Staples, Office Depot to stand stronger together - merger

Discount Store News, Nov 4, 1996 by Laura Liebeck

When Staples' television spots tell viewers, "Yeah, we got that," the chain is talking about more than products. Now it's talking about market share.

The proposed merger of Staples and Office Depot--the two leading office supply chains--announced on Sept. 4, should be completed early next year, making the industry's final consolidation and a return of Staples to the top of the heap.

It was Staples founder Tom Stemberg, the retailer's chairman and ceo, who created the office products superstore industry 10 years ago with the opening of the first Staples store. Now, after a decade of consolidations, Staples, the first chain, will become the No. 1 chain, with sales exceeding $10 billion and a store count of more than 1,100 units. Its closest competitor will continue to be OfficeMax, which should post 1996 sales of more than $3 billion.

In 1995, Staples was the No. 2 chain in the industry, with $3 billion in sales; Office Depot, the largest chain in the field, had sales of $5.3 billion.

"This is a logical and rational attempt to put these two growth machines together into one even bigger growth machine," Stemberg said when he and David Fuente, chairman and ceo of Office Depot, announced the merger and creation of the new entity, Staples/Office Depot. "In this particular transaction, every single major set of stakeholders wins. The company looks forward to pioneering greater savings."

Apparently, the stock market has agreed with Stemberg's optimistic viewpoint.

Since the announcement two months ago, Staples' stock has been trending up, closing at 21 3/8 at press time, near its 52-week high of 22 5/8. In addition, several retail analysts who follow Staples have issued reports reiterating a "buy" or a "strong buy" rating on its stock.

As a merged entity, earnings per share have been estimated for 1997 to run as high as 95 cents from 83 cents, and for '98, $1.25.

This merger is valued at more than $3.6 billion. It is intended to be stock-for-stock merger, a tax-free re-organization and a pooling of interests. The agreement calls for Office Depot stockholders to receive 1.14 shares of Staples common stock for each outstanding share they own. The deal also calls for each company to purchase up to 19.9% of the outstanding stock of the other retailer.

Staples reported that the merger will create the following financial benefits to the combined company:

* A cost savings to $90 million in 1997, $145 million in 1998 and $210 million in 1999. Included in the $210 million are $75 million in savings linked to product procurement. Staples projects $85 million in savings associated with advertising costs and $50 million in general and administrative expenses. Analysts have typically viewed these savings as conservative estimates.

Pat McCormack, senior vp, Dean Witter, noted in his Sept. 13 report that the cost-savings estimates are low for several reasons: The 1999 savings amounts to only 1% of estimated sales for that year ($16.2 billion); $75 million in product procurement savings is low since it is based on estimated product purchases of close to $5 billion in 1999; the advertising savings is low considering the two companies will probably spend $200 million each in advertising in 1996; and Staples' targeted savings of $50 million in G&A "seems small" considering Office Depot will spend $175 million on G&A in 1996.

Through 2001, McCormack projects sales for the combined company at $10.3 billion for 1996; $11.6 billion for '97; $13.8 billion or '98; $16.2 billion for '99, $18.7 billion in 2000; and $21.5 billion in 2001.

* Non-recurring merger expenses on a pretax basis of $520 million, which is comprised of $125 million for store closings, $150 million for store remodels, $100 million for obsolete inventory and $145 million for merger/transaction costs.

Such huge merger expenses have raised a red flag to some retail analysts who follow Staples. They noted that $520 million is an enormous number, one that far exceeds the amount PriceCostco booked ($120 million) in its merger deal three years ago, then a $15 billion entity.

What Staples/office Depot appears to be doing is creating a huge cushion of funds from which it can draw for merger-related programs without raising assorted accounting issues and protecting its stock price. These funds will be used for store closings (estimated at 70 units), store remodeling, altering inventories and assortments.

As a result of this merger, store expansion should slow considerably over the next two years or so, permitting Staples/Office Depot breathing room to bolster profitability and enhance store design and customer services.

In 1997, the combined chain will open about 50 stores, dramatically below the store opening pace of either chain in the last few years. After that, the combined chain should open approximately 150 stores per year, making the 1,500-store mark by 2000 well within reach in the waning years of the decade.

This also is good news for OfficeMax, a position taken by that chain's chairman and ceo, Michael Feuer. When the merger was announced, Feuer told DSN that a smaller playing field offers it unique opportunities in the marketplace.