Feb 21 - Fitch views the potential merger between Office Depot (ODP)
and Office Max (OMX) to be moderately positive for Staples in the short
to medium term based on the continued top line weakness at the two merging
companies. We believe that weakness could be exacerbated by merger-related
disruptions and potentially by accelerated store closings. The merger is
expected to close by the end of calendar 2013 and is subject to shareholder and
This merger (of the second and third largest players in the office supplies
store chains) will create a combined entity with $17.6 billion in sales and
almost 2,200 stores, which is below Staples' $24.4 billion in sales on a base of
2,290 units. Domestically, the combined entity will have close to 2,000 stores
with over $13.0 billion in sales (both retail and delivery) versus 1,900 at
Staples with sales of around $16.6 billion.
We believe consolidation of the second and third office supply chains may
alleviate some competitive pressure in the Staples' North American Retail
segment in the near term as the combined entity continues to rationalize its
footprint through store closures on top of any mandated Federal Trade Commission
(FTC) closures. ODP and OMX have closed about 10% (approximately 250 units) of
their 2008 footprint versus relatively flat units at Staples.
Not unlike some other specialty retail areas, the overall traditional office
supply segment continues to face long-term structural challenges given an
increased offering of products in alternative channels such as online and mass
merchants. Taking the heightened competition and broader product and service
offerings at the large office supply retailers into consideration, ODP and OMX
could potentially face fewer challenges from the regulatory agencies versus
Staples when its attempt to acquire ODP was obstructed by the FTC in 1997.
Staples' business has been fairly resistant over the past five years, while
other traditional players have faltered. Staples' core business has continued to
show modest top line growth (excluding the addition of Corporate Express in
2008, which added about $4 billion in revenue) and EBITDA has been relatively
flat - in the range of $2.1 billion to $2.3 billion. However, ODP's top line
shrunk to $10.7 billion in 2012 from $15.5 billion in 2007, or a negative 7.2%
on a compounded annual growth rate (CAGR), while its EBITDA was more than halved
during the same period to $300 million at a 2.8% EBITDA margin. OMX fared
somewhat better on the top line, which contracted to $6.9 billion in 2012 from
$9.1 billion in 2007, or a negative CAGR of 5.3%, while EBITDA also more than
halved to $213 million. We note that while the business delivery segments have
seen some stabilization since 2009, the retail segments for both these companies
remain under significant pressure.
The ODP-OMX merged entity would have proforma 2012 EBITDA of just over $500
million, or 2.9% of sales, significantly lower than Staples' 8.6% margin. The
companies expect to realize significant cost-related synergies of $400 million
to $600 million, which would equate to 230 to 340 basis points on 2012 pro forma
sales. However, we believe continued top line weakness, potential operating
disruptions, and the significant costs associated with achieving these synergies
($350 to $450 million and $200 million in incremental capex) could offset much
of these benefits. In addition, Staples has a stronger balance sheet and credit
metrics with leverage expected to remain at 2.8x to 3.0x and free cash flow
(FCF) expected to in the $500 to $700 million range over the next few years.
While the combined ODP-OMX entity has over $1 billion in available cash and more
than $1 billion via its revolving credit facilities on a proforma 2012 basis,
the entity would be levered in the mid to 5.0x range and generates minimal FCF.
Additional information is available on www.fitchratings.com.
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expressed are those of Fitch Ratings.