Does Blocked Staples-Office Depot Merger Just Delay the Inevitable?

Does Blocked Staples-Office Depot Merger Just Delay the Inevitable?

The Federal Trade Commission intends to challenge Staples’ $6.3 billion acquisition of Office Depot, the two remaining big-box office supply retailers. The companies, which announced the merger in February, plan to fight the FTC to complete the transaction, which received support from shareholders when it was announced in February.

Wall Street took the FTC announcement hard. Several firms downgraded Staples from Buy to Hold and the Framingham, Mass.-based retailer’s stock took a hit of nearly 20 percent; it’s now trading at a 52-week low at $9.60.

While the news that the FTC plans to block the merger disappointed a lot of people, real estate owners are not among them. “In general, owners aren’t in favor of the merger because they’re concerned about the immediate closures that would result,” says Brian Bern, a senior director with Franklin Street who has worked with both Staples and Office Depot on store dispositions. “Everyone was predicting a huge number of closures.”

Seeking operational efficiencies

A merger between Staples and Office Depot would have massive implications for the retail real estate industry. Staples operates more than 1,300 stores in the U.S., while Office Depot operates about 1,800 stores, including those absorbed through its previous acquisition of OfficeMax. The stores average about 20,000 sq. ft., which means that the combined companies would occupy somewhere in the neighborhood of 62 million sq. ft.

With that amount of space in play, it makes sense that retail center owners are closely watching the situation.

“People are nervous,” Bern says. “If the merger doesn’t go through, the closures will still happen, but they will occur over a period of time, which makes the situation more manageable for the industry.”

But other experts point out that Staples and Office Depot pursued the merger for a reason, and that a failure to merge could be disastrous.

“Usually M&A occurs when companies have run out of organic growth opportunities or need to create economies of scale to be more efficient and fight off competition,” says Nathan Brzozowski, managing director of consulting services at real estate services firm Savills Studley. “Staples and Office Depot have a high degree of overlap with their store footprint, and if they don’t merge, they’ll be operating in a much, much weaker position.”

Staples and Office Depot say the combined company would generate significant savings from synergies, which would “enable lower prices for all customers.” The companies also indicate they would use the cost savings to continue to invest in people, technology and customer service.

When the two companies initially announced the acquisition, Staples said it expected to generate at least $1 billion in annualized cost synergies by the third full fiscal year post-closing.

Competitive pressure everywhere

From the FTC’s perspective, the Staples-Office Depot merger is problematic because of the companies’ commercial business. The agency doesn’t seem to have any issues with the merger as it relates to the consumer side of the business.

The FTC’s administrative complaint proclaims that the merger would violate federal antitrust laws by “significantly reducing competition nationwide in the market for ‘consumable’ office supplies sold to large business customers for their own use.”

In a statement, Staples and Office Depot contend that the government’s challenge, if successful, will “hurt customers of both companies and jeopardize our ability to compete in a rapidly evolving marketplace.” The companies assert that the FTC “underestimates the disruptive effect of new competitors in the digital economy.’ They claim the FTC is also ignoring the “vigorous existing and expanding competition… from numerous strong competitors.”

Indeed, the list of competitors is long: large national wholesalers, manufacturers selling office supplies directly to business customers, dealers in adjacent categories, cooperatives of regional players, Internet resellers, big-box chains and club stores.

“Today, there are so many places you can get office supplies,” Bern points out. “But that wasn’t the case when these companies first emerged in the ‘90s. The industry really exploded, but now you can even get office supplies in the grocery store.”

Bern did a lot of disposition work with Office Depot when it acquired Office Max in 2013. The FTC approved that deal, acknowledging the competitive pressures facing the industry. Staples and Office Depot allege that the FTC’s complaint against their merger contradicts the agency’s earlier statements.

Industry “needs” to shrink

Office Depot is still working through the store closures from that acquisition, according to its recent earnings release. It expects to close approximately 180 stores by year-end 2015 and more than 50 in 2016, for a total of at least 400 closures by the end of 2016.

Likewise, Staples is reducing its store footprint, both in terms of the number of stores and the size of its stores. Since 2014, the chain has closed 230 stores in North America. During its third quarter earnings statement, it announced that it had expanded the number of store closures.

“The bottom line is that the industry needs to shrink,” Bern says.

Staples has discussed reducing the amount of space dedicated to furniture and technology. “We continue to believe we’ve got stores that are too big given our current volume,” says Ron Sargent, the chain’s chairman and CEO.

A shift in Staples’ sales is driving the need to right-size its stores. Sargent says office supplies account for 55 percent of sales, while “beyond office supplies” or BOS accounts for 45 percent. BOS includes services, computers, business technology and furniture, for example.

“It wasn’t that long ago, we were probably 75 percent to 80 percent office supplies,” he says. “As BOS continues to grow, at some time point those lines will cross and will be more non-office supplies than we are office supplies.”

As of Nov. 30, 2015, Staples’ North American stores accounted for 46 percent of its sales, or roughly $10.4 billion.

Time for contingency plans

At this point, it looks like the FTC and Staples and Office Depot are gearing up for a fight. And while retail real estate owner might be rejoicing at the thought, Brzozowski is quick to point out that there are no guarantees either way.

“If the merger goes through, you’re facing the possibility they won’t renew at your location, but if the merger doesn’t go through, they might go into plan B crisis mode where they have to walk away anyway,” Brzozowski says. “Would you rather have a healthier company or would you rather have a tenant begrudgingly on the hook, who may or may not be able to perform on their lease? And down the road, if they have to restructure, that won’t end up well for a landlord, either.”

Brzozowski advises landlords to have a contingency plan in place—a strategy for repositioning their space if Staples or Office Depot goes dark. “Either way, you need to understand that the companies, whether merged or not, are not going to operate like they’re operating now,” he notes.

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