Originally dismissed as the fanciful musings of an analyst a few months ago, news that hedge fund Starboard Value has accumulated sizable positions in both office supplies retailers suggests it might not be so far-fetched as believed.
Staples is the largest bricks-and-mortar office supplies retailer with over 2,040 stores, trailing revenues of $22.7 billion, and a market cap of $10.5 billion. Office Depot, which recently completed its acquisition of rival OfficeMax, also has over 2,000 stores but had $15.7 billion in revenue and sports a market cap of just $4.2 billion. Even with the industry consolidation, the retailers are in a world of hurt.
Crumpled like a piece of paper
Revenues at Staples dropped 2.5% in the third quarter to $5.96 billion as same store sales tumbled 4% and it closed 127 stores year to date. Office Depot also saw revenues in the third quarter fall 3% to $4.1 billion as comps fell by a like amount as it closed 160 stores globally. With a large number of stores overlapping between it and OfficeMax, it's expected hundreds more stores will be shut down.
The push into the office supplies business by Internet retailers like Amazon.com (NASDAQ:AMZN), as well as mass marketers such as Wal-Mart (NYSE:WMT) and Costco (NASDAQ:COST), continue to wear down the profitability of the last two industry stalwarts.
Over the first nine months of their 2014 fiscal years, Staples recorded net income of $395 million, down 20% from the year ago period, while Office Depot had losses of $270 million compared to a profit of $52 million by the third quarter in 2013.
This is why the talk of a merger between Staples and Office Depot just won't die.
Returning zombie-like from the grave
What was once seen as fanciful thinking is now becoming an imperative. If the two office supplies retailers don't join together, they will soon wither away and die. It's no longer a question of can they merge, but rather can they afford not to?
The office supplies market suffers from a glut of stores. Even if both companies dramatically shrink their footprint, there is little need for 3,000 stores when there are numerous alternative outlets for obtaining the same basic office necessities.
And Starboard Value seems to be jumping on board in anticipation of making that happen.
Starboard Value is Office Depot's largest shareholder and just increased its stake in the company to 10% from the previous 8.6% position it held. What has tongues wagging, though, is that Starboard also established a 6% position in Staples. This suggests Starboard believes regulators will be more agreeable to the two companies merging than they were in 1997 when Staples last tried to acquire Office Depot.
It's easy to speculate (and I have) about how much stronger the office supplies industry would have been had the trade regulators not interfered with the marketplace. Fearing anticompetitive restraint, they blocked the creation of a stronger company that might have been able to fend off, or at least more effectively compete against, the rise of Amazon.
Staples own online presence has become massive, rivaled only by Amazon itself in terms of number of SKUs sold. But the intense war that's raging in office supplies is what led Staples to begin price matching last year to counter the threat the online marketplace presented. And this past summer it announced a 110% back-to-school price-match guarantee for anything Amazon or any other retailer with both a physical and online presence offered.
Sales have been good, but the competition is better
From 1997 to last year, Staples sales have grown from $4 billion to $23.1 billion, a compounded 11.6% annual rate of growth. However, revenues at Amazon have grown from less than $148 million to $74.5 billion, or a 47% compounded annual growth rate. Even Wal-Mart, which was a retail behemoth even back in the mid-1990's, went from $118 billion in revenues in 1997 to $476 billion last year. Considering its size, the 6% annual growth rate is still impressive.
Against such competition it's not surprising Staples and Office Depot are struggling. A merger wouldn't guarantee their survival, but it would likely forestall their demise.
Because consumers have so many options for getting office supplies both online and in-store, antitrust regulators may have less reason to reject a merger these days. Starboard Value apparently sees that as a distinct possibility and has smartly positioned itself in the event that an offer is made.
Follow Rich Duprey's coverage of all the retailing industry's most important news and developments. He has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Costco Wholesale. The Motley Fool owns shares of Amazon.com, Costco Wholesale, and Staples. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.