With Staples (SPLS) proposed purchase of Office Depot (ODP) publicly announced, reporters have jumped on the antitrust concerns associated with the deal; somewhat surprisingly (to me at least), their primary focus seems to be retail, not the commercial / delivery business:
Bloomberg - “The two companies, which agreed to the merger after pressure from activist investor Starboard Value, would create a retail chain with about $39 billion in revenue and thousands of stores. The move is expected to draw scrutiny from the Federal Trade Commission, though regulators have been increasingly willing to approve retail mergers in light of burgeoning e-commerce competition.”
Reuters - “The first time the two agreed to merge - in 1996 - the deal was derailed by a government lawsuit that successfully argued the move would have meant higher prices for pens, paper and other office supplies in a long list of U.S. cities... Since the failed deal, Amazon and other online sellers, which can deliver to almost anywhere, have exploded onto the scene, while megastores like Costco and Wal-Mart Stores are also crowding the market.”
New York Times – “In planning a $6.3 billion merger, Staples and Office Depot are betting that 18 years was long enough for government regulators to change their minds about how consumers buy office supplies. But the two retailers will argue that since then, the business of selling office supplies has become significantly more competitive. Customers can choose from a variety of sources, including giants like Walmart, Target and Amazon.”
Wall Street Journal – “These are two struggling chains, and they are struggling because the world around them – one they controlled so firmly back when the Internet was still nascent – has completely shifted. Online has eaten into their market share, especially Amazon.com. Big-box retailers like Wal-Mart Stores have eaten into their market share. This isn’t a deal that’s being executed from a position of strength.... An FTC report from the time of the 2013 tie-up of Office Depot / OfficeMax – itself a combination of two struggling companies – made it clear that these companies are not in control of their market anymore.”
That last article, referring to a Barron’s write-up (here), noted that Staples and Office Depot account for 6% of the $230 billion office-supply market (and in the Wall Street Journal’s defense, they’ve done a better job looking at the commercial / delivery antitrust concerns in some other articles); looking at those numbers in more detail shows what I think is being overlooked.
“Oversized retail outlets account for roughly 6% of the $230 billion-plus office-supply market, with consumer-focused e-commerce sales at about 9%, according to one estimate. Nearly half the market's sales come from other sorts of retailers - everything from mom-and-pop stationery stores to mass merchants and other commercial players. A sizable chunk of the market, estimated at 36%, is done via delivery, usually on a contract basis to businesses.”
At 36% of the total, delivery accounts for $83 billion in sales. Staples Commercial business in North America will generate ~$8.2 billion in sales this year – nearly enough for a 10% share of the global market; Office Depot’s North American Business Solutions segment is on track for ~$6 billion in sales for 2014 – enough for another 7% of the global pie. I’m not sure if that number is referring to global sales or North America specifically (I’ve looked everywhere and can’t find a definitive answer), so I’ll assume the best for Staples / ODP (North America only); with those numbers, we can see the two companies will have a high teens share of the delivery market. If it’s a global figure, that would suggest at least 25% market share in North America.
By comparison, the FTC is giving Sysco (SYY) a lot of trouble on their proposed merger with U.S. Foods – a deal which would give the combined company a roughly 25% share of the U.S. foodservice market. In that situation, the FTC has indicated they’re uncomfortable with the idea of eliminating Sysco’s only national rival (Sysco has recently tried to address these concerns by selling distribution centers – primarily out west – to PFG, contingent upon the completion of the merger; if that transaction moves forward, it would bring a combined Sysco / U.S. Foods market share to the low 20’s). Many commentators argued early on that the FTC would only force asset divestitures in parts of the country where the combined company would be too dominant (a regional focus); management’s commentary on their most recent call suggests they were wrong.
From my view, that seems similar to what we’re looking at here: I don’t know who the next closest competitor would be, but I know they would be significantly smaller than a combined Staples / Office Depot; as far as I know, they also would not have national scope. W.B. Mason, a regional player with $1.5 billion in annual sales, was specifically mentioned in the FTC’s 2013 review of the Depot / Max deal (link); they would be one-tenth of the size of a combined Staples / Office Depot.
This quote from Amanda Wait, a former FTC litigator, succinctly captures my thinking:
“This investigation isn’t going to be about where you and I can buy a stapler. It’s about where a company can buy 10,000 staplers.”
Unsurprisingly, Staples came out of the gate ready to make their case to the investment community and the FTC: CEO Ron Sargent played up the competitive threats a combined Staples / Office Depot would still face in the market, saying “There are really strong regional players, who bid on contracts all the time, and have been very, very successful”.
Anybody who’s been following the developments at Sysco knows they’ve been making a similar argument over the past fourteen months: CFO Chris Kreidler told analyst at CAGNY last February that “it’s a fiercely competitive industry… customers are going to have a tremendous amount of choice out there in terms of who they do business with”. Sysco’s management team has frequently noted that regional players are a key part of what makes this industry fiercely competitive - yet despite their ongoing efforts, the FTC still isn’t buying it.
The wording in the Office Depot – Office Max ruling leads me to believe that this could be difficult to overcome in the commercial / delivery business (see my earlier analysis – link); the retail business that the financial media is focused will likely be a low hurdle by comparison.
As Mr. Sargent noted on the call, both boards reviewed the potential merger and decided to move forward despite the antitrust risk; clearly Starboard has been thinking along the same lines.
For what it’s worth, I’m less confident than they are; it will be interesting to see how this all plays out over the coming months.
