Office Depot Inc. and OfficeMax Inc. may need to merge after heightened competition for office-supply sales and a 26-year high in the U.S. unemployment rate helped wipe out almost $13 billion of shareholder value.
Office Depot, the second-largest U.S. office-supply chain, has plunged 90 percent to $1.16 billion in the last five years, more than any American retailer that still has a market value greater than $500 million, according to data compiled by Bloomberg. OfficeMax is now valued at $664 million after plummeting 78 percent, the third-steepest drop. Both trade at 10 cents or less per dollar of sales — one-tenth of the industry average and ranking in the bottom five of 126 retailers.
With businesses spending less on paper and printers as the U.S. jobless rate hovers at 9 percent, combining Office Depot with OfficeMax may reduce costs by almost $500 million, said KeyBanc Capital Markets Inc. Regulatory approval won’t be a hurdle because of more competition from Wal-Mart Stores Inc. and Target Corp. since Staples Inc. was blocked from buying Office Depot in 1997, said BB&T Capital Markets. Money-losing Office Depot of Boca Raton, Florida, hired interim Chief Executive Officer Neil Austrian in May after a seven-month search.
“Office Depot needs OfficeMax,” said Anthony Chukumba, an analyst with BB&T in New York. “They need to combine so they can scale up to better compete with Staples. For them to bring in a guy who’s been on the board forever and who has been CEO twice before on an interim basis, that just smacked of them saying, ‘We’re going to try to sell the company.’”
Jennifer Rook, a spokeswoman for OfficeMax, didn’t respond to a phone call or e-mail requesting comment.
‘Consider All Options’
“We have been saying on a consistent basis (for the last four years) that, in a market as fragmented as ours, consolidation makes sense,” Brian Levine, a spokesman for Office Depot, said in an e-mailed statement. “At this point in time, we are focusing on executing our strategic plan and restructuring our operations to drive improved performance and grow the company in the future. That said, we will continue to consider all options that are in the best interests of our shareholders.”
Office Depot named Austrian as its permanent chairman and CEO on May 23 after he’d served in the roles on an interim basis since November following Steve Odland’s resignation. Austrian, 71, has been on the board since 1998 and previously served as the company’s interim head in 2004 and 2005.
Austrian is “very open” to industry consolidation and a potential transaction with OfficeMax, Brian Nagel, an analyst with Oppenheimer & Co. in New York, wrote in a June 20 report after meeting with him last week.
‘Lot of Sense’
“What I’ve said for a long time is that a consolidation makes a lot of sense in the office products space,” Nagel said in an interview yesterday.
Both companies run retail outlets and sell directly to businesses. Office Depot, which operated 1,279 retail stores as of March, generated 29 percent of its sales last year outside of North America. Naperville, Illinois-based OfficeMax has 991 stores and a smaller international presence, with only 19 percent of total 2010 revenue coming from outside the U.S., data compiled by Bloomberg show.
“Scale is the key. Without it, I don’t think either can survive long-term,” said Malcolm Polley, who oversees $1 billion as chief investment officer at Stewart Capital in Indiana, Pennsylvania. “Both are really too small on their own. The climate is not improving for retailers.”
In the last five years, Office Depot’s market value has shrunk by $10.3 billion. The company reported losses the past three years as businesses cut back on office supplies amid the worst U.S. recession since the Great Depression and price pressure from other office-supply retailers, including Wal-Mart, Target and online sellers.
While the recession ended in June 2009, job growth has remained sluggish. The unemployment rate was 9.1 percent in May, 1 percentage point less than the 26-year high of 10.1 percent in October 2009, data from the Labor Department show.
“As businesses have been reluctant to hire, it becomes incumbent on these firms to really manage down costs,” said Peter Jankovskis, who helps manage about $2.7 billion at Oakbrook Investments in Lisle, Illinois. “The larger they are, obviously the greater influence they have over their suppliers and their ability to keep their cost of goods as low as possible.”
Merging the two companies may lead to $300 million to $500 million in cost cuts from advertising, overhead spending, better prices from suppliers and closing retail stores, said Bradley Thomas, an analyst with KeyBanc in New York.
Lost Market Value
OfficeMax has lost $2.3 billion in market value since June 2006. That’s the third-biggest drop on a percentage basis among 128 U.S. retailers that still have market values above $500 million, after Office Depot and Liz Claiborne Inc.
OfficeMax trades at 0.09 times sales, while Office Depot is valued at 10 cents per dollar of sales. The industry average is 1.01 times, data compiled by Bloomberg show.
Still, OfficeMax also hired a new CEO, Ravi Saligram, in November and started working on a five-year plan last year to boost revenue by offering more services and products tied to computers and catering more to women. Sales declined in each of the past three years.
“The ball is probably in OfficeMax’s court,” regarding a merger, said Mike Balkin, a fund manager in Chicago at William Blair & Co., which oversees $41 billion. He co-manages the Small Cap Growth Fund, which includes Office Depot shares. “It’s been talked about for a long time. I’m not sure that the OfficeMax guys are there yet.”
FTC Blocked Staples
In 1997, the U.S. Federal Trade Commission derailed Staples’s attempt to acquire Office Depot for $4 billion after a federal judge ruled the takeover violated antitrust laws and would allow Staples to increase prices or maintain prices at an “anti-competitive level.”
“You’re now talking about the No. 2 and No. 3 players merging and still being considerably smaller than the No. 1 player,” said BB&T’s Chukumba. “I don’t foresee antitrust being a major obstacle.”
Staples, the largest U.S. office-supply chain, has a market value of $11 billion, dwarfing Office Depot and OfficeMax, and is valued at 0.45 times its $25 billion in sales in the last 12 months.
Staples Chairman and CEO Ronald Sargent said a merger between Office Depot and OfficeMax would be “natural.” The FTC is more likely to allow such a combination than if Framingham, Massachusetts-based Staples were to buy either company, he said at a June 3 analyst conference.
“The landscape has changed dramatically since 1997, when the FTC blocked the Staples/Office Depot merger,” Office Depot said in the e-mailed statement yesterday. “However, government approval is certainly not a given.”
Combining Office Depot with OfficeMax would be a “smart move,” said David Strasser, an analyst at Janney Montgomery Scott LLC in New York.
“The industry needs the consolidation because we need to get rid of stores,” he said. “It’s just an absolute necessity.”
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