A few weeks ago, activist investor Starboard Value made headlines when it was revealed they had made a $550 million investment (~6% effective stake) in Staples (SPLS). In addition, it was revealed that the firm had boosted its stake in competitor Office Depot (ODP) from ~8.6% to 10%. For those that haven’t been following the developments closely over the past few years, it’s worth noting that Starboard initially got involved in the industry when they revealed a 13% stake in Office Depot back in September 2012; the investment firm pushed for the merger with Office Max, which was announced less than six months later.
The revelation that Starboard has taken a stake in Staples has naturally resulted in much speculation that they will push for a combination of the remaining two players; a CNBC contributor familiar with the firm’s thinking has confirmed that’s its plan going forward.
One CNBC article discussing the revelation noted the following:
“Analysts say the deal is less likely to raise eyebrows among antitrust regulators than it did back in 1997, when Staples and Office Depot contemplated a merger only to be blocked. Since then, online competition has increased dramatically while the likes of Walmart (WMT, Financial) and Target (TGT, Financial) have moved aggressively into the office supply business. In 2013, the Federal Trade Commission gave the Office Depot-OfficeMax deal clearance without requesting any divestitures. The decision acknowledged that the competitive environment had changed over the years as new competition emerged.”
This article will attempt to answer that question: how concerning is potential antitrust action?
Retail business
The FTC statement from September 2013 approving the merger of Office Depot and Office Max was clear that the retail environment had changed significantly in the 16 years since the Staples-Office Depot merger was blocked:
“Today’s market for the sale of consumable office supplies is broader, due mainly to two significant developments. One is that customers now look beyond OSS for office supply products and rely more heavily on non-OSS brick-and-mortar retailers. Mass merchants like Walmart and Target and club stores like Costco (COST, Financial) and Sam’s Club have proliferated and expanded their product offerings and sales of office supplies… The other is the explosive growth of online commerce, which has had a major impact on this market. Online retailers stock a vast array of office supply products and can deliver them quickly anywhere in the country at nominal cost. Company documents show that OSS are acutely aware of, and feel threatened by, the continued growth of online competitors, most notably Amazon (AMZN, Financial).”
As noted above, the Depot-Max deal was cleared without any required divestitures; as noted in the release, pricing is “no longer dictated by the number of local OSS,” suggesting that a merger between Staples and Office Depot would have an immaterial impact on OSS retail pricing, if at all. Mass merchants and online retailers have changed the world of category specific retailing. I think there’s a high probability that the FTC wouldn’t require any divestitures in a SPLS-ODP merger; there’s almost no chance they’ll stop a potential deal on retail concerns.
Commercial / contract
As I’ve noted from day one, the contract business is what drew my attention to Staples: it’s the most valuable business segment at the company, and has expanded its lead against its main competitors pretty significantly over the past 10 to 15 years (from a near even split between the three in 2004 to ~60% market share for Staples relative to the other two players in 2011).
Somewhat ironically, if you read the FTC’s press release explaining its rationale for attempting to block the proposed Staples-Office Depot deal in 1997, there isn’t a single mention of the commercial / contract business; my belief is that this time around, the FTC’s view on this business will ultimately decide whether or not Staples and Office Depot will able to combine (assuming a deal is proposed).
Let’s start with the FTC’s commentary from the Depot-Max merger, reprinted in full (with bold added for emphasis):
The Commission also examined the potential for competitive harm in the sale of consumable office supplies to businesses and other customers on a contract basis, a channel not at issue in Staples. Many businesses and public entities purchase office supplies under a contract. Unlike retail purchasers, contract customers typically receive discounted pricing based on actual or anticipated purchase volume. These contracts allow customers to order office products at previously negotiated prices. Because there are dozens, if not hundreds, of office suppliers that compete effectively to serve small and medium-sized businesses, the investigation focused on contracts for large multi-regional or national customers, which typically have the most demanding purchasing requirements and, as a result, fewer potential suppliers capable of meeting their needs.
A substantial body of evidence indicates that the merger is unlikely to substantially lessen competition or harm large contract customers. First, large customers use a variety of tools to ensure that they receive competitive pricing such as ordering certain products (like ink and toner) directly from manufacturers and sourcing (or threatening to source) certain categories of office supply products from multiple firms. Second, the merging parties’ documents show that they are rarely each other’s closest competitor for most large customers and that non-OSS competitor’s take business from the parties in a substantial number of contracting opportunities. Third, the parties will continue to face strong competition for such customers from Staples and a host of non-OSS competitors, such as W.B. Mason Co., Inc. Non-OSS competitors are growing in number and strength and have demonstrated the ability to win large multi-regional and national customer contracts. In particular, regional office supply competitors have developed and utilized various strategies to compete successfully for large national accounts, including working with office supply wholesalers and joining cooperatives of independent office supply dealers to create a distribution network capable of meeting the needs of large multi-regional and national customers. Finally, potential competitors in adjacent product categories, such as janitorial and industrial products, have existing contractual relationships with large office supply customers and can leverage those relationships to enter the office supply distribution market.
