance.

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Expansion is often seen as a sign of strength and future growth for companies. However, this isn’t always the case.

When a company decides to acquire a business that operates with much thinner margins, it raises immediate questions for investors.

Will the new, less profitable segment drag down the overall financial performance of the acquiring entity?

This scenario played out last week.

Dick’s Sporting Goods (DKS), one of the top sports retails in America, recently announced its intent to acquire Foot Locker (FL), one of the largest shoe retailers, for approximately $2.4 billion. 

This acquisition is a significant strategic move for Dick’s Sporting Goods as it will enable the company to expand its reach, not only by leveraging Foot Locker’s existing U.S. store locations but also by venturing into international markets for the first time. 

This global expansion could open new revenue streams and customer segments for the sporting goods company.

The business also anticipates achieving between $100 million and $125 million in cost synergies over the medium term.

However, this news has not been met with enthusiasm from the market, as Dick’s Sporting Goods’ stock has dropped over 12% since the announcement.

On the surface, the acquisition price of $24 per share for Foot Locker appears to be a significant premium, representing an 80% increase over Foot Locker’s stock price just before the announcement. 

However, it’s important to note that Foot Locker’s stock had been trading at depressed levels, largely due to concerns over tariffs. 

In fact, Foot Locker’s stock was at the $24 per share mark as recently as December 2024. 

This suggests that while the premium seems large compared to its recent low, it’s not necessarily a reflection of a sudden, significant increase in Foot Locker’s intrinsic value.

The market’s negative reaction to the sporting goods company’s move, despite the seemingly favorable acquisition price for Foot Locker, can be understood by looking at their respective business performances. 

Dick’s Sporting Goods has achieved a healthy Uniform return on assets ”ROA” of 12% last year. In contrast, Foot Locker’s ROA stands at a much lower 3%, which is below the cost of capital.

When a higher-performing company acquires a lower-performing one, it often dilutes the acquirer’s overall profitability. 

The market recognizes this potential impact on Dick’s Sporting Goods’ financial health. 

Investors anticipate that integrating a business with a significantly lower ROA like Foot Locker will inevitably weigh down Dick’s Sporting Goods’ traditionally strong returns.

Our EEA model clearly shows this.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market expects the company’s Uniform ROA to decline to 8% from 12%, towards pre-pandemic levels.

This expectation is a key driver behind the recent sell-off in Dick’s stock. 

The market’s current assessment is that Dick’s Sporting Goods’ profitability will likely decline in the coming years due to this acquisition, and this appears to be a valid concern given the disparate profitability of the two companies.

For investors, this situation serves as a reminder that growth for growth’s sake does not always equate to value creation. 

A company’s true financial strength is best measured by its ability to generate returns above its cost of capital—the minimum return required to satisfy its investors and lenders. 

When a business expands by acquiring operations that earn below this threshold, it risks destroying shareholder value, even if the deal appears cheap on paper.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Officer &
Director of Research
at Valens Research