Staples’ Purchase of Office Depot Makes No Sense

If you want to see why we have retail apocalypse in the United States, you should take a look at Staples’ (NASDAQ: SPLS) plan to buy Office Depot (NYSE: ODP). This plan symbolizes everything that’s wrong with American retail these days.

News articles indicate Staples plans to spend around $6.3 billion to buy Office Depot. The purchase would merge the three major office supply chains in the United States into one retail giant with around 4,400 stores. Office Depot already bought Office Max in 2013 and is slowly liquidating it.

The Office Depot purchase is a very dumb move for Staples for a simple reason: Staples is already burdened with too many stores. It has plans to shut down 250 stores, and now it plans to buy 1,000 more stores at a time when sales are weak and falling. To make matters worse, Staples plans to spend $6.3 billion to buy Office Depot.

Spending $6.3 Billion to Save $1 Billion

Staples plans to spend several billion to buy a struggling competitor at a time when its TTM revenue is collapsing. In October 2012 Staples reported a TTM revenue figure of $24.19 billion; by October 2013 that number had fallen to $23.