Office Depot Inc. (ODP:US) agreed to buy OfficeMax Inc. (OMX:US) for $1.17 billion in a bid to revive a retailer that’s been losing sales to online rivals and Staples Inc. (SPLS:US), the largest U.S. office-supplies chain. The shares of both companies fell, with Office Depot dropping the most since April 2010.
Office Depot will issue 2.69 new shares for each outstanding OfficeMax common share, the companies said today in a statement. Based on Office Depot’s closing price yesterday, that values OfficeMax at $13.50 a share, 26 percent higher than on Feb. 15, before reports the companies were in talks.
The merger will combine companies with revenue (ODP:US) of about $18 billion, compared with Staples’ more than $24 billion in sales last year. The company may accelerate the closing or selling of hundreds of stores after Starboard Value LP, an activist fund that became Office Depot’s largest shareholder (ODP:US) in September, pushed for expense reductions.
“Consolidation is needed in an overstored and secularly declining industry,” Greg Melich, an analyst at International Strategy & Investment Group LLC in New York, wrote in a note yesterday.
After bidding up both companies yesterday on reports of a possible deal, investors sold off the shares today. Some investors expected Office Depot to be acquired by OfficeMax and when the opposite scenario was announced, they exited the stock, said Louis Meyer, a special-situations analyst at Oscar Gruss & Son Inc. in New York. OfficeMax also fell because its value is tied to Office Depot with the merger pending, he said.
“Office Depot shareholders didn’t think they would be the buyer or use their stock as the currency for the deal,” Meyer said in an interview. “They thought they won the lottery.”
Office Depot, based in Boca Raton, Florida, fell (ODP:US) 17 percent to $4.18 at the close in New York. It surged 9.4 percent yesterday. Naperville, Illinois-based OfficeMax dropped 7 percent to $12.09 after a 21 percent rise yesterday.
Both companies have been gaining this year on speculation about a possible merger and the actual terms didn’t meet expectations, said Ian Gordon, analyst for Standard & Poor’s in New York. Office Depot gained 40 percent this year through Feb. 15 while OfficeMax advanced 10 percent.
A conference call with executives also did little to sway sentiment because there weren’t many details offered, said Bradley Thomas, a New York-based analyst at Keybanc Capital Markets Inc. Merger costs were also more than expected, he said.
“Investors would have preferred a little more excitement and more details,” he said in an interview.
The new company’s board will include an equal number of directors designated by Office Depot and OfficeMax, the companies said. The board will conduct a search for a chief executive officer. Both incumbent CEOs, Neil Austrian at Office Depot and OfficeMax’s Ravi Saligram, will be considered.
Under the terms of the deal, OfficeMax will have the right to pay a cash dividend of as much as $1.50 a share before the transaction is completed, the companies said.
The merger may generate as much as $600 million in annual cost savings in three years, the companies said. The new company also would have more than $1 billion in cash on hand and another $1 billion available in a revolving credit line. The deal is expected to close by the end of the year.
Some confusion was created before the market opened when the deal was prematurely announced on Office Depot’s website. Both companies then issued statements announcing the deal shortly after the market opened.
Starboard Chief Executive Officer Jeffrey Smith pushed for changes at Office Depot in a letter to Austrian on Sept. 17 arguing that the retailer’s “poor operating performance” has hurt the stock. Smith, whose firm owns more than 14 percent of the chain, recommended smaller stores carrying fewer items. It also should cut general expenses and lower advertising costs, he said.
Both chains have been closing locations and that trend would accelerate with a merger as about 50 percent of their store territories overlap, Daniel Binder, an analyst for Jefferies & Co. in New York, wrote in a note to clients.
The combined OfficeMax and Office Depot may close or sell as many as 600 locations, giving Staples an opportunity to increase sales in those areas, Gary Balter, an analyst for Credit Suisse Group AG in New York, wrote in a note to clients.
Staples had 2,295 stores worldwide as of Jan. 28, 2012. In statements earlier this month, Office Depot said it had about 1,675 global locations and OfficeMax said it had about 900 stores in the U.S. and Mexico.
“It makes sense to close a lot of stores and fulfill orders out of facilities that specialize in packing and delivering, using less-expensive real estate,” Erik Gordon, a business and law professor at the University of Michigan in Ann Arbor, said in an e-mail yesterday. “It’s become a cost-driven, commodity business. Everyone sells Bic pens and Swingline staplers. The competitive advantage is to sell them cheaper and get them delivered quickly.”
Office Depot in a separate statement today reported a fourth-quarter net loss of $17.5 million compared with net income of $12.3 million a year earlier. Analysts on average had projected a net profit of $13.7 million. Sales fell 12 percent to $2.62 billion.
OfficeMax also reported fourth-quarter results. The company posted a net loss of $33.9 million compared with net income of $2.9 million a year earlier. Analysts on average had estimated a profit of $12.5 million. Sales fell 7.4 percent to $1.7 billion.
The deal may be challenged by the Federal Trade Commission, according to David Balto, an antitrust attorney in Washington who was the FTC’s director of policy for six years ending in 2001. He worked on the FTC’s lawsuit that stopped Staples from acquiring Office Depot in 1997.
Balto said reducing the number of big-box office retailers from three to two may be viewed as anticompetitive, just as it was back then. In addition, the Obama administration has been tough about enforcing antitrust laws, he said.
“They are facing a stiff wind,” Balto said in a phone interview. “You have three players right now and they want to reduce it by one. That rivalry results in better pricing and services for consumers.”
The industry has “dramatically changed” since 1997 with consumers having more choices since the emergence of online competitors such as Amazon.com Inc. (AMZN:US), Binder said in the same note. It is these competitors and the digitization of the office that can no longer support three national office-supply chains, he said.
The companies are confident the deal will be approved, Saligram said on the conference call. Regulatory approval may take nine months, Austrian said.
As small businesses, the main customer of all three chains, shifted to using fewer pens and filing cabinets, the companies have broadened their selection into technology products such as software, tablets and smartphones. The chains have also branched out into offering more services such as copy printing and computer repair.
There has been speculation of a merger between the two smaller office retailers since last year. A combination of Office Depot and OfficeMax would be “natural,” Staples Chairman and CEO Ronald Sargent said last year at a conference. The FTC is more likely to allow such a combination than if Framingham, Massachusetts-based Staples were to buy either company, he said.
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