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What's in Store for the Office Max and Office Depot Merger?

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For years, the office supplies industry has been struggling with a rapidly changing market. On the one hand, companies in this industry have faced the rise of e-commerce, and with it, a decrease in customer traffic at their brick-and-mortar stores. On the other hand, developments in technology and mobile computing have decreased demand for things such as printing paper and ink. As a result, companies are looking for ways to streamline business and cut costs. A very large merger is in the works, which will reportedly create the largest office supply chain in the US.

Terms and effects
The two companies planning a merger are Office Depot (NASDAQ: ODP  ) and OfficeMax (UNKNOWN: OMX.DL  ) , the second and third largest chains after Staples. A merger of equals, shareholders of both companies will surrender their shares to receive stock issued by the merged entity. The combined company will have around 2,500 stores worldwide. With combined revenue of $17.65 billion last year it will be the biggest player in the industry .

An all-stock deal, 2.69 Office Depot shares will be issued for every OfficeMax share, which will leave Office Depot with a total of 520 million outstanding basic shares by the end of 2013. In an increasingly competitive market, the deal may prove a lifesaver for both firms. With revenue more or less flat over the last few years, achieving cost synergies looks like a good way to boost the bottom line .

The companies are targeting a combined $400-600 million in synergies, which are divided as follows. Between $130 million and $200 million is expected to be saved in purchasing efficiencies because the total cost of goods sold is expected to decline. Some $70-100 million is expected to be saved by combining supply chains together with transportation and delivery efficiencies. Another $70-100 million should be saved in advertising and marketing, and standardization of administrative processes is expected to save between $130 million and $200 million. The time frame for these benefits is about three years . Office Depot and OfficeMax have both been catching upgrades lately following their optimistic cost-cutting expectations . 

Taking on the competition
Basically, all this merger action is geared at taking on the two main players in the office supply space, Staples (NASDAQ: SPLS  ) and Amazon (NASDAQ: AMZN  ) . Staples has a relatively strong position in the online retail space. It sells over $10 billion worth of supplies through its website annually.

However, the real online retail giant is Amazon with trailing-twelve-month revenue of $66.85 billion. The e-commerce giant has steadily been gobbling up market share with its own office supplies, benefiting from low prices and shipping costs .

Because the company has no physical stores, it has an enormous edge in terms of cost-efficiency. In June 2012, around 1.1 million online shoppers considered buying office supplies from Amazon, versus OfficeMax' 2.4 million. The online store seems to be doing particularly well with backpacks .

Staples has been working hard on upping its competitive power in the e-commerce segment. The company recently announced the acquisition of Runa, a company specialized in e-commerce personalization technology. This should help draw in shoppers and increase turnover . Also, Staples has unveiled a plan to match Amazon's prices, which may prove a serious threat to Office Depot and OfficeMax .

The challenge faced by the new combined office giant thus seems two-fold. On the one hand, it will need to display a clear pricing edge in order to compete with main rivals Staples and Amazon. Amazon especially has an advantage in this area due to its low-cost business structure. Moreover, with Staples planning to match these prices it is likely that prices for office supplies will be pushed down across the board. Yet, considering the significant cost efficiencies that will be generated by the merger, Office Depot and OfficeMax look like they could start competing on price as well.

Secondly, the success of the combined company appears to depend on its ability to sustain growth in the online market and avoid the show rooming effect. Brick-and-mortar store traffic seems to be on the decline throughout most retail sectors, and office supplies are no exception. Like Staples, the combined company should probably consider partnerships or acquisitions that will boost its online presence. So far, Office Depot and OfficeMax haven't given much detail on their online strategy going forward.

The bottom line
America's second and third-largest office supply firms have decided to team up in order to compete more effectively with Staples and Amazon. Considering the cost-efficiencies expected to be achieved under the deal, it looks like a winner so far. In any case, the market has reacted favorably. However, with prices for office supplies decreasing and online traffic on the rise, the combined firm's success will hinge on its ability to cut costs and increase its online presence.

Office Max and Office Depot aren't the only retailers undergoing major change
The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

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