The deal could face some regulatory opposition as there will be only one brick-and-mortar office supply superstore left in the market. While many see antitrust opposition as the biggest hurdle for getting the deal completed, investors should perhaps be more worried about what happens if Staples actually gets over that hurdle.
The last big acquisition the office supplies leader made mired the company in mediocrity for years, and Staples' bid for Office Depot is almost two-and-a-half times larger than that. Worse, the merger doesn't solve what's really the root of Staples problems today: the business being lost to competitors Amazon.com (NASDAQ:AMZN), Wal-Mart (NYSE:WMT), and Costco (NASDAQ:COST).
A cash-and-stock deal
Under the terms of the merger agreement, Staples will pay Office Depot stockholders $7.25 in cash and 0.2188 shares of Staples for each share they own. It values Office Depot at $11 per share, representing a 44% premium over its closing price Monday.
Although hedge fund Starboard Value has been agitating for Staples to make this deal since January -- it had disclosed an activist stake in the company the month before -- the office supplies leader said it had actually begun the negotiations well before that beginning in September. Starboard has an even larger position in Office Depot and will profit on both ends of the transaction.
History repeats itself
Antitrust concerns could put the kibosh on it. Staples tried to buy Office Depot in 1997, but was shot down by regulators who feared it would give Staples monopoly like pricing power.
Of course, they didn't have the foresight to see the rise of the Internet, and when the regulators examined Office Depot's acquisition of OfficeMax in 2013, they admitted the landscape was substantially altered since they last looked at the marketplace.
Consumers no longer look just to the office supplies stores for their needs, they now have online options open to them at Amazon and other e-commerce outlets. Staples' own online presence is massive, second only to Amazon in terms of number of SKUs sold. But the highly competitive office supplies market led Staples to start price matching, culminating in its 110% back-to-school price-match guarantee for anything Amazon or any other retailer with both a physical and online presence offered.
Yet mass merchants like Costco, Wal-Mart, and Target (NYSE:TGT) have also significantly expanded their office supplies offerings.
A bunch of Doubting Thomases
Regulators are going to have to revisit the issue again with the new merger offer, but the markets seem to think they're not going to come to a different conclusion than they did 18 years ago when Staples first made a run at its rival.
Shares of Staples fell 10% on the merger announcement and Office Depot's stock is only 1% higher at around $9.40, well below the offer price. Things may have not changed enough for regulators to allow there to be only one office supplies superstore. Staples said if regulators block the deal again it will pay Office Depot $250 million.
But even if they did approve the deal, Staples would still have to prove it could successfully integrate its rival.
An uninspiring record
When Staples bought Corporate Express in 2008, it was hailed as launching the retailer to the forefront of the contract segment of office supplies here at home and globally. Corporate Express was the No. 2 largest company supplier in Europe, and the top one in the Asia-Pacific region.
But the acquisition was one long slog dragging profits down well after management had expected the integration to be completed. It's the Great Recession hurt a more speedy resolution, but even now sales and profits are still falling, with comparable sales down as it closes stores. That's pretty persuasive evidence the market can't profitably support the thousands of stores each retailer operates.
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.
That might argue in favor of a merger, but this deal is several times larger than the Corporate Express acquisition. According to Stephen Paulone, director of graduate business programs for the Malcolm Baldrige School of Business at Post University, anywhere from 50%-75% of all mergers fail to add any value, and blockbuster deals like this seem to routinely go awry. Staples singular track record doesn't inspire confidence either.
Joining the two companies together won't guarantee their survival, though it may hold off the day of reckoning for awhile. But that will only come about if they can convince regulators this is a deal that should be done in the first place, and there's no guarantee that will happen.