Staples (SPLS) will report third quarter earnings next week (at which point I’ll have more to add), but it seems appropriate to offer a quick update on industry developments. First off, as everybody likely knows by this point, the Office Depot (ODP)-Office Max merger has gained regulatory approval from the FTC as of Nov. 1. The commission’s two and a half page statement is best summed up by this line from the opening paragraph:
“Although sixteen years ago the Commission blocked a proposed merger between Staples, Inc. and Office Depot, the nation’s two largest OSS, our current investigation has shown that the market for the sale of consumable office supplies has changed significantly in the intervening years.”
Those significant changes won’t come as a surprise to anyone. They include the non-OSS brick and mortar retailers — namely Wal-Mart ( WMT ), Target ( TGT ) and Costco ( COST ) — and ecommerce, which includes all of the aforementioned brick and mortar retailers, as well as the 800-pound gorilla: “Company documents show that OSS are acutely aware of, and feel threatened by, the continued growth of online competitors, most notably Amazon ( AMZN ). OSS have lost, and continue to lose, substantial in-store sales to online competitors.”
For the sake of simplicity, I’m going to use year-end 2012 data to examine what this means. At the end of 2012, Office Depot had approximately 1,100 stores in North America; Office Max had approximately 850 stores. For 2012, ODP reported North American Retail sales of $4.45 billion; OMX reported sales of $3 billion (with the remainder of reported sales tied to their Mexican operations). Collectively, we’re at $7.45 billion in sales across approximately 1,950 locations; this equals $3.8 million in annual turnover per store.
Compare this to Staples: At the end of 2012, SPLS had 1,547 stores in the U.S. For the year ending February 2013, North American Stores & Online reported $11.8 billion in sales; this includes 340 stores in Canada (22% of the total North American store base), while OMX and ODP have not had stores in that country since at least 2011. There’s no way of knowing whether these stores have higher or lower productivity on a per unit basis (likely to be immaterial regardless), but be cognizant of the differences in the comparison (categorizing e-commerce sales is another area where this gets murky). Including the Canadian operations, Staples' average unit reported 2012 sales of $6.3 million in sales — more than 60% higher than the average output for the ODP-OMX retail network.
Don’t lock in on that number due to the potential “apple and oranges” comparison on the margins; the point is that Staples has a much stronger position than its combined competitors. If we look at the business solutions and contract segment, we find a similar trend but to a much lesser extent. The shakeout in this segment post-merger is much harder for me to get a grasp on – but as Staples management indicated in their last earnings call (and I will likely elaborate on next week), they’re hiring in a big way in expectation of some issues that may impact ODP and OMX.
Here are the guideposts we were given for the retail businesses at the time the 10-Ks were filed:
Office Depot: “The majority of our retail stores are located in leased facilities that currently average over 20,000 square feet. During 2012, we committed to significant changes to our store portfolio. Over the next five years, we expect to downsize approximately 500 stores to either small (averaging 5,900 sales square feet) or mid-size format (averaging 14,800 sales square feet). Approximately 50 stores will be closed at the end of their lease terms. These plans may change based on market conditions. As of December 29, 2012, we had 79 locations in the small (31) and mid-size (48) store formats.”
Office Max (while it was less transparent about what lies ahead, its actions speak quite clearly): “We ended 2012 with 941 stores. In the U.S., we closed forty-six retail stores during 2012 and opened one, ending the year with 851 retail stores.” That’s a nearly 10% reduction in their U.S. store base in a single year.
We don’t have the details yet on how the merger will change these plans and recent trends, but should get them relatively soon. This is where things will start to get quite interesting…
The other material news worth noting is that the newly combined company (which will retain the Office Depot name) has hired a CEO – per Bloomberg:
“Office Depot, which completed a merger with OfficeMax Inc. last week, named Roland Smith as chief executive officer and chairman of the newly formed office-supply chain. Smith most recently served as CEO of Delhaize America LLC, a chain of supermarkets with $18 billion in revenue that includes the Food Lion brand, Boca Raton-based Office Depot said yesterday in a statement. He was also CEO for Wendy’s Co. (WEN).”
Here’s a bit more detailed description of Mr. Smith’s career, per Wendy’s proxy statement:
“He served as Chief Executive Officer of the Company from June 2007 to September 2011, as President of the Company from September 2008 to September 2011, and as Special Adviser to the Company from September 2011 to December 2011. He also served as Chief Executive Officer of Wendy’s International from September 2008 to September 2011. Mr. Smith served as Chief Executive Officer of Arby’s Restaurant Group, Inc. (“Arby’s”) from April 2006 to September 2008, as President of Arby’s from April 2006 to June 2006, and as interim President of Arby’s from January 2010 to May 2010. Mr. Smith currently serves as President and Chief Executive Officer of Delhaize America and as Executive Vice President of Delhaize Group, an international food retailer, positions he has held since October 2012. Previously, Mr. Smith served as President and Chief Executive Officer of American Golf Corporation and National Golf Properties from February 2003 to November 2005, as President and Chief Executive Officer of AMF Bowling Worldwide, Inc. from April 1999 to January 2003, and as President and Chief Executive Officer of Arby’s, Inc., predecessor to Arby’s, from February 1997 to April 1999. Mr. Smith also serves as Chairman of the board of directors of Carmike Cinemas, Inc.”
It’s important to recognize that the time frame of Mr. Smith’s tenure at Wendy’s included the merger with Arby’s (in September 2008), as well as the eventual sale of the Arby’s chain to private equity firm Roark Capital Group less than three years later (June 2011). Mr. Smith said at the time that the merger had “absolutely not” been a failure, “but any business that continues to do well and perform has to be nimble and adapt to what the market is.”
Well, he has been put in another situation where being able to adapt will be priority number one. I’ll be out with a review of Staples' quarterly results next week (released on the 20th).
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About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with a handful of positions accounting for the majority of the total. From the perspective of a businessman, I believe this is sufficient diversification.