Office Depot Inc (ODP), OfficeMax Inc (OMX), Amazon.com, Inc. (AMZN): Shaking Up the Office Supply Space

Through a merger announcement that surprised virtually nobody, Office Depot Inc (NYSE:ODP) agreed to buy OfficeMax Inc (NYSE:OMX) for roughly $1.2 billion on Feb. 20.  The two companies, along with industry leader Staples , Inc. (NASDAQ:SPLS), control the office supply store sector.  However, the mass merchandisers and online merchants, like Costco Wholesale Corporation (NASDAQ:COST) and Amazon.com, Inc. (NASDAQ:AMZN), have been using their purchasing power and free shipping offers to eliminate the superstores’ profit margins.  While the Feds broke up a potential industry merger years ago, this one looks pretty solid.  So, which companies are winners in this shake-up?

The #2 chain finally made its big move, after receiving unrelenting pressure from its institutional shareholder base over the past year.  The company has over 1,100 domestic stores, as well as a smaller international segment that sells products in 59 countries.  Office Depot Inc (NYSE:ODP) also offers printing, mailing, and tech support services in select stores through its Copy and Print Depot unit.

The past five years have been tough for the company, with declining revenues, store closings, and marginal profitability.  In FY2012, Office Depot Inc (NYSE:ODP)’s results remained true to form, with declines in revenues and adjusted operating income of 6.9% and 11.4%, respectively, versus the prior year.  The company’s results were hurt by a 5% decline in domestic comparable store sales, as well as relative weakness in its international division.

On the upside, Office Depot Inc(NYSE:ODP)’s gross margin has benefited from less promotional activity and lower occupancy expenses in its smaller store formats.  The merger with OfficeMax Inc(NYSE:OMX) should also improve Office Depot Inc(NYSE:ODP)’s financial profile, given OfficeMax Inc(NYSE:OMX)’s strong net cash and investment holdings.  Management expects $400 million to $600 million in operating synergies from the merger, with the combined company’s $18 billion in sales vaulting it into the industry leadership position.

The #1 chain is roughly the size of its two nearest competitors combined and it should benefit from the removal of a major industry player.  Staples has similarly suffered from a lack of sales growth, with notable weakness in its European and Australian markets.  In response, the company has closed select stores and initiated the sales process for its European printer systems division.

In FY2012, Staples reported generally weak results that led to a poor performance for its stock price.  For the year, the company reported decreases in revenues and adjusted operating income of 2.6% and 9.6%, respectively, compared to the prior year.  Its international operations were especially weak, with a 12% decline in sales, due to Staples’ significant presence in Europe gained through its 2008 purchase of Corporate Express.  However, the company has the highest operating margin in the industry, which should be further enhanced by its restructuring activities and its focus on contract business.