Common shares of Staples (SPLS, Financial) trade on the NASDAQ at $14 for a market cap of roughly $9.5 billion.
Staples sells office supplies. The company, with 95k employees, operates roughly 2,000 stationery superstores globally and is the No. 2 Internet retailer, second only to Amazon (AMZN, Financial) and ahead of Dell (DELL, Financial).
Arnold van den Berg, George Soros, Brian Rogers, Whitney Tilson are long SPLS.
Numbers used in this analysis can be found in recent SEC filings:
In 1985, Thomas Stemberg is fired after complaining to his boss about the sale of First National Supermarkets’ warehouse division, the division he heads. The division is now sold (without Stemberg) to Supermarket General Corporation, of which Leo Kahn is chairman.
Part of the reason Kahn had been attracted to First National was that it meant getting Stemberg on his team. The two Harvard alumni swap ideas at a Harvard basketball game and after some research decide Stemberg’s proposal to concentrate on office supplies is best.
Traditionally, manufacturers of paper and other items sell their goods to major wholesalers. Wholesalers then sell the goods to dealers and stationery stores. The dealers sell supplies to large corporations, while stores cater to small businesses and individuals. Stemberg’s idea was for a superstore that offered low prices by eliminating two layers of middlemen by buying in bulk, directly from the manufacturers.
1986: The first office supplies superstore opens in Brighton, a suburb of Boston.
1989: IPO, raising $37 million to fund expansion. Though sales had reached $120 million, Staples is still unprofitable due to the cost of rapid expansion.
1996: Staples reaches an agreement to acquire Office Depot for $3.4 billion in stock. Stemberg argues the superstores do not just compete against each other but also with Walmart (WMT, Financial), direct marketers, and others. The FTC disagrees and blocks the deal on antitrust grounds.
2002: Ron Sargent (former COO) becomes CEO and is charged with leading Staples through a transition from a growth-oriented firm to a company competing in an increasingly saturated U.S. market.
Sargent launches a remodeling effort and eliminates hundreds of items from the store shelves. Staples now focuses on customers who spend more than $500 per year on office supplies. These customers account for 70% of revenues and 90% of profits. A new slogan, "That was easy" replaces “We got that.”
Internet operations are merged into the company's catalog unit.
Staples surpasses arch rival Office Depot.
2004: SPLS starts operations in China where it's now the largest office supplier with over $ 200m of revenue. Staples is losing money here due to the cost of rapid expansion.
2008: Purchase of Corporate Express for $2.7 billion. The acquisition increases the U.S. delivery business by 50%.
2010: Staples generates $25 billion in sales. $10 B delivery, $9 B retail, and $6 B international; mostly delivery.
Direct competition comes from Office Depot (ODP, Financial), United Stationers (USTR, Financial) and OfficeMax (OMX, Financial). By acquiring Corporate Express (CXP), Staples became larger than ODP and OMX combined. Together, the publicly traded giants have 13% of the $300B global office supply market and 40% of the $100B North American delivery segment. All were founded between 1986 and '88.
A glance at the 10-year financials makes it clear SPLS has superior gross margins (>26%). If we exclude delivery specialist United Stationers, we find SG&A as a percentage of revenue is lowest (20%). Meanwhile, Staples is the only one spending an amount on capex that’s roughly equal to DD&A.
SPLS is the only retailer in the group to have increased book value per share since 2001. OMX and ODP don’t pay a dividend and still still managed to lose book value per share.
United Stationers - with no retail operations - does a good job of growing book value and revenue per share. It has done some acquisitions and bought back a load of shares. Still, the company as a whole is basically where it was a decade ago.
Though Staples has dominated this business, this does not mean it wil necessarily do so going forward. We need to understand if there are sustainable advantages.
Advantage 1: I believe superior gross margins come from bargaining power with manufacturers. Staples is the largest purchaser of office products. Wal-mart comes second selling about $ 20B worth of office supplies. This competitive advantage is sustainable.
Advantage 2: Staples has lower SG&A as a fraction of revenue. I believe this is the result of the fraction of revenue from Internet delivery and contract delivery. Delivery requires less (human) capital than classic retail. With delivery, there are significant economies of scale. This advantage is sustainable.
In practice: You've just been hired by Amazon as the manager in charge of taking on Staples. On day one you analyze your competitive position:
0) You've got a popular website; so does Staples. Staples' site is more popular with your target audience though... let's call it a draw.
1) Staples has its own distribution network; you rely on UPS. UPS specializes in parcels not pallets. You can offer a low price but the client soon finds out UPS isn't free.... ouch !
2) Manufacturers won't give you the same deal because you don't have the volume.... ouch !
3) High volume customers want cheap generic (own brand) products, you don't have that. Staples does..... three strikes, you're out.
