Office supply retailers have been crushed in recent years. In the aftermath of the Great Recession, when the broader retail industry enjoyed a significant rebound amid rising consumer spending, Staples (NYSE: SPLS) and Office Depot (NYSE: ODP) missed out on the recovery.
The reason is simple: Office supplies are a dying business. As more and more work gets done on the Internet, physical office supplies like printer toner, paper and staplers aren’t nearly as necessary as they were 10 years ago. Add to this the deterioration in brick-and-mortar retail more broadly due to pressure from Internet retail, and this is a recipe for disaster.
As one would expect from a shrinking industry, office retailers have responded by attempting to consolidate. This was the last hope for Staples and Office Depot to maximize value for shareholders, but the two companies were dealt a severe blow when the government blocked their merger plans.
With no deal in sight, it’s time for investors to abandon ship.
Hopes Are Dashed
A federal judge blocked the $6.3 billion planned merger on antitrust grounds. In a statement, the judge expressed the opinion that had the merger gone through, the newly-formed entity would have increased prices on its big-business customers in a way that violates U.S. antitrust law. In the judge’s opinion, even though this wasn’t a mega-merger, U.S. antitrust law still applies for smaller mergers.
The U.S. Federal Trade Commission had opposed the deal, on similar grounds.
It’s easy to see why the two remaining office retail juggernauts would want to combine forces. A merger would likely result in significant scale benefits and competitive advantages, essentially forming a virtual monopoly on what’s left of the office supply industry.
Plus, as is typically the case with large mergers, the remaining entity would be able to generate significant cost synergies, since the two companies are nearly identical. This would be another way to create value for shareholders.
Indeed, Staples and Office Depot need to pull as many levers as they can to provide returns to shareholders, because the underlying businesses are deteriorating.
It’s not hard to see why both stocks collapsed when news broke that the Staples merger had been blocked. On Wednesday, May 11, shares of Staples and Office Depot fell 18% and 40%, respectively.
Office Depot will receive a $250 million breakup fee from Staples, but this is hardly consolation. It badly needed the merger to survive over the long-term, and since the stock market is a forward-looking mechanism, the huge share price decline is a clear indication of that.
Now that merging is officially off the table, there seems to be little reason for investors to hold onto either of these two stocks.
Their fundamentals are in poor shape. Office Depot’s sales fell 10% last year. It managed to squeeze out a profit of $0.01 per share for the year, due to significant cost-cutting. But sales dropped another 9% in the first quarter this year.
Staples has held up better than Office Depot. Its sales declined a more modest 6% last year, and it is more profitable thanks to cost-cutting.
Going forward, both companies will continue to focus on cost cut costs: Staples announced a plan to cut expenses by $300 million per year by the end of 2018, but cost cuts can only take a retailer so far.
These companies are seeing sales fall, and will need to close additional stores. Office Depot closed 56 stores in the fourth quarter, and another nine in the first quarter 2016. Staples closed 242 stores in 2014 and 2015 combined.
The Bottom Line
Staples and Office Depot are managing to remain profitable for now, because they are slashing costs to the bone. But there is a bigger, longer-term challenge, which is that the industry is changing. Retail is a dynamic industry. It’s critical for companies and investors to stay on top of the trends. Investors have seen retail disrupted time and again from bookstores to record stores and now to office supply chains.
The clear takeaway here is that office supplies are out, and digital is in. This is a clear shift in the way people are working today, and the trend shows no signs of reversing any time soon. As a result, when it comes to Staples and Office Depot, there is no need for investors to go down with the ship.
This Is Making Ordinary People Rich
Ordinary people across America are getting insanely rich. Take Gladys Holm. She never earned more than $15,000 a year as a secretary. But by making one simple move, she was able to leave an $18 million fortune to a children’s hospital when she died. There’s many more just like her.