Lowe’s Companies Inc. (NYSE: LOW) plans to buy the majority of Orchard Supply Hardware Stores Corp.’s (Nasdaq: OSH) assets for $205 million through a bankruptcy auction.

Orchard was placed on Mergers & Acquisitions June 11 Distressed Company Watch List after it indicated in filings with the U.S. Securities and Exchange Commission that it doubted its ability to continue as a going conern, or without the threat of liquidation. The company filed for Chapter 11 bankruptcy protection on June 17 in the U.S. Bankruptcy Court for the District of Delaware in Wilmington.

Orchard, headquartered in San Jose, Calif., operates 91 neighborhood hardware and garden stores, mostly in California, with 2 stores in Oregon. Mooresville, N.C.-based Lowe’s would purchase 60 of those stores, and assume payables owed to Orchard’s suppliers, as the company’s stalking-horse, or lead, bidder.

“Strategically, the acquisition will provide us with immediate access to Orchard’s high density, prime locations in attractive markets in California, where Lowe’s is currently underpenetrated,” says Robert Niblock, Lowe’s CEO.

Lowe’s would receive a 3 percent breakup fee if it doesn’t win the auction. For another bidder to win, they must pay at least $217 million, plus an expense reimbursement fee of $850,000.

To continue operating its business during the bankruptcy process, Orchard has secured a $177 million debtor-in-possession loan from Wells Fargo Bank, the company’s existing asset-based lender, and its term-loan lenders.

From 2011 to 2012, Orchard’s accumulated deficit grew from about $179 million to about $298 million, SEC filings show. The company listed between $100 million and $500 million in assets and liabilities on its bankruptcy petition.

In Orchard’s most recent 10-K filing with the SEC, the company raised substantial doubt about its ability to continue as a going concern, or without the threat of liquidation.

The company’s sales have declined from around $850 million in 2007 to just more than $650 million in 2010, it says in court papers. Orchard, in bankruptcy documents, says the decline was caused by the downturn in California’s economy, continued completion from Home Depot Inc. (NYSE: HD) and Lowe’s, and chain-wide operational deficiencies caused by a highly-leveraged capital structure.

Orchard says it has had a hard time addressing the overleveraging that happened in 2006, when it was owned by Sears Holdings Corp. (Nasdaq: SHLD). The company was spun off in 2011, and has reduced debt and made other improvements, but says it would not have been able to make loan payments when its debt matures in December 2013. The company has $208 million in debt due in the next year, SEC filings show.

The debtor, since its founding in 1931, has had many owners. W.R. Grace & Co. (NYSE: GRA) bought the company in 1979, and sold it to Wickes in 1986, which led to the company’s initial public offering in 1993. By then, Orchard owned more than 40 stores. In 1996, Sears bought and doubled the amount of stores it owned, Orchard says in bankruptcy filings. In 2011, Orchard had another IPO.

Sears sold all of Orchard’s Class A common stock and Series A Preferred stock. Around that time, Ares Capital Corp. (Nasdaq: ARCC) bought all of the company’s Class C common stock.

Moelis & Co., FTI Consulting and DLA Piper are advising Orchard.

Goldman Sachs acted as Lowe’s financial adviser, while Hunton & Williams LLP is acting as legal adviser. 

Restructuring