Office Depot's survival in question if merger with Staples fails, analysts say

Analysts question Office Depot's survival if Staples' merger fails, but Office Depot CEO says he is 'prepared'

Office Depot will have to "get creative," as one analyst puts it, if the Federal Trade Commission blocks its acquisition by Staples.

Deeper inquiries into the merger have fueled speculation on Wall Street that the proposal could be struck down. Stock prices for both companies have declined in recent weeks amid reports both U.S. and European regulators are questioning the anti-competitive effects of the merger, which would create the largest office-supply retailer in the nation.

For some 2,000 headquarters employees of Office Depot in Boca Raton, failure of the $6.3 billion deal proposed in February would provide initial relief as hundreds of jobs are at stake if the merger goes through. Staples' CEO Ron Sargent has said the combined company would be based at its headquarters in Framingham, Mass.

Yet, failure of the merger might not be the end of employees' worries.

Analysts say they're not sure Office Depot can survive on its own over the long-term. In interviews and company reports, analysts point to the office supplies industry as a rapidly shrinking market were both retailers are having to close stores. But while Staples has remained profitable in the transition, Office Depot is struggling to return to profitability after losing a combined $447 million in 2013 and 2014.

But Office Depot's chairman and chief executive Roland Smith said on Friday that the company is ready to move forward, merger or not.

"Office Depot is a strong company that has delivered six consecutive quarters of significant profit improvement and has more than $2 billion of liquidity. While we continue to work with regulatory agencies to complete the transaction with Staples, we are prepared for any outcome," Smith said in a prepared statement.

Regulators may accept the companies' argument that competition in the consumer market is fierce, as the FTC did in allowing Office Depot's acquisition of OfficeMax in 2013, analysts say. But many large companies and government agencies, which negotiate long-term contracts for supplies, depend on competition in the commercial market. Without that competition, office-supply prices are likely to rise, say critics including the nonprofit American Antitrust Institute. That's what is likely drawing scrutiny by antitrust regulators, analysts say.

"The industry still faces a lot of challenges," said Brian Yarbrough, a senior retail analyst for Edward Jones in St. Louis. If it is to survive, Office Depot "will have to shrink faster than they are to get to profitability," he said.

That would mean more store closures. Office Depot already has announced plans to close 400 stores nationwide by the end of 2016.

Yarbrough said he expects retail margins will remain flat and margins for the more lucrative commercial business won't hold up as competitors such as Amazon enter the sector.

David Marcotte, a retail industry analyst at the consulting firm Kantar Retail in Boston, said he has believed Staples' proposed acquisition of Office Depot to be "problematic" since the beginning, when the deal was announced in February.

If the merger fails, Office Depot "will have to get creative," Marcotte said. "They might be able to do a more intelligent expansion internationally. There are a lot of countries where you don't have high-quality Internet and they have a larger requirement for paper."

Jefferies' analyst Daniel Binder, who expects the deal eventually to be cleared by the FTC, says in his Aug. 4 report that Office Depot "is correctly right sizing the retail footprint and improving profitability."

But Office Depot's strategic plan needs more clarity, he says, noting that the company has been working on its "unique selling proposition" – how it can differentiate itself in the market -- but little detail has been revealed.

Office Depot CEO Smith explained in 2014 that he was focusing on developing a new vision to set Office Depot apart from the competition.

"A company without a vision is lost, just like being in the woods without a map," Smith told business executives at a Business Development Board of Palm Beach County. Smith, hired to lead Office Depot in November 2013, has been part of six turnarounds, including the Wendy's fast food chain.

But analysts agree that Staples is the better-run company of the rival retailers.

Staples "has always been the best operator -- like the best house in a bad neighborhood," Yarbrough said.

While still in a tough market, Staples still turns a profit, he said.

If the merger falls through, "Staples is in a better position," Marcotte agreed. Staples has been "carefully and intelligently shrinking its number of locations and increasing its product lines," he said. "They're doing it in a controlled, profitable way."

Staples began getting into new supply product lines, targeting restaurants, schools and health care facilities, long before the Office Depot merger was proposed, he pointed out.

Should Staples' acquisition of its rival be blocked, "I see them coming out ahead," Marcotte said.

Staples' CEO Sargent said in his last earnings conference that the company would prosper with or without Office Depot.

Other factors complicating the situation are costly breakup fees and an activist shareholder's big stake in Office Depot.

Staples would pay Office Depot $250 million if regulators block the merger, according to the agreement. But Staples can break off the transaction without the penalty if the FTC or other regulators request it divest $1.25 million or more to get the deal done.

Activist shareholder Starboard Value – which has stakes in both Office Depot and Staples -- urged the retailer to acquire then No. 3 office-supply retailer OfficeMax in 2013, and then pushed for Staples' acquisition of Office Depot. If the new merger proposal falls through, those activist investors will looking to get their money back, analysts say.

Marcotte said that could mean a new acquisition partner, possibly Federal Express or UPS, which might be interested in the Office Depot's nationwide real estate. More likely, Office Depot will focus on generating enough revenue to pay back the investors, he said.

Meanwhile, Office Depot's stock has plummeted from about $9.50 after the deal was announced in February to at $ 6.40 at Friday's close. Staples' offer in February valued Office Depot at $11 a share.

mpounds@tribpub.com or 561-243-6650

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