OFFICE DEPOT INC ODP
April 05, 2014 - 10:54pm EST by
frankie3
2014 2015
Price: 4.20 EPS $0.00 $0.11
Shares Out. (in M): 535 P/E 0.0x 38.0x
Market Cap (in $M): 2,247 P/FCF 0.0x 0.0x
Net Debt (in $M): -285 EBIT 0 167
TEV ($): 1,962 TEV/EBIT 0.0x 12x

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  • Turnaround
  • Acquisition
  • Synergies
  • Secular headwinds
  • Insider Buying

Description

Office Depot is a multi-year turnaround trading at a mere 2.2X 2016 forecasted EBITDA.  It was written up in years past in VIC with negative returns but today I believe that the valuation is attractive even despite some of the secular headwinds that the company is facing.  The company and the industry are undergoing significant changes and Office Depot will be the beneficiary of over $600mm of cost synergies plus another few hunded million of working capital synergies.  An experienced turnaround expert is at the helm and the balance sheet has net cash.  I believe ODP is worth $7.25/share which represents about 4X 2016 EBITDA. 
 
The Office Superstore Industry
 
The office superstore industry today is made of of Staples and Office Depot.  Both companies operate retail stores throughout the US and the world as well as offer delivery to commercial businesses and the government.  The stores sell office related equipment and supplies including everything from printers and computers to furniture and pens and pencils.  They sell products at their retail stores, online and commercial delivery.  The major secular headwinds facing the industry are the digitalization of the office (i.e. less paper) and the competition from online (e.g. Amazon) and warehouse retailers like Costco and Walmart.
 
These secular headwinds have not been addressed by the industry participants significantly until this year.  While Staples has been trying to diversify their business away from core office supplies (like paper etc.), hard decisions have not been made.  But they finally are this year.  With the combination of Office Depot and Office Max in late 2013, and the large store rationalizing of Staples, the industry's retail capacity will finally begin to shrink materially which will reduce competition and increase store productivity and margins.  Currently in North America, Office Depot has 1,850 stores and Office Depot has about 1,900 stores for a total of 3750 stores in North America.  Staples has announced that it will close 225 stores and Office Depot will shut down upwards of 450 stores for a total of 675 stores or nearly 20% of the industry's capacity.  This significant capacity reduction will occur over the next 2 years and both Staples and Office Depot will benefit but due to the significant synergies that Office Depot will achieve with its merger with Office Depot, they stand the most to benefit. 
 
The Big Question for the Industry
 
Will the synergies achieved with massive store rationalization serve to outweigh the secular headwinds in the industry?  
 
There is no question that the paper based economy is going away and the trend of buying products online will continue. 
 
So the Office Superstores are not "out of the woods" just by rationalizing their store base, but the Office Superstores are not just bricks and mortar.  The Office Superstores also have a significant online and delivery presence.  Staples.com is the #2 ecommerce player behind Amazon and has next day delivery coverage to over 95% of the US population.  Online sales are increasing and the Commercial delivery business is steady.  Both Staples and Office Depot have built a brand and relationship with businesses across the country that will not go away overnight.  The office superstore is not going the way of Blockbuster video. 
 
So while the core office products continue to see headwinds, the Office Superstores are also slowing diversifying away from core office equipment and supplies adding new sales categories such as janitorial, sanitary, food and medical.
 
Industry Insider Purchases
 
Both Staples and Office Depot stocks have gotten decimated along with some other retailers.  Weather has affected them in Q4.  Recently there has been some insider purchases by the management and boards of both Staples and Office Depot including the CEO of Staples Ron Sargent and the CEO of Office Depot Roland Smith.  The board member in Office Depot, "Starboard" also has been purchasing a large amount stock.  In total, about $14mm of stock has been purchased by industry insiders.
 
