Renewed Staples-Depot takeover talk

An analyst on the Seeking Alpha website has suggested that Staples could be gearing up to acquire Office Depot.

An analyst on the Seeking Alpha website has suggested that Staples could be gearing up to acquire Office Depot.
In the Seeking Alpha article, the unnamed analyst argues that acquiring Depot would offer Staples more margin opportunities at retail with an increased store footprint allowing it to compete more effectively with retail giants like Target.
The article is the second example of Office Depot takeover talk on internet in the space of a few days; on 9 February the website The Fly On The Wall referred to "renewed takeover chatter" surrounding the company following higher-than-normal call volume from Wall Street traders.
Some form of consolidation of the three big-box office suppliers in the US – Staples, Depot and OfficeMax – is a subject that has been brought up regularly in the last couple of years as they have largely struggled in the depressed economic climate.
At various times a ‘Max-Depot tie-up or a Staples takeover of one of the other two have been mooted.
Stumbling block
One potential stumbling block to big-box consolidation in the US has been the likelihood that any such move would be met with disapproval by the Federal Trade Commission which vetoed the proposed Staples-Depot merger back in 1996.
Speaking as recently as June last year, Depot CEO Neil Austrian said that the FTC’s stance on consolidation in the office supplies sector had not changed since then, although he called its view of the market "antiquated".
The FTC debate aside, would a Staples move for Depot make sense at this particular time?
Staples – so often ahead of its main rivals in terms of top-line growth and profitability on a quarter-by-quarter basis – has itself struggled to achieve organic sales increases and there are big question marks about the performance of the international business.
With little visibility on any meaningful economic recovery, perhaps Staples needs another major acquisition under its belt in order to fuel growth and drive economies of scale. It’s now more than three years since the Corporate Express acquisition and much of the integration has been completed or is well on track.
The retail argument of the Seeking Alpha analyst would appear to be a bit on the flimsy side. There is consensus that there is overcapacity in the office supplies retail space and any acquisition is likely to be followed by widespread – and costly – store closures. And that’s before the structural challenges of the traditional bricks-and-mortar retail space are taken into consideration.
On the US B2B side, while the Corporate Express acquisition was largely complementary and didn’t lead to that much contract attrition, the same isn’t necessarily true in the event of a Depot takeover.
European attractions
The most obvious synergies are on the international front, especially in Europe.
Depot’s European business has been credited with keeping the company afloat in the dark days of 2008-2009, but has lagged behind North America in recent quarters and has been undergoing something of a restructuring process in the last few months.
Staples’ International division has traditionally struggled to achieve margins anywhere near its North American counterparts. In its last quarterly announcement in November, Staples reported International operating income margin of just 3%, a 1.36% decline on that of a year earlier.
Both businesses are faced with the same economic challenges in Europe and investments in emerging markets such as India and China are taking longer than hoped to provide a return.
The European retail footprint is complementary and a tie-up would give a strong store presence in the three main markets of Germany, UK and France.
Staples would also get the Viking brand in the direct channel to go alongside the European contract business it acquired when it bought Corporate Express.
The question is therefore whether Staples would be able to acquire Office Depot’s international – or even just the European – operations.
Previous estimates have valued Depot’s European business at around $1 billion, and the company’s beleaguered shareholders may now feel it’s time to cash in.
Wider plan?
Or an international sell-off could be part of a wider Depot plan that involves spinning off the North American business to private equity. BC Partners appears to have shown patience in its Office Depot investment until now, but the current share price is still some way below the $5 break-even threshold.
And why not add an attempt to then merge with OfficeMax while we’re at it (assuming no FTC objections)? Investment firm Thornburg has recently increased its stake in both Depot and ‘Max to over 9% – it is clearly banking on some kind of return on that investment, and there appears to be little upside based purely on current results predictions.
Then there are Office Depot’s profitable operations in Mexico. It’s been over three years since joint-venture partner Gigante made a $430 million offer to buy out Depot’s stake in that business. There were tax issues for Depot at the time if that deal had gone through – at least that was the official line at the time – but maybe it’s time for another review.
The above is, of course, pure speculation, but the longer the economic headwinds blow, the greater the pressure becomes on the big boxes to actively seek structural change.
All three companies will publish their fourth quarter and end of year results over the next couple of weeks. Perhaps we will be given some clues – or more – when these are released.