At a junction

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When Boise Cascade Corporation made the decision in September 2004 to sell off its non-OP assets to affiliates of Boise Cascade LLC for $3.7 billion, and take on the ‘OfficeMax’ name, it could not have envisioned the bumpy start it was to face

At the time, the marriage of Boise Cascade Corporation and OfficeMax seemed to make perfect sense. OfficeMax was a recognisable name in the industry and gave Boise a serious launch pad from which it could strike out against Staples and Office Depot. It could finally become, as Boise CEO George Harad said at the time, a "strong independent company in the office products distribution business".

Equally for OfficeMax, which had been trailing a distant third to Staples and Depot, the deal offered a considerable contract presence and a higher battling platform.

But since the start of the year, ‘Max’s waters have turned positively boggy. The company has dismissed six employees as part of an internal investigation into $3.3 million in irregular bills to a supplier. The scandal delayed the release of its earnings report; led to threats of class action law suits by numerous shareholders; and eventually reflected a lowering of net earnings by more than $4 million in the first nine months of 2004.

Dynamics

To add to this problem, CFO Brian Anderson and retail chief Gary Peterson departed the company in January, followed by president/CEO Chris Milliken – the former CEO of Boise Office Solutions – in February. The atmosphere within the OfficeMax realms has since been likened to a morgue.

Not surprisingly, the aforementioned investigation has led analysts and industry insiders to question the company’s future, and has also opened the closet door even wider to the slew of critics blaming the dynamics of the Boise-‘Max marriage in the first place – and its resulting integration problems.

One major shareholder says: "I don’t think Boise is regretting the decision because it made a lot of sense, but I think it is regretting leaving certain people in charge."

Dan Binder, SVP at Buckingham Research Group, has been clear about his reservations from the start. "Boise was a better quality delivery company than ‘Max was a retailer," he says. "The integration was always going to be difficult."

OfficeMax executive chairman George Harad dismisses the claims, announcing that the company made "substantial progress in 2004 towards integrating its contract and office products businesses".

The challenges, however, cannot be denied. Both culturally and geographically, the two companies were at opposing ends of the spectrum.

The pre-merger OfficeMax suffered a somewhat wobbly reputation on Wall Street, hampered no doubt by two years of straight losses and eccentric treatment of its own shareholders. Boise, by relative contrast, enjoyed a solid reputation among shareholders and industry players alike.

OfficeMax spokesperson Bill Bonner claims that the way the company dealt so openly with its recent accounting scandal will actually improve its reputation among shareholders. "We went public about the situation straightaway, which shows customers and investors that they can trust us," he says. "Although there is definitely an awareness among the company of what has been going on, it has made us more determined than ever to prove ourselves going forward."

Jim Hawley, VP of Henkel, which has supplied OfficeMax since the opening of its first stores in Cleveland, Ohio, claims that recent events have in no way damaged the partnership between the two firms. "We will continue to be a good partner and support the growth of OfficeMax," he says. "As for the accounting irregularities, these things can happen even in the best of companies. OfficeMax continues to have strong leadership and growth potential and will overcome these issues for sure."

Leadership

Indeed, it is largely expected that OfficeMax will recover from these irregularities relatively quickly and unscathed. The real issues now are the company’s recent earnings misses (Q4 profits plunged 90 per cent to $700,000); its obvious struggle to stay above water; and most importantly, its leadership vacuum.

On the day of Milliken’s departure on 14 February – during which the company’s share price fell $1.95, or 6 per cent – Harad promised that OfficeMax was "taking steps to strengthen its management team", and "fully expects to demonstrate the value inherent in this business for our shareholders".

A spokesman for one major shareholder that would not be named says that, although he believed the top executives were not directly involved in the accounting irregularities, he remained concerned about the company’s lack of management.

However, he adds that his company would stay on as shareholders, as OfficeMax shares are currently undervalued. "When OfficeMax brings in a top notch retailer that is able to run the business at all levels, we stand to make money," he claims.

Echoing the view that the retailer’s intrinsic value is not reflected in its stock price, shareholder K Capital, which holds a 6.2 per cent stake, recently disclosed that it has asked the OfficeMax board of directors to seek a break-up or sale of the company through a filing with the Securities and Exchange Commission. It will continue to communicate with the company, industry observers and other companies about "possible strategic transactions", it has said.

Contenders

Buckingham’s Binder says he suspects other large shareholders could support K Capital in its efforts. "A break-up or sale would be great for the OP industry. And selling it off would be the best way to unlock the company’s value," he says. "OfficeMax was dressing up for a sale before Boise bought it. Now the company has no leadership, it almost has no choice but to be sold off."

He believes that although Office Depot and Staples would not buy the firm in its entirety, they would be interested in the delivery business and pieces of OfficeMax’s real estate, if they are sold off by major market.

"The delivery business would sell without a problem and we would expect a single buyer given the complexity in trying to break it up," he predicts. "Staples, Office Depot and Corporate Express are the major contenders." In such a scenario, he suspects that the acquiring operator would gain pricing power to significantly hurt wholesalers such as United Stationers.

The real estate sale, he estimates, would be more problematic, but would most likely be done geographically. With Staples’ aggressive launch into Chicago this year, it may be strategic for it to acquire OfficeMax outlets in the region. Similarly, Depot may want to acquire in Florida, for example.

"Both companies would have to accept less than perfect stores with good ones in the market," says Binder. "Given the opportunity and long-term benefits to eliminate a third player in a crowded industry, we suspect both Staples and Depot will be interested in whole market acquisitions of stores. But this would likely result in store closures and a need to sell unwanted real estate."

The other option, of course, is for private equity buyers to buy OfficeMax and run it privately, he adds.

But although Binder believes the OfficeMax board would not necessarily rule out a deal, he is not sure whether it would be immediately receptive to the action.

Indeed, Harad recently dismissed the need to consider splitting up the company, claiming it would be a "particularly inopportune time" for it to change direction as other strategic steps are already being taken. (In this he refers to reshaping top management, integrating the business, reducing debt and repurchasing shares.)

But even if OfficeMax does not sell, Staples and Depot, which have both been trading near their 52-week highs of late, have had opportunity to gain more ground. But then again, by sales, the big three still look competitive: in 2004, Staples posted revenue of $14.4 million; Depot $13.6 million; and OfficeMax $8.9 billion.

The activity of the shareholders could well act as a catalyst to a break-up or sale, as Binder predicts. But it is clear that in whatever direction the out road leads, it is sure to be an interesting ride.