The office supply sector got a boost today, after rumors surfaced of a possible merger between office supply retailers OfficeMax (NYSE: OMX) and Office Depot (NASDAQ:ODP). Shares of OfficeMax surged 26%, while shares of Office Depot gained 18%. The two retail chains have suffered lately as a result of increased competition from larger rival Staples (NASDAQ:SPLS) and e-commerce giant Amazon.com (NASDAQ:AMZN). But will combining OfficeMax and Office Depot really be enough to reverse slumping sales at the two chains?
Let's dig deeper to uncover what the proposed merger would mean for shareholders.
According to a report from The Wall Street Journal, "The deal is expected to be stock-for-stock." However, the exact terms of the deal have not been disclosed. If the merger were to happen, OfficeMax and Office Depot together as one would emerge bigger, but not necessarily better. According to research from Morningstar, the deal would transform the duo into the largest office-supply retailer by store count in the United States.
Unfortunately, having the most physical storefronts won't help these companies better compete against more nimble rivals, such as Amazon. Last year, the e-tailer launched its business-to-business website, AmazonSupply.com. The site puts pressure on brick-and-mortar office products retailers by letting businesses conveniently order office supplies online with free shipping offered on any order over $50.
It is difficult for a company such as Office Depot or Staples to compete with this, because their cost structure is significantly higher than Amazon's. For example, unlike Office Depot, Amazon doesn't pay rent or staff traditional store locations. In spite of these challenges, an all-stock union between Office Depot and OfficeMax would likely result in cost savings.
Analysts estimate cost cuts would be from around $400 million to as much as $700 million annually if the merger were completed. However, even with such cost synergies factored into the equation, both OfficeMax and Office Depot face a challenging retail environment going forward, as more consumers shop for office supplies and other products online.
While we wait to see how a hypothetical merger plays out, investors may want to instead consider shares of Staples. As it stands, the office-supplies retailer is heavily investing in its online business in hopes of better competing with Amazon. Not to mention, Staples could be a potential buyout candidate. According to the Journal, "Staples has had discussions with private-equity dealmakers in recent months." If the company were to be taken private, shareholders could see a premium to Staples' current stock price at around $14 a share.
Amazon is the other obvious choice here for investors. Everyone knows Amazon is the big bad wolf in the retail world right now, but at its sky-high valuation, can the e-tailer's stock continue to move higher from here?