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Should Staples, Inc., Amazon.Com Be Worried About Potential ODP/OMX Deal

 February 19, 2013 03:27 PM
 


(By Mani) The Wall Street Journal has reported that Office Depot, Inc. (NYSE: ODP) and OfficeMax, Inc. (NYSE: OMX) are engaged in advanced merger discussions and that an official announcement of a stock-for-stock deal could come as early as this week.

The potential merger would be a game changer in the office products space and the combination would spur a rationalization of excessive office products retailing real estate and render the sector more capable of managing through a challenged product cycle.

The deal, which would merge the number two and three players in the industry, could create an effective and efficient competitor to new entrants such as Amazon.com, Inc. (NASDAQ: AMZN) and heavyweight Staples, Inc. (NASDAQ: SPLS) by cutting costs via closing overlapping stores and workforce.

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However, Staples, the world's largest office products company should not be too worried about the deal as it would rationalize the competition in the $50 billion industry. Since it is number one, Staples has economies of scale in purchasing and the ability to stock wider ranges of products. Moreover, it benefits from cost savings and increased penetration from its acquisition of European rival Corporate Express.

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In addition, Staples is being aggressive with its online pricing as it competes with the likes of Amazon.com, including free shipping on ink and toner. In the contract business, Staples is also aggressively trying to win new paper business while attempting to push through cost increases. Lastly, larger customers continue to push for better deals.

Staples has had some luck adding new categories, with copy and print and breakroom and facilities being high profile recent examples. Copy and print and tech services come to mind as areas where Staples has had recent success. They will continue to test other areas including computer rentals and shredding.

The deal could benefit Staples as the combined company may shut down overlapping stores, creating growth opportunities for Staples.

"Despite a number of fundamental missteps lately, we view SPLS as well positioned to benefit from more rationalized competition within the office products sector," Oppenheimer analyst Brian Nagel wrote in a note to clients.

For Amazon, the deal shouldn't pose much of a problem as office products is only a small part of their wide categories in online retail. Further, it also holds the price advantage that in turn may hurt others in the industry, and it offers certain features, including free shipping, which are popular among the consumers.

The market has waited for this potential merger for more than 10 years after the failed attempt of Staples to buy Office Depot in the late 1990s due to antitrust concerns. But this time, Federal Trade Commission is unlikely to thwart the deal, given significantly changed competitive dynamics within the office products sector.

The merger would create a combined entity with annual revenues of more than $18 billion and would compete with market leader Staples, which generates annual revenues of about $25 billion.

Boca Raton, Florida-based, Office Depot operates nearly 1,700 global stores, are expected to generate 2012 sales of about $10.88 billion, while Naperville, Illinois-based OfficeMax operates about 900 stores in the U.S. and Mexico, annual sales are estimated at $6.97 billion. Analysts reportedly expect the deal to generate cost synergies in a range of $400 million to $700 million.

The U.S. office products industry has been hit by a weakening economy, curtailing customers purchases. In addition, the competition has intensified with bigger retailers such as

Costco Wholesale Corp. (NASDAQ: COST) and Wal-Mart Stores, Inc. (NYSE: WMT) have diversified their business in to office supply sales triggering a price war that hurt margins at Office Depot and OfficeMax.

As a result, activist investors, who have recently taken stakes in both firms, have been pushing for the companies to go for a merger as a joint company would be better positioned to cope with the industry dynamics.

Starboard Value, which owns about 15 percent stake in Office Depot, has been pressuring to increase profitability and cut costs leading the company to adopt a 'poison pill' in the form of a shareholder rights plan to defend itself against hostile takeover.

"We assume that any deal would be structured as primarily a merger of equals with OMX more of the acquiree. At this juncture, we have yet to determine a potential deal value," Nagel wrote.

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