In light of the foregoing, there was little concern from contract customers about the proposed merger, and even the largest customers believe the merger would be either procompetitive or competitively neutral. We therefore find that the proposed merger is unlikely to result in competitive harm in the contract channel.
Let's start with the first bold point: similar to the issue at hands in the proposed Sysco (SYY)-U.S. Foods merger, there are plenty of regional suppliers that can meet the needs of small and medium-sized businesses. The real concern comes from the multi-regional and national customers, with few suppliers who can meet all their needs – again, similar to Sysco-U.S. Foods. To put this in perspective, Staples’ president of the North American commercial business stated in the third quarter 2013 conference call that medium-large regional customers and Enterprise customers each account for roughly one-third of the company’s contract business.
The second bold point makes an argument that is likely to be specific to the Depot-Max merger (“they are rarely each other’s closest competitor for most large customers”); the reason I say that is because there’s reason to believe the “closest competitor” in most of those cases (or at least in a large percentage of them) was Staples. Clearly that same logic won’t hold in this scenario.
As it relates to non-OSS competitors, it’s difficult for me to get a good grasp on just how big of a factor this really is/could be. Consider the mentioned competitor, W.B. Mason: according to the company, they are the largest privately owned office products dealer in the United States.
However, as of a few years ago (from a Boston Business Journal article), annual revenues for W.B. Mason were only ~$1 billion (seems accurate in light on some SEC data: United Stationers (USTR) reported in their 2013 10-K that W.B. Mason accounted for ~11% of their sales, or ~$560 million). To put that $1 billion in perspective, Staples had ~$8 billion in Commercial sales in 2013; including Office Depot (~$3.5 billion) would bring the total to more than $11 billion.
Personally, I think it’s logical to assume that the largest customers believed the merger would be either procompetitive or neutral because it would create a stronger direct competitor to Staples; I don’t think that holds when you consider taking the next step - combining Staples and ODP.
As it relates to regional office supply competitors developing strategies to compete for large national accounts, “including working with office supply wholesalers and joining cooperatives of independent office supply dealers to create a distribution network capable of meeting the needs of large multi-regional and national customers”, I don’t have any sense of how competitive this offering is for a Staples / Office Depot; the one thing I do know is that, since I started following these companies, I can’t remember hearing these competitors mentioned a single time.
The same can be said for janitorial and industrial product suppliers: as opposed to moving into office supply products, I think the bigger move has been Staples (in particular) encroaching on their turf in recent years. Staples has said their goal is to be the number one commercial player in categories beyond core office supplies (third quarter 2013 call), with their most notable efforts coming from facilities and breakroom: as noted on the second quarter 2014 call, facilities is a $1 billion business in North American Commercial – or 15% of the total. Categories beyond office supplies represented 40% of the mix in North American Commercial (third quarter 2014).
On the second quarter 2013 conference call, the president of Staples’ North American commercial division called Office Depot and Office Max “not the only competitors out there but obviously the two major competitors” – suggesting that these three companies (now two) are a different animal than others in the space; I haven’t found anything to suggest otherwise.
Conclusion
In summary, I don’t think Staples will have any trouble in the retail business from the FTC if it attempts to make a deal with Office Depot. We’ve all personally seen the change highlighted in the FTC’s Depot / Max review first hand. The world is very different than it was 18 years ago: non-OSS retailers and Amazon (AMZN, Financial) have completely changed the game, with ecommerce penetration in office supplies outpacing the overall penetration in U.S. retail by a wide margin; I think a proposed deal would be approved on the retail side with near certainty.
The commercial / contract business is where I think there could be some problems. While I’ll admit that I’m working off incomplete information, I think there’s reason to believe that rolling up the three largest competitors in the industry in a few years without any significant period of time to analyze the impact of prior deal making could be a potential roadblock. A combined Staples-Office Depot would be an order of magnitude larger than the competitor called out by the FTC in their Max-Depot analysis. Their best shot may come from their move beyond office supplies in recent years, in categories where they still have minimal market share; arguing that the competitor set should be viewed with a wider lens should improve their odds of success.
As always, I would be interested in hearing the thoughts of fellow investors.
