Do We Need More Proof Office Depot Needs to Merge?

It should've happened years ago when Staples (NASDAQ: SPLS  ) wanted to buy out Office Depot (NASDAQ: ODP  ) ; but when the latter's merger with OfficeMax (NYSE: OMX  ) finally goes through, we'll get the much-needed consolidation of the office-supply market that's been seriously lacking.

It's just that when you look at Office Depot's latest quarterly results, you understand why the tie up is necessary, and why the Justice Dept. was wrong to thwart Staples' efforts. Second-quarter sales fell 4%, to $2.4 billion, as it recorded losses of $64 million. It's not a surprising outcome considering the continued sluggish state of the economy.

The Bureau of Economic Analysis issued its GDP estimates the other day that showed 1.7% growth in the second quarter, better than the 1.1% growth the country experienced three months earlier (but revised sharply downward from previous estimates of 1.8% in June, and significantly beneath the 2.4% original forecasts). Yet, when you remember the Commerce Dept. changed the way it calculates GDP -- now it includes "investments" from intellectual property like movies and TV shows, as well as research and development expenses that used to be, well, expenses, not productivity -- it suggests that the economy is a lot weaker than the government's letting on.

With economic affairs in such an anemic condition, it's clear that the market can't support so many office supply outlets. Office Depot has around 1,100 storefronts; OfficeMax has almost 940 stores after eliminating 6 million square feet of store space since 2005; and Staples, the largest such retailer, has around 1,500 stores. This despite all of the retailers rationalizing their footprint, and not opening any net new locations.

Last quarte,r net revenues at Staples fell 3%, and were down twice that rate for OfficeMax. When Justice blocked Staples from buying Office Depot over fears the office-supply market would become too concentrated, it ensured they'd have a future of value destruction and wasted resources.

Even when the merger is completed, which is expected by the end of this year, it's not guaranteed that a stronger retailer will emerge, as both may be irreparably damaged at this point. Think of the outcome Sears had after merging with K-Mart. Two sick companies don't necessarily make a healthy one.

That might prove a benefit to Staples in the long run, but it's also trying to overcome its ill-advised acquisition of Corporate Express from a few years back. The office-supply business in the U.S. is at one of its weakest points ever, with its major players handicapped by the economy, the government, and their own choices.

If the industry ever hopes to recover, even as the economy limps along, it's only going to be at a vastly reduced size. 

With the American stock markets reaching new highs even if the economy lags, investors and pundits alike are skeptical about future growth. They shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," outlines three companies that could take off when the global economy gains steam. Click here to read the full report!


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