Staples Looks Sharp

I'll say one thing for management at Corporate Express: It's decisive. These guys may not be good businessmen. They may not be too bright. Or particularly good at math.

But decisive? Yeah, they're that.

The story
After weeks of rumors, Staples (Nasdaq: SPLS  ) finally bid for its European rival on Tuesday, offering approximately $10.63 per share of Corporate Express (CE), $3.7 billion cash in all. It took CE management all of two hours to review the bid and declare that, "this proposal significantly undervalues the company and fails to reflect Corporate Express' prospects."

Balderdash
CE management has destroyed roughly two-thirds of shareholder value over the past year, as the share price fell from $15 a year ago to just over $5 before rumors of the takeover began circulating. Judging from the track record, shareholders could be forgiven for wondering whether CE, under its current management, has any "prospects" at all. And don't tell me "retail is bad all over." Costco (Nasdaq: COST  ) is doing just fine. Wal-Mart's (NYSE: WMT  ) and Staples are basically flat over the past year. Even housing market-plagued Home Depot (NYSE: HD  ) has fallen only half as hard as CE.

In fact, seeing just the hope of a change in stewardship drive CE's stock price up nearly 40% yesterday, I'd say the votes are in -- shareholders want CE management to sell out.

Stop whining
But what about CE's argument that it's worth more than Staples is offering? Absurd. Look at the valuations in this industry:

P/S

P/E

Operating Margin

Staples

0.84

16.2

8.2%

Corporate Express

0.45

14.2

3.6%

Office Depot (NYSE:ODP)

0.25

7.4

4.5%

OfficeMax (NYSE:OMX)

0.20

8.7

3.6%

All other data courtesy of Capital IQ, a division of Standard & Poor's, and Yahoo! Finance, based on trailing-12-month data. Corporate Express valuations based on the $3.7 billion price offered by Staples.

Just a few weeks ago, CE was selling for the lowest price-to-sales and price-to-earnings ratios in this sector. (And rightly so. Did I mention how management wiped out two-thirds of shareholder value in 12 months?) Today, Staples is offering multiples higher than rivals (other than itself) for a company that produces operating margins inferior to most of the industry. Far from undervaluing CE, I'd say Staples is doing these guys a favor.

Walk with me
But the real beneficiaries of Staples' bid -- if it goes through -- would be the shareholders. Not just CE's, but Staples', too. Walk through a few more numbers with me, and I'll show you why.

Right now, Staples consists of three businesses:

  • North American Retail: Staples' big boxes earned 9.6% operating margins on $9.9 billion in sales over the 12 months ending November 2007.
  • North American Delivery, which delivers office supplies directly to businesses. Staples' second biggest business earns 10.7% margins on $5.8 billion in sales.
  • International: Staples' redheaded stepchild gets a mere 2.1% operating margin on $2.4 billion in business. When he recommended Staples to Stock Advisor members last year, Fool co-founder Tom Gardner identified this as Staples' weakest link.

CE casts a near mirror image:

  • CE sold $3 billion in 2007 in North America, earning a mere 2.8% margin.
  • In contrast, "international" is CE's strong suit. Here the firm gets 5.5% margins on $2.1 billion in revenue.
  • (CE has two corollary businesses providing printing and graphics services. Combined, these two earn 4% margins on $1.2 billion in sales.)

A match made in heaven
It's the mirror images cast by the two firms that make this match so very good for both sides. Staples and CE complement each other perfectly. Consider for a moment what might happen if Staples succeeds in buying CE. Assume Staples can bring CE's North American business up to Staples' own standards. Assume further that with the added scale of CE's existing operations, Staples can translate CE's international margins into its own global business. (For ease of reference, let's just leave CE's corollary units alone.) What might this look like?

  • North American Retail: Staples' existing big boxes would pull in $10.2 billion at a 9.6% margin. That's $980 million.
  • North American Delivery: Take Staples' $6.5 billion, add $3 billion from CE, and you get $9.5 billion. At Staples' 10.7% operating margin, that's $1.02 billion in profit.
  • International: $4.5 billion at CE's 3.2% margin gives us $144 million.
  • Corollary businesses: About $48 million.

Together, a combined Staples-Corporate Express could potentially generate roughly $25 billion in total revenues and nearly $2.2 billion in operating profit, based on Staples' domestic margins and Corporate Express' international margins.

Compared to the $1.9 billion the two companies earned separately over the last 12 months, that makes for a 16% improvement.

Foolish takeaway
This deal will rescue CE shareholders from management immediately. For Staples shareholders, the deal pays for itself in as little as six years. That makes it a no-brainer in my book.

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