Competition from Mass Merchants Spurs Office Retailers to Propose Merger

Encroachment from retailers Walmart, Costco, Target, Best Buy, Amazon and others pushed Office Depot and OfficeMax toward a merger that’s expected to be finalized by the end of the year, executives for the companies said on a conference call Wednesday. OfficeMax stockholders will net 2.69 Office Depot shares of common stock for each share of OfficeMax common stock in the $1.2 billion deal, the companies said. Both companies reported declining revenue in reports released Wednesday, with Office Depot posting a loss of $17 million on sales that fell 12 percent to $2.6 billion in Q4 from the year-ago quarter. OfficeMax reported a loss of $33.9 million for Q4 on revenue that fell 7.4 percent year over year to $1.7 billion, the company said.

Announcement of the proposed merger came sooner than the companies intended when the deal was prematurely announced on the Office Depot website Wednesday, a week before the company had planned to release earnings data. OfficeMax earnings had been scheduled for release Thursday. The early release led to speculation from online publications that Office Depot was buying OfficeMax, a perception CEOs of both companies were quick to quell on the conference call, presented as a “tango” and “a merging of equals” between the two companies that professed to share similar philosophies and goals.

The pro forma ownership of the new company will be 54 percent Office Depot and 46 percent OfficeMax, the companies said. If BC Partners, Office Depot’s largest shareholder, converts half of its preferred shares into common shares, the new company will be 51 percent Office Depot, 44 percent OfficeMax and 5 percent BC Partners, the companies said. BC Partners has agreed to vote for the deal, said Office Depot CEO Neil Austrian. Upon completion of the deal, Office Depot and OfficeMax would have equal board representation in the new company, executives said.

Austrian and OfficeMax CEO Ravi Saligran will stay in their current positions through the search process for a new CEO of the combined company, Saligran said. The search process will be handled by a committee with an equal number of board members from each company, he said. Both current CEOs along with third-party candidates will be considered, Saligran said.

The proposed merger, still subject to shareholder and regulatory approvals, would put both retailers on “solid footing,” Janney Capital Markets analyst David Strasser told us, enabling them to eliminate “hundreds of millions” from expenses. The companies estimated $400 million-$600 million of “cost synergies” resulting from the merger over a three-year period. Synergies will derive from “purchasing efficiencies, supply-chain advertising, headcount reduction” and other general and administrative expenses, Austrian said. Despite the cost reductions, revenue is “still an issue,” Strasser said. While Office Depot “needed it more,” both companies will benefit from a “much better cost structure” to compete with Staples and Amazon, Strasser said. Combined pro forma revenue of the two companies this year is estimated at $18 billion, executives said.

Executives wouldn’t comment on upcoming store closings for competitive reasons -- the chains remain rivals until the deal closes, Austrian noted -- but the effect on the office supplies market will be consolidation, Strasser said. In a report prior to the conference call Wednesday, Janney said 90 OfficeMax stores, representing 10 percent of the U.S. market, are within half a mile of an Office Depot location, 169 stores are within one mile (19 percent), 293 within two miles (33 percent) and 364 within three miles (41 percent). Metro market overlap is most prevalent in California, Colorado, Florida, Texas and Georgia, it said. Janney sees the most “store rationalization opportunities” in Atlanta, Charlotte, N.C., Chicago, Dallas, Denver, Detroit, Houston, Miami, Kansas City, and Minneapolis, projecting that the 169 stores with less than a mile overlap would likely be closed, either by the combined entity or by the government as part of a Federal Trade Commission stipulation resulting from approval of the merger. Of the 169 OfficeMax stores within a mile of a Depot, only 20 were within one mile of a Staples store, the report said, which clips the benefit Staples would realize from “direct sales recapture” following the first round of store closings.

On the likelihood that the FTC will approve the merger, Saligran said the merger has been “talked about for 20 years.” Previously, the two retailers had a lock on the office supplies market, but Saligran said the market has changed quickly enough “that we have a very strong case here.”