On Thursday, Heiton Holdings will hold its annual general meeting. The shareholders will have much more to think about as their company's main rival in the Irish market, Grafton, the Woodies DIY company, has built up a strategic holding of nearly 14 per cent in the company.

Some Heiton shareholders may shrug that off - Heiton has described it simply as an "investment", so that hardly poses a threat. Also Grafton has not demanded a seat on the Heiton board.

That, of course, would not be Grafton's style. But Grafton will have to decide, sooner rather than later, what to do with this "investment".

So far it has paid off. . . on paper. That investment is showing a paper capital profit of €4 million (£3.2 million). If it wanted to give its shareholders a bit of a thrill, it could pay that out in the form of a special payment - that would represent more than 20 cents per share, or about the same being paid as an interim dividend which represented a 40 per cent increase on last year.

That is unlikely to happen. Grafton has always refused to comment on the stake in Heiton. But it has been incorrectly speculated that it is defensive; that the holding would prevent a third party making a bid for Heiton. When Grafton first built up its initial stake, of some 5 per cent, there were some informal talks, according to reliable industry sources. However, since then there has been no contact.

Clearly, the boards should meet and discuss the pros and cons of a get-together. While both companies have been expansionist, and are significant in the domestic market, they are small internationally. Grafton is capitalised at €360 million, while Heiton has a value of only €158 million. Together, with a value of more than €500 million, they would have more clout but remain small internationally.

It could be argued that each will continue to grow as individual companies and the benefits from a merger are not quantifiable. Because both companies have a significant share of the Irish market - combined between 40 per cent and 44 per cent of the Republic's builders' merchants market - they might have difficulties in gaining regulatory approval. And they would lose market share if they amalgamate. When Heiton acquired Buckley, for example, it is understood to have lost market share, and Chadwick - a Grafton subsidiary - was the beneficiary.

However, the anticipated loss of market share would have to be weighed against the benefits. These include better buying power from suppliers, rationalisation benefits, and benefits from the pooling of know-how (Grafton, for example, gets better margins).

The domestic market is bound to become less important as each expands outside the Irish market. Sales from Grafton's British and Northern Ireland businesses outstripped the domestic market for the first time in the first half of 1999. And following the acquisition of Cooper Clarke, the British operations of Heiton will account for around 20 per cent of group sales this year.

Institutions are known to be in favour of a deal. Irish Life, Scottish Provident and AIB have significant shareholdings in each company. If they really wanted it to happen, they could push it through. However, Grafton would probably shy away if Heiton put the cold shoulder forward. Based on the market values, Heiton would end up with over one third of an enlarged company. As Grafton already has a large minority stake, it would only have to bid for the outstanding equity. Also, any deal is likely to be all shares, with a cash alternative, as Grafton would not want itself to be over geared.

Although Grafton has bought the Heiton shares at an average of €2.67 compared with the last price of €3.35, it would have to offer a price at least as high as the highest paid in the past 12 months and that was €2.90. In practical terms it would have to offer a premium to the share price and give Heiton shareholders a little more than its underlying worth. Grafton, the more expansionist, has a higher rating than Heiton. At €3.35, Heiton's shares are on a prospective p/e of 12. Grafton at a price of €22 is on a prospective p/e of 12.6. Grafton can be expected to continue to build up its stake but not at any price.

But both companies have been expanding strongly. Heiton, under the able leadership of Richard Hewat who retires early in 2000 (and now Leo Martin, the group chief executive designate), has generated strong growth in earnings per share over the last three years (25.5 per cent, 30.1 per cent, 23.5 per cent). Grafton, under the able leadership of Michael Chadwick who is also a large shareholder with almost 11 per cent stake, also recorded a lot of growth over the past three years (39.1 per cent, 29.2 per cent, 21.1 per cent).

Without a merger, both companies are likely to continue to show strong growth over the next few years. Indeed, Grafton could be expected to seek other large acquisitions and Norcros, the UK builders' merchants which turned down a £170 million MBO in July, could be a target. However, the benefits from a merger of the Irish companies should outweigh any loss of market share in the domestic market and allow them to expand internationally at a faster pace.