Office Depot, the stock is up 4 1/4%, getting a $350 million investment from private equity firm BC Partners and the firm getting a 20% stake and three board seats…” Fox Business Network 6/23/2009

Office Depot (ODP) received a significant cash infusion announced today from private equity firm BC Partners.  The large PIPE transaction (Private Investment in Public Equity) is becoming more common for companies in need of capital quickly, and Office Depot will pay a hefty price for the quick funding.  In addition to the three seats on the Office Depot board, BC Partners will receive a 20% stake in the company through preferred shares that also carry a 10% dividend payment.  The investment comes as a lifeline to the office supplies retailer at a time where sales are suffering and earnings have turned negative as of the quarter ended 3Q 2008 and are expected to stay in negative territory for at least the next two quarters according to consensus estimates.

In light of slowing sales, Office Depot has slowed new store openings as well as closing some 9% of its under performing locations.  Additionally, the company has cut back on employment costs by cutting some 2200 jobs.  In May, Office Depot’s debt was downgraded by Moody’s as the company’s profitability looked less appealing in the near term.  The company’s exposure to the depressed markets of California and Florida are also of concern to Moody’s as it may take at least a few more quarters for an up-tick in sales.  This downgrade was after an upside surprise in the first quarter, as the cost cutting helped the company beat expectations, but the results were still far worse than the year before.  ODP needed an infusion of capital such as this to alleviate some concerns about the strength of their balance sheet.  The company had less than $200 million in cash at the end of the last quarter, less than half of what they had 6 months prior.

This deal provides Office Depot with more “financial flexibility” in a very difficult time.  This was a time of need for the retailer as they spent a fair amount of time under the $1 mark this year, reaching a low point of just $.59.  Obviously, BC Partners believes that the company has potential to rebound, and with the additional capital Office Depot has a much better chance.  With the large ownership in the company and the high yielding preferred shares, it appears it is a win-win. 

Although, for individual investors that deal is not available, and even though the price is still very low compared to historical norms, at Ockham we are neutral on ODP shares at this price.  The shares receive our Fairly Valued rating because the earnings and sales trends are not impressive, and the company has lost market share to the likes of Walmart (WMT).  We think the stock is in better position after the investment, but according to our methodology a price between $4 and $6.50 is reasonable given the weakness in fundamentals right now.