Management at office supply company Staples (ticker: SPLS) thought it had the future planned. Its vision for a creating a dominating presence within the office supply industry seemed all but ensured when it agreed to a $5.5 billion merger last year with Office Depot (ODP).
But the Federal Trade Commission doesn’t share the vision. In December, it said it wouldn’t allow the merger to go through due to concerns that the combined company would have too large of a market share in servicing the office supply needs of large companies.
The decision comes despite Staples’ best efforts to push the deal through, including an offer to dump $1.25 billion in commercial contracts. Now the merger is a long shot, and Staples appears to be in a precarious position.
Starboard Value, the New York hedge fund that instigated the proposed merger, revealed last week that it has sold its 15 percent stake in Office Depot. And Staples’ CEO says the company will likely stop its efforts to acquire ODP should federal officials win a preliminary injunction in May to stop the deal.
That leaves Staples with no clear path forward — and after failing to significantly increase sales since 2008, its stock has fallen more than 60 percent. “Staples is the best-run company in a very challenged industry,” says Bradley Thomas, director of retail equity research at KeyBanc Capital Markets.
When you’re the best in a bad field, what do you do to escape it?
Digital has cut into sales. Like many retailers, Staples is struggling with competition from online suppliers — particularly Amazon.com (AMZN). With cheaper prices, great customer reviews and the ease of ordering pens and paper without leaving your house, the Amazon experience has had an impact: Staples’ sales are down 15 percent since 2012.
True, the company is trying to cut costs. It closed 12 percent of its stores from 2014 to 2015 to reduce expenses by $500 million a year, then announced last week it would close 50 more locations. But the effect of closing each new store has less upside, since stores are now farther away from each other. Closing one won’t prop up another, and closing too many locations could result in lost customers.
It may be the simple digitization of many of the products Staples sells that has served as the greatest blow against the company. With more users taking notes on tablets and smartphones or filing papers digitally via cloud networks, there’s less of a need to buy paper products at Staples. “People are using less of the category,” Thomas says.
The office market remains the bright side. The office supply segment of Staples’ business is becoming more important. In 2013, this segment accounted for 34 percent of sales. That now stands at 40 percent.
In an effort to increase opportunities, Staples is focused on one of most successful marketing strategies: the Easy Button. Fortune reports that developers are building a tool that would allow business customers to place orders using a so-called Easy Button. It’s a tactic that’s not only smart for online sales, but could make it simpler for companies to renew previous orders and drive larger purchases.
Staples has also begun to invest more in ancillary office services, such as break room support and janitorial supplies. Plus, it remains a step ahead in its ability to ship entire orders at once, compared to multiple shipments that competitors often provide, says Joe Feldman of the Telsey Advisory Group in New York.
The merger that wasn’t remains a problem. There’s a belief that for the office supply space to survive online competition, it must consolidate. That’s what the Office Depot purchase would have done for Staples. It estimated that the combined companies would save $1 billion a year in “cost synergies,” making it cheaper to operate.
The FTC nixed the Office Depot merger because it would reduce competition for office supplies that are provided to large companies. Analysts were surprised by the decision because it offered a “very narrow market definition by zooming in on the most capable and biggest customers that Staples sells to,” Thomas says.
But investors aren’t holding out much hope since the FTC rarely loses such decisions. If the court rules that the merger can’t go through, Staples is on the hook for a $250 million fee to pay to Office Depot for the failed closing of the deal.
It’s a cheap buy if you’re hopeful. The positive side of Staples is that it’s cheap. Feldman values the company at 10 times 2016 price-to-earnings ratio, which compares to an industry average of 15. That’s “below where it traded during the recession,” he says.
Although the company remains profitable, the lower valuation comes because analysts struggle to pinpoint growth if the merger fails to go through. For instance, if the merger succeeds, then Thomas would value it at 4.8 times enterprise value to earnings that excludes taxes, depreciation and other costs.
The only upside to a failed deal would be that the company would likely repurchase shares of Staples stock, something it stopped doing in preparation for the merger.
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Staples Searches for Growth Amid Merger Headaches originally appeared on usnews.com
