Tuesday, February 24, 2015

Merge Ahead? Staples, Office Depot, and the FTC

If it’s not a bankruptcy, it’s a merger or an acquisition. At least, that’s the way it seems in the retail world these days. Last month we addressed recent bankruptcies and faltering retailers in the Juniors apparel category that have been largely impacted by the new fast-fashion retailers such as Forever 21 and H&M. Other retailers are coping with operating inefficiencies by looking for a friendly suitor or white knight to take over and avoid the inevitable. We just witnessed the epic battle between Dollar Tree and Dollar General for Family Dollar (see Family Dollar: Holiday Woes or Something Deeper? in our April 2014 edition). Other retailers are coping with the gradual but continual loss of market share to Amazon and other online retailers. Some are engaging in mergers and acquisitions to stem the tide: earlier this month came the announcement that Staples and Office Depot had entered into a $6.3 billion merger agreement. And that’s our story this month.

The heyday of the office supply superstore was in the mid-to-late 90’s. In 1996, Staples made its first attempt at a merger with Office Depot, but was denied by the Federal Trade Commission on the basis that a potential monopoly would develop that would dictate office supply pricing, particularly in markets where Office Max had no presence. While Staples and Office Depot made the case that other category competition existed in the form of Wal-Mart, Target, Circuit City and Best Buy, among others, the FTC was not swayed. So why will the FTC view the merger any differently this time around? More competition, that’s why. A great deal has happened in this category in the last 18 years. This time it’s not about monopolizing market share; it’s a question of remaining viable.

For one thing, the traditional workplace isn’t the same anymore. The need for paper, pens, fax machines, copiers and printers has waned dramatically. The home office, the virtual office, and cloud storage are becoming more popular every day. Also, on the brick-an-mortar side, stores such as Costco have expanded rapidly since the mid-1990s, adding more competition. But what’s really driving the proposed merger is e-commerce.

18 years ago there was no Amazon to worry about. Although the internet retail giant launched in 1995 as an online bookstore, it didn’t sell office products until as recently as 2007. Walmart.com wasn’t established until 2000. The same goes for Target, and its online presence, among other supercenters, wholesale clubs, and online office products retailers. Now Amazon and other online retailers have been driving down pricing and impacting gross margin.

Currently Staples is ranked #3 behind only Amazon and Apple in online sales. Office Depot is ranked #9. While brick-and-mortar sales of these two office products retailers has been trending down in recently years, partly a result of store closings, partly a result of negative comp store sales, it could have been worse without the sales growth both companies generated from their online segments.

Commercial sales are also a big part of each companies business: reports indicate that Staples generates 80% of sales from this component online. By merging, the two companies can leverage that part of the business to compete effectively against Amazon and the other online retailers.

The recent merger between Office Depot and Office Max made it through the FTC approval process without a hitch, and the FTC specifically cited increased competition as a basis for its decision. Not a single store was required to close – although in this case store closings may be a necessity, if not by FTC direction, then by choice: analysts predict that the geographic overlap between Staples and Office Depot will probably require the closing of 500 to 1,000 stores and the downsizing of others, something landlords won’t like, but should be accustomed to by now.

In any case, it’s clear that the proposed merger between Staples and Office Depot spells survival in today’s office supply category. That’s why it has to happen. The FTC’s recognition of new competitive restraints bodes well for a successful attempt this time around.

Bob Sheehan, Vice President of Research
BSheehan@KeyPointPartners.com

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