 
Office Depot/Office Max Combination
 
The merger of Office Depot and Office Max will be transformational for the industry and for the combined entities.  Management has estimated that there will be over $600 million of synergies achieved by 2016.  These synergies do not include the benefit from the store rationalizing strategy.  Management believes they will be able to exit 2014 with achieve a run rate of $340 million synergies exiting 2014.  The synergies included IT, purchasing, and personnel.  In addition there is huge overlap in the retail footprint between both Office Max and Office Depot.  There are about 200-300 stores with the same Zip Code area.  Closing one of these stores in each location will yield higher sales at the store that they keep in the area thus bolstering sales per store.  The synergies for closing stores are not in the $600 million that management has targeted.  Upside could be an additional $100mm as management targets low producing stores or store that have heavy overlap.
 
Purchasing.  Of the $600 million about $150 million will fall under purchasing efficiencies.  Both Depot and Max had private label programs which can be optimized.  Larger scale purchases can also reduce costs from suppliers. 
 
Supply Chain.  Both Depot and Max operated their own distribution network that now can be combined.  About $100mm in saving can be achieved by eliminating duplicative costs.
 
Advertising and Marketing.  There are about $100mm of advertising and marketing savings.  Currently both companies run TV ads, newspaper ads, etc.
 
SG&A..There are about $250mm in savings in SG&A.  Reduction in personnel, IT costs, professional fees, office space,
 
There are also working capital opportunities that management has not addressed but as stores and distribution facilities are closed inventory levels will come down.  In addition, there is the possibility that Office Depot will be able to extend payment terms with supplier.  Both inventory and payables could raise $200-300mm to the balance sheet.
 
Financial Projections
 
  2014 2015 2016
Average North American Stores (1,912 Stores today) 1,850 1,700 1,560
Retail Revenue (in $ millions) 6,700 6,300 5,900
Business Solutions 6,800 6,850 7,000
International 3,000 2,900 2,800
Total Revenue (in $ millions) 16,500 16,050 15,700
EBITDA 460 675 900
Adjusted EBITDA Margins 2.7% 4.2% 5.7%
EBIT 160 375 600
Interest 75 75 75
EBT 85 300 525
Tax 25 90 157
Net Income 60 210 368
EPS .11 .40 .68
 
Over the past 3 years, there has been a low negative single digit decline in same store sales in the US.  I expect this to continue.  My model is projecting modestly down same store sales in North Amercian Retail, offset from a partial benefit from customers from closed stores moving their purchases to the stores that remain open.  The Business Solutions Division has flat to slow growth. and Internation sales decline as well.
 
In 2014 and 2015, there will be little if any Free Cash Flow as the company will be spending money to achieve synergies.  In 2016, the free cash flow will start to flow back and it will approximate Net income or $370mm. 
 
Can the $600 million in synergies be hit?
 
Looking at the 5.7% EBITDA margin in 2016 may seem like a big ramp up but this is a margin that should be very achievable as scale does matter.  In addition Staples is currently running 7-8% EBITDA margins.  However Staples is a better business with a larger base of stores in urban areas meaning higher sales per store.  In addition Staples also has a larger commercial business with a focus on smaller businesses rather than large business accounts like Office Depot and Office Max.
 
 
Management
 
Roland Smith was brought in to orchestrate the turnaround in November last year. 

Most recently, Smith was the Chief Executive Officer and President of Delhaize America, LLC, which is the U.S. division of Delhaize Group. Delhaize America produces over $18 billion in annual revenue through its U.S. supermarkets, including Food Lion and Hannaford, and represents approximately 65% of the revenue of the Delhaize Group. While at Delhaize, Smith orchestrated the successful integration of the major supermarket chains owned by Delhaize, including successful dispositions of three of the chains thereby materially improving profitability and driving substantial shareholder value creation at Delhaize Group.

Previously, Smith was President and CEO of The Wendy’s Company; President and CEO of Wendy's/Arby's Group, Inc.; and CEO of Wendy's International, Inc. Throughout his tenure at these companies, Smith orchestrated numerous transformative initiatives. Originally at Arby’s, Smith helped to rejuvenate the brand, turn around the culture, and integrate the acquisition of its largest franchisee. Later, Smith successfully completed the acquisition and merger of Wendy’s by Arby’s. While transforming the culture, menu, and product, Smith also improved operations and accelerated international expansion. Additionally, Smith orchestrated the successful sale of Arby’s.

