Office Depot ODP S
December 04, 2015 - 12:30am EST by
2015 2016
Price: 6.63 EPS 0 0
Shares Out. (in M): 562 P/E 0 0
Market Cap (in $M): 3,700 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0 0
Borrow Cost: Available 0-15% cost

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  • Merger Arbitrage


Office Depot offers an attractive short opportunity with a near-term catalyst. Office Depot is a secularly
challenged business but more pertinently it has an artificially inflated stock price because of a pending
takeover by Staples that is very unlikely to go through.
Merger Background
Staples announced the transaction in February of this year. The terms are $7.25 in cash and 0.2188 in
SPLS stock. At the current price of $6.63 the takeout offer for ODP is $9.87, a 49% gross spread. Clearly
the market is skeptical of the likelihood of the deal closing but the downside from here is substantial
Historical Precedent
An identical transaction was proposed in 1997 and that deal was blocked by the FTC. The companies
have been emboldened to attempt the transaction again by the allowance of ODP to buy Office Max in
2013. In fact, the FTC published a closing statement after the deal that “the market for cosummable
office supplies has changed considerably since 1997”. That is unquestionably true with the entrance of
Amazon but the retail market here is not of concern from an anti-trust perspective. However, ODP and
SPLS are by far the largest players in the commercial segment and it is lack of competition in this
segment that will hang up the deal.
Relevant Segment Definition
The enterprise segment is one in which corporate customers bid out their office product needs and
service. These contracts last a few years and importantly are non-exclusive essentially the winning bid
is merely a negotiated price list. In the US somewhere between 500 to 1,000 of the largest national
accounts get bid out from a single office and the supplier is expected to service the entire account. At
the moment, these types of customers have only two options: Office Depot and Staples. No other
competitors come close to being able to effectively serve these types of customers. While Amazon is
obviously a national provider and both ODP and SPLS are quick to invoke its recent focused entry into
the commercial segment as price disciplining factor, it is not really a viable option for procurement. High
touch, value-added service is a major component of the offering, something that Amazon altogether
lacks. This merger will create a monopoly in the commercial segment and will thus have to be blocked.
Office Max and Office Depot were allowed to merge because the OMX commercial business was a very
weak number 3 player. An analogous situation is the failed transaction between US Foods and Sysco,
which were define as the only major broadline distributors with a national network.
Remedy Potential
The merger agreement allows for up to $1.25bn of revenue divestitures, however there is no possible
solution to create a workable #2 competitor. Essendant is the largest player in the space after ODP and
SPLS. It is a wholesaler with $5bn in revenue and it supports the thousands of independent suppliers as
well as ODP and SPLS for their long-tail tail SKUs. Essendant’s motto is ‘win from the middle’ and given
that its customers are the direct suppliers themselves, it is unlikely that they will step into the role to
compete with their customers. I don’t see them as a potential acquirer of any divestiture package.
The commercial segment office product ecosystem is very fragmented, at the basic level suppliers are
just sales organizations with very low capital intensity. WB Mason is the largest independent supplier
but it is only $1.3bn in sales (vs. $5bn for ODP and $8bn for SPLS) and is strongest in the Northeast
region. WB Mason would have to bite off a major piece of ODP’s business to have a true national
footprint. Furthermore, having one possible acquirer puts ODP/SPLS in a very fragile negotiating position
and renders agreement on price by the counterparties to be less likely.

Options for procurement officers
Investors long the deal tout the ability for customers to go direct to the manufacturer, such as Walmart.
Similarly there is a view that regional players can patched together to substitute a national offering. I
think that while these options may keep pricing discipline, the FTC also factors in the service component,
which will clearly deteriorate. One must ask, what is the pain threshold for these options at which point
they are no longer considered viable substitutes?
FTC has a December 8 deadline but this will likely be extended by the parties, which could be perceived
as a positive event (the spread has mostly been in the low 30%s). The outside date for a decision is
March 2, 2016 which is the EU deadline.
ODP has $550m remaining in additional synergies from the OMX transaction, which is being partially
offset by high single digit top line declines. A 4x EBITDA multiple is fair for a secularly challenged
business where EBITDA will be in decline once synergies are realized. At $900 of EBITDA in 2018,
discounted back at 15% yields a stock price today of $5.40, 19% down from today’s price. However, it
will likely go lower on a deal break the price was in the mid $5’s before the deal announcement.
2013 2014 2015 2016 2017 2018
Total Sales 16,549 15,941 14,793 14,097 13,468 12,870
Y/Y -3.7% -7.2% -4.7% -4.5% -4.4%
Pre-Corp Operating Income 227 411 380 364 350 336
Sales Decline 1,148 696 628 598
Decrimental Margin
16% 16% 16% 16%
Operating Income Decline 189 115 103 98
Pre-Corp Operating Income 227 411 192 250 246 237
Corporate Operating Income 128 122 122 122 122 122
Adj. Operating Income 99 289 70 128 124 115
New Synergies OfficeMax - recognized 310 100 50 0
Total Synergies 290 310 410 460 460
Europe Improvements - incremental 30 30 30
Total Europe Improvements 30 60 90 90
Total Synergies 340 470 550 550
Adjusted Operating Income 410 598 674 665
Reported Adjusted EBITDA 687 867 931 907
FTC allows the transaction to go through


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


FTC block

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