For good measure we throw a croc into the moat. Staples can and does carry an inventory. Manufacturers like this because business is somewhat seasonal. Your boss at Amazon thinks inventory is a dirty word.
And a (sweetwater) shark. Staples has an extensive database of (potential) clients in the small/home-office space with their individual behaviour and needs. Your database is less comprehensive making Staples' marketing more cost-effective.
You tell your new boss you'd rather go after a different audience; low-volume, high-margin clients looking for specialty products. She likes the sound of that.
Would it matter if you were hired by Wal-mart or Costco instead ?
Staples has $2.5 billion of debt, $950 million of cash and $1.5 billion of income before interest. A $1.5 billion portion of that debt comes due in 2014. It’s hardly surprising the debt yields less than 3% in the market.
The $1.5 billion of notes that come due in 2014 were issued in 2009 bearing an interest of 9.75%. Refinancing at 3% or retiring that debt would dramatically reduce interest expense of $ 210m.
For decades, people have argued digitization presents a "paperless" risk. This time could be different; don’t bet on it.
OMX & ODP get their acts together and/or merge. Last year, OMX unveiled a new strategy and hired a new CEO who started working on a five-year plan to boost revenue by offering more services and products tied to computers and catering more to women. OMX used to compete on price; now it doesn’t. Margins in general should rise.
A merger of OMX and ODP (or USTR) would create a formidable company that's still not on par with SPLS. Such a combination would still be smaller and would still not match SPLS' Internet presence. Case in point: the merger of Boise Cascade's $4 B delivery business with OMX's $4 B retail business in 2003 was supposed to create an industry leader. It never happened.
Like ODP, SPLS could be caught overcharging on government contracts. That causes a lot of delivery contracts to be breached and awarded to competitors.... http://money.cnn.com/2010/02/15/news/companies/office_depot.fortune/
After raising millions from the IPO in 1986, management has created billions of dollars of value. Senior executives have typically been with the company for more than a decade.
The CEO owns more than a million shares while other officers typically own more than 300k shares. That doesn’t seem like a lot till you realize the CEO is paid about $1.5 million a year. Ron Sargent has 10 x his annual salary in stock and earns less than the CEOs of ODP and OMX. The new guy at OMX makes more than $12 million. He's probably being underpaid for trying to mend a broken company.
Either Staples' managers are idiots or they really love the company. I see no evidence of the former.
Investors could rightly blame management for mistiming the purchase of Corporate Express in 2008. They should also credit the same group for creating an online retailer that is second only to Amazon.
Compare this to ODP CFO Michael Newman. He's the former CFO of Platinum Research Organization (bankrupt per 2009) and OMX CFO Bruce Besanko who used to be the CFO of Circuit City.
Since the acquisition of CXP, FCF as reported (GuruFocus) has averaged $1.2 billion. Starting from this, we check to see if FCF doesn't overstate sustainable cash earnings due to unsustainably low capex.
Staples continued spending roughly $450 million on capex; that’s 20% of PP&E which is MUCH more than any competitor spends. The numbers indicate Staples is spending on growth so $1.2 billion is a pessimistic estimate of run-rate owner earnings. Also, interest expense is currently artificially high due to the bad timing of the bond issue.
A pessimistic estimate of IV for an investor seeking 9% (index) returns is 1.2/0.09 = $13 B => $21.
Corporate Express itself bid $2.6 billion or 2x revenue for French peer Lyreco. We ignore this data point.
In 2009. BC partners bought 20% of ODP for $ 350m. ODP ran out of cash so they sold shares; still they got 9 x FCF. EBITDA was negative.
The transactions imply Staples, with earnings of $ 800m, EBITDA of $ 1.5 B and FCF of $1.2 B is worth $12 billion => $19.
1) The economic outlook is bad.
2) Market participants underestimate the earnings power of a company spending on growth.
Staples has a more solid capital structure, higher margins, a better management team and a superior track record than any of its currently struggling competitors. The company has room for both revenue growth and margin expansion. Mr. market offers us shares of the company at a discount to a pessimistic estimate of intrinsic value.
This is not a recommendation to buy or sell anything. I had no position in any of the stocks mentioned at the time of writing.
Any and all questions welcome as usual.
Staples sells office supplies. The company, with 95k employees, operates roughly 2,000 stationery superstores globally and is the No. 2 Internet retailer, second only to Amazon (AMZN, Financial) and ahead of Dell (DELL, Financial).
Arnold van den Berg, George Soros, Brian Rogers, Whitney Tilson are long SPLS.
Numbers used in this analysis can be found in recent SEC filings:
Business & History
In 1985, Thomas Stemberg is fired after complaining to his boss about the sale of First National Supermarkets’ warehouse division, the division he heads. The division is now sold (without Stemberg) to Supermarket General Corporation, of which Leo Kahn is chairman.
Part of the reason Kahn had been attracted to First National was that it meant getting Stemberg on his team. The two Harvard alumni swap ideas at a Harvard basketball game and after some research decide Stemberg’s proposal to concentrate on office supplies is best.
Traditionally, manufacturers of paper and other items sell their goods to major wholesalers. Wholesalers then sell the goods to dealers and stationery stores. The dealers sell supplies to large corporations, while stores cater to small businesses and individuals. Stemberg’s idea was for a superstore that offered low prices by eliminating two layers of middlemen by buying in bulk, directly from the manufacturers.
1986: The first office supplies superstore opens in Brighton, a suburb of Boston.
1989: IPO, raising $37 million to fund expansion. Though sales had reached $120 million, Staples is still unprofitable due to the cost of rapid expansion.
1996: Staples reaches an agreement to acquire Office Depot for $3.4 billion in stock. Stemberg argues the superstores do not just compete against each other but also with Walmart (WMT, Financial), direct marketers, and others. The FTC disagrees and blocks the deal on antitrust grounds.
2002: Ron Sargent (former COO) becomes CEO and is charged with leading Staples through a transition from a growth-oriented firm to a company competing in an increasingly saturated U.S. market.
Sargent launches a remodeling effort and eliminates hundreds of items from the store shelves. Staples now focuses on customers who spend more than $500 per year on office supplies. These customers account for 70% of revenues and 90% of profits. A new slogan, "That was easy" replaces “We got that.”
Internet operations are merged into the company's catalog unit.
Staples surpasses arch rival Office Depot.
2004: SPLS starts operations in China where it's now the largest office supplier with over $ 200m of revenue. Staples is losing money here due to the cost of rapid expansion.
2008: Purchase of Corporate Express for $2.7 billion. The acquisition increases the U.S. delivery business by 50%.
2010: Staples generates $25 billion in sales. $10 B delivery, $9 B retail, and $6 B international; mostly delivery.
Competitive advantages
Direct competition comes from Office Depot (ODP, Financial), United Stationers (USTR, Financial) and OfficeMax (OMX, Financial). By acquiring Corporate Express (CXP), Staples became larger than ODP and OMX combined. Together, the publicly traded giants have 13% of the $300B global office supply market and 40% of the $100B North American delivery segment. All were founded between 1986 and '88.
A glance at the 10-year financials makes it clear SPLS has superior gross margins (>26%). If we exclude delivery specialist United Stationers, we find SG&A as a percentage of revenue is lowest (20%). Meanwhile, Staples is the only one spending an amount on capex that’s roughly equal to DD&A.
SPLS is the only retailer in the group to have increased book value per share since 2001. OMX and ODP don’t pay a dividend and still still managed to lose book value per share.
United Stationers - with no retail operations - does a good job of growing book value and revenue per share. It has done some acquisitions and bought back a load of shares. Still, the company as a whole is basically where it was a decade ago.
Though Staples has dominated this business, this does not mean it wil necessarily do so going forward. We need to understand if there are sustainable advantages.
Advantage 1: I believe superior gross margins come from bargaining power with manufacturers. Staples is the largest purchaser of office products. Wal-mart comes second selling about $ 20B worth of office supplies. This competitive advantage is sustainable.
Advantage 2: Staples has lower SG&A as a fraction of revenue. I believe this is the result of the fraction of revenue from Internet delivery and contract delivery. Delivery requires less (human) capital than classic retail. With delivery, there are significant economies of scale. This advantage is sustainable.
In practice: You've just been hired by Amazon as the manager in charge of taking on Staples. On day one you analyze your competitive position:
0) You've got a popular website; so does Staples. Staples' site is more popular with your target audience though... let's call it a draw.
1) Staples has its own distribution network; you rely on UPS. UPS specializes in parcels not pallets. You can offer a low price but the client soon finds out UPS isn't free.... ouch !
2) Manufacturers won't give you the same deal because you don't have the volume.... ouch !
3) High volume customers want cheap generic (own brand) products, you don't have that. Staples does..... three strikes, you're out.
For good measure we throw a croc into the moat. Staples can and does carry an inventory. Manufacturers like this because business is somewhat seasonal. Your boss at Amazon thinks inventory is a dirty word.
And a (sweetwater) shark. Staples has an extensive database of (potential) clients in the small/home-office space with their individual behaviour and needs. Your database is less comprehensive making Staples' marketing more cost-effective.
You tell your new boss you'd rather go after a different audience; low-volume, high-margin clients looking for specialty products. She likes the sound of that.
Would it matter if you were hired by Wal-mart or Costco instead ?
Balance sheet
Staples has $2.5 billion of debt, $950 million of cash and $1.5 billion of income before interest. A $1.5 billion portion of that debt comes due in 2014. It’s hardly surprising the debt yields less than 3% in the market.
The $1.5 billion of notes that come due in 2014 were issued in 2009 bearing an interest of 9.75%. Refinancing at 3% or retiring that debt would dramatically reduce interest expense of $ 210m.
Risk
Digitization
For decades, people have argued digitization presents a "paperless" risk. This time could be different; don’t bet on it.
Direct Competition
OMX & ODP get their acts together and/or merge. Last year, OMX unveiled a new strategy and hired a new CEO who started working on a five-year plan to boost revenue by offering more services and products tied to computers and catering more to women. OMX used to compete on price; now it doesn’t. Margins in general should rise.
A merger of OMX and ODP (or USTR) would create a formidable company that's still not on par with SPLS. Such a combination would still be smaller and would still not match SPLS' Internet presence. Case in point: the merger of Boise Cascade's $4 B delivery business with OMX's $4 B retail business in 2003 was supposed to create an industry leader. It never happened.
Fraud
Like ODP, SPLS could be caught overcharging on government contracts. That causes a lot of delivery contracts to be breached and awarded to competitors.... http://money.cnn.com/2010/02/15/news/companies/office_depot.fortune/
Management
After raising millions from the IPO in 1986, management has created billions of dollars of value. Senior executives have typically been with the company for more than a decade.
The CEO owns more than a million shares while other officers typically own more than 300k shares. That doesn’t seem like a lot till you realize the CEO is paid about $1.5 million a year. Ron Sargent has 10 x his annual salary in stock and earns less than the CEOs of ODP and OMX. The new guy at OMX makes more than $12 million. He's probably being underpaid for trying to mend a broken company.
Either Staples' managers are idiots or they really love the company. I see no evidence of the former.
Investors could rightly blame management for mistiming the purchase of Corporate Express in 2008. They should also credit the same group for creating an online retailer that is second only to Amazon.
Compare this to ODP CFO Michael Newman. He's the former CFO of Platinum Research Organization (bankrupt per 2009) and OMX CFO Bruce Besanko who used to be the CFO of Circuit City.
Value
Owner earnings
We use FCF as a starting point to estimate the magnitude and sustainability of the cash income available to stockholders.Since the acquisition of CXP, FCF as reported (GuruFocus) has averaged $1.2 billion. Starting from this, we check to see if FCF doesn't overstate sustainable cash earnings due to unsustainably low capex.
Staples continued spending roughly $450 million on capex; that’s 20% of PP&E which is MUCH more than any competitor spends. The numbers indicate Staples is spending on growth so $1.2 billion is a pessimistic estimate of run-rate owner earnings. Also, interest expense is currently artificially high due to the bad timing of the bond issue.
A pessimistic estimate of IV for an investor seeking 9% (index) returns is 1.2/0.09 = $13 B => $21.
Private market value
Staples paid $2.7 B for Dutch competitor Corporate Express, roughly 20x earnings, 9 x FCF and 7 x EBITDA. The financial numbers are here. CXP had $ 1.6 billion of debt.Corporate Express itself bid $2.6 billion or 2x revenue for French peer Lyreco. We ignore this data point.
In 2009. BC partners bought 20% of ODP for $ 350m. ODP ran out of cash so they sold shares; still they got 9 x FCF. EBITDA was negative.
The transactions imply Staples, with earnings of $ 800m, EBITDA of $ 1.5 B and FCF of $1.2 B is worth $12 billion => $19.
Catalysts
Share buybacks
Ron Sargent, prior to the acquisition of Corporate Express, used more than half of FCF to repurchase stock. Ten percent was spent on dividends. The stock repurchase plan was reinstated in 2010 they once again have cash to spare on the balance sheet. Using just 50% of current FCF to repurchase shares, will reduce shares outstanding by 10% per annum.Refinancing of debt
SPLS issued most of its debt in early '09. They’re paying 9.75% on notes now trading at less than 3%. Refinancing that debt or retiring it as it comes due (2014) will have a dramatic impact on interest expense of roughly $200 million. This has a positive effect on the bottom line.The opportunity exists because
1) The economic outlook is bad.
2) Market participants underestimate the earnings power of a company spending on growth.
Conclusion
Staples has a more solid capital structure, higher margins, a better management team and a superior track record than any of its currently struggling competitors. The company has room for both revenue growth and margin expansion. Mr. market offers us shares of the company at a discount to a pessimistic estimate of intrinsic value.
Disclosure
This is not a recommendation to buy or sell anything. I had no position in any of the stocks mentioned at the time of writing.
Any and all questions welcome as usual.