Smith also led operational turnarounds at American Golf Corporation, the world’s largest owner and operator of golf courses, and AMF, the world’s largest owner and operator of bowling centers.

- See more at: http://news.officedepot.com/press-release/corporatefinancial-news/roland-c-smith-appointed-chairman-and-ceo-office-depot-inc#sthash.vNqk9TU3.dpuf
He has been successful in turnaround efforts.  

Most recently, Smith was the Chief Executive Officer and President of Delhaize America, LLC, which is the U.S. division of Delhaize Group. Delhaize America produces over $18 billion in annual revenue through its U.S. supermarkets, including Food Lion and Hannaford, and represents approximately 65% of the revenue of the Delhaize Group. While at Delhaize, Smith orchestrated the successful integration of the major supermarket chains owned by Delhaize, including successful dispositions of three of the chains thereby materially improving profitability and driving substantial shareholder value creation at Delhaize Group.

Previously, Smith was President and CEO of The Wendy’s Company; President and CEO of Wendy's/Arby's Group, Inc.; and CEO of Wendy's International, Inc. Throughout his tenure at these companies, Smith orchestrated numerous transformative initiatives. Originally at Arby’s, Smith helped to rejuvenate the brand, turn around the culture, and integrate the acquisition of its largest franchisee. Later, Smith successfully completed the acquisition and merger of Wendy’s by Arby’s. While transforming the culture, menu, and product, Smith also improved operations and accelerated international expansion. Additionally, Smith orchestrated the successful sale of Arby’s.

Smith also led operational turnarounds at American Golf Corporation, the world’s largest owner and operator of golf courses, and AMF, the world’s largest owner and operator of bowling centers.

 

Risks

The main risk is that the synergies are not achieved or if they are achieved, they may not be able to offset further secular headwinds.  Customers of Office Max may choose to take their business to Staples.  Reorganization costs may increase thus reducing the amount of benefit the synergies will have.  Office Depot needs to spend money in order to achieve the synergies and if it costs more than they thought it would be a drag to earnings.

Most recently, Smith was the Chief Executive Officer and President of Delhaize America, LLC, which is the U.S. division of Delhaize Group. Delhaize America produces over $18 billion in annual revenue through its U.S. supermarkets, including Food Lion and Hannaford, and represents approximately 65% of the revenue of the Delhaize Group. While at Delhaize, Smith orchestrated the successful integration of the major supermarket chains owned by Delhaize, including successful dispositions of three of the chains thereby materially improving profitability and driving substantial shareholder value creation at Delhaize Group.

Previously, Smith was President and CEO of The Wendy’s Company; President and CEO of Wendy's/Arby's Group, Inc.; and CEO of Wendy's International, Inc. Throughout his tenure at these companies, Smith orchestrated numerous transformative initiatives. Originally at Arby’s, Smith helped to rejuvenate the brand, turn around the culture, and integrate the acquisition of its largest franchisee. Later, Smith successfully completed the acquisition and merger of Wendy’s by Arby’s. While transforming the culture, menu, and product, Smith also improved operations and accelerated international expansion. Additionally, Smith orchestrated the successful sale of Arby’s.

Smith also led operational turnarounds at American Golf Corporation, the world’s largest owner and operator of golf courses, and AMF, the world’s largest owner and operator of bowling centers.

- See more at: http://news.officedepot.com/press-release/corporatefinancial-news/roland-c-smith-appointed-chairman-and-ceo-office-depot-inc#sthash.vNqk9T
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

Announcement this summer of stores being closed by Office Depot
Achieving early synergy targets
Higher synergy targets announces
Any glimse that the secular headwinds are subsiding.
Insider purchases
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