Staples merger offers chance to avoid RadioShack fate

February 3, 2015 05:37 PM

(Bloomberg) — A merger of Staples Inc., No. 3 in the Internet Retailer 2014 Top 500 Guide, and Office Depot Inc. (No. 9) may help them weather the competition from online and big-box retailers in a way that RadioShack Corp. (No. 317) couldn’t.

The three companies were all hit hard in the past decade by discount-offering giants such as Inc. (No. 1) and Wal-Mart Stores Inc. (No. 4). Their fates diverged this week. RadioShack is preparing to file for bankruptcy protection, while the other two—in a less dire situation—are considering combining.

Staples and Office Depot shares traded Tuesday at prices they haven’t reached in years as investors show support for their potential merger, which would consolidate the No. 1 and 2 office-supply chains. Analysts estimate $1 billion to $2 billion of costs could be cut through the deal, which may give the combined company some room to lower the prices of its products in hopes of drawing in shoppers.

“From a financial standpoint and from a competition standpoint it makes sense,” Joseph Feldman, an analyst for Telsey Advisory Group in New York, said in a phone interview. “Shareholders on both sides are cheering the deal. It probably would be a good thing to see happen for the industry and for both companies.”

Approval odds

The question is whether the merger would secure approval from antitrust regulators, though analysts are leaning toward the idea that it can. Office Depot purchased OfficeMax Inc. in 2013, so a subsequent deal between Office Depot and Staples would leave just one major office-supply chain.

The companies can argue that the competition is far broader and now includes Amazon, Costco Wholesale Corp., Wal-Mart and Target Corp. That’s something the U.S. Federal Trade Commission—the same agency that blocked Staples from buying Office Depot in 1997—noted in its approval of the OfficeMax acquisition.

“Our decision highlights that yesterday’s market dynamics may be very different from the market dynamics of today,” the FTC said in its closing letter about the Office Depot-OfficeMax transaction in November 2013.

That analysis “doesn’t leave the commission a lot of room” to challenge a Staples merger today, said Morris Bloom, an antitrust lawyer at Axinn, Veltrop, & Harkrider LLP in Washington.

“The fact this merger is of the remaining two office-supplies stores should not lead to anticompetitive effects because consumers have more choices than the super-supply stores,” said Bloom, a former FTC lawyer.

Activist push

Starboard Value, which has stakes in both Staples and Office Depot, has been urging the retailers to combine, which has helped lift the shares over the past couple of months.

The FTC’s decision to allow Office Depot and OfficeMax to combine “probably encouraged Starboard to push for the merger,” said Chris Pultz, a portfolio manager at Kellner Capital, an event-driven investment firm in New York. “They will probably get a second request from the FTC, but I find it hard to believe that they would have a case to block the transaction.”

Staples shares climbed 11% Tuesday to $19.01. Office Depot surged 22% to $9.28.

Becoming one company isn’t a perfect long-term solution. Even though their outlook isn’t nearly as grim as RadioShack’s, office and school supplies are increasingly a commodity business and it will still be difficult to match competitors’ low prices without eroding earnings, said Brian Yarbrough, an analyst for Edward Jones & Co. in St. Louis.

In the most recent back-to-school shopping season, Staples school supplies cost 53% more than an identical basket of goods at Wal-Mart and Target, according to a study by Bloomberg Intelligence in August.

Deal gains

Shareholders would benefit from a deal because it would give a pop to Office Depot’s stock price and there would be synergies for Staples, Yarbrough said.

“But in the longer run, I just don’t see how this combined company is any better off,” he said. “Starboard cares about one thing: this deal going through. Five years down the road they’re not going to be anywhere near this company, they’ll be long gone.”

And don’t forget what happened after Sears Holdings Corp. and Kmart merged in 2005. The deal was an attempt to stem falling sales and fend off Wal-Mart. Since that transaction closed, Sears has lost three-quarters of its value, continued to suffer revenue declines, shut stores, eliminated jobs and sold off assets to raise money as it burns through cash.

“Merging two bad retailers in a tough environment doesn’t make one good retailer,” Yarbrough said.





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