Any company spending over $1 billion on a buyout is going to be on the hook to make its new asset work. That's the case with struggling office-products retailer Office Depot (NASDAQ:ODP), which in early October announced a roughly $1.1 billion acquisition-and-debt-assumption deal to buy privately held IT services specialist CompuCom Systems from private-equity operator Thomas H. Lee Partners.
The market indicated its displeasure at the news by trading Office Depot stock down by around 15%. Many investors clearly don't believe CompuCom can return the company to growth. I don't think it's impossible, but Office Depot will need to demonstrate that it's viable -- and do so quickly.
The recent hardships of office-supply retailers have been well documented. Office Depot is a prime example of these woes, enduring several years of revenue erosion and more than a few bottom-line losses. A federal judge last year effectively quashed a seemingly sensible plan for it to merge with Staples, which would have consolidated operations.
Since then, private-equity operator Sycamore Capital has scooped up Staples in a $6.9 billion deal. Meanwhile, Office Depot continues to fend for itself as a standalone company.
Although the difficulties of brick-and-mortar office-products retailers (and many other types of traditional retailers, come to think of it) have often been ascribed to determined online competition, that doesn't tell the whole story.
Office products, in general, aren't moving off the shelves rapidly. According to data from industry researcher One Click Retail, total U.S. office product sales inched up a mere 1% on a year-over-year basis in 2016, to just over $12 billion. A big reason is a digitization, which has reduced the need for traditional products such as pens, staplers, and even printers.
And it's naturally compounded by the boom in e-commerce -- the famous Amazon Effect. Amazon.com (NASDAQ:AMZN), which is apparently determined to take over every possible segment of the retail world, is going gangbusters in the office-products sphere. One Click Retail's figures have it that the company's sales in the category were $2.25 billion last year, a beefy 25% increase over the 2015 tally.
That $2.25 billion, by the way, was nearly 20% of the entire market. So basically, the industry is barely growing at all, while Amazon is swallowing a much bigger chunk of it.
From caterpillar to butterfly?
The rationale behind the CompuCom buy, then, is understandable.
It's a business that isn't hard to bolt on to existing operations, it's an established company with a track record (it was founded in 1987), and it has a customer base that comprises a total of around 5.1 million users, according to Office Depot. Its new owner says it could potentially produce $1.1 billion in revenue and $40 million in cost synergies.
But even though it's an established operator in its field, CompuCom is hardly the only game in town for third-party tech support. Best Buy's Geek Squad is a roughly comparable example of a retailer tech services add-on. Also, there are thousands of smaller companies that can offer the services that CompuCom, Geek Squad, and the like can provide.
Meanwhile, there doesn't seem to be any core growth in sight for Office Depot. Analysts are modeling a flat line for net profit both this fiscal year and next, on the back of revenue that's anticipated to slide to $9.7 billion from just over $11 billion of 2016.
With its splashy new acquisition, Office Depot says it's shifting "from a traditional office products retailer to a broader business services and technology products platform." But revenue's draining away, profitability doesn't seem to be going anywhere, and rivals like Amazon are getting stronger.
Office Depot's latest move is big, bold, and potentially transformative. Whether the company can harness it to improve its fortunes is another matter.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Eric Volkman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.