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 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.
The electronic commerce giant changes the dynamic in every sector that it enters, including online marketplaces, publishing, video streaming, and web hosting services. Founded in 1995, Amazon.com, Inc.(NASDAQ:AMZN)’s mission is to provide the world’s greatest selection of merchandise at the lowest prices through easy to use websites. Unfortunately for the office supply superstores, Amazon.com, Inc.(NASDAQ:AMZN)’s product mix increasingly includes office supplies.
In FY2012, the company continued to grow at a solid pace, with a 27.1% increase in total revenues. Despite economic headwinds in various international markets, Amazon.com, Inc.(NASDAQ:AMZN)’s international segment grew 23% and came close to accounting for half of the company’s total sales. However, Amazon.com, Inc.(NASDAQ:AMZN)’s operating income declined again due to the high technology and personnel costs of building leading positions in so many segments.
Amazon.com, Inc.(NASDAQ:AMZN)’s goal is fund investments that will create long-term, sustainable growth in its free cash flow. For years, the company has foregone near-term operating profits in the hopes of creating an online business with massive scale and massive profitability. While management’s investment activities have pushed Amazon’s operating profits into future years, investors believe the story and have bid the shares up over 200% in the past five years.
The OfficeMax Inc(NYSE:OMX)/Office Depot tie-up should improve the surviving competitors’ profitability, but it is unlikely to change the underlying sales trends. While the office supply superstores previously offered unbeatable selections, online merchants now offer virtually unlimited merchandise. The superstores likely need to continue downsizing their retail store bases and focus on their higher margin business and government distribution channels. As for investors that want to play in the retail office supply space, they need to stick with the e-commerce king, Amazon.
The article Shaking Up the Office Supply Space originally appeared on Fool.com and is written by Robert Hanley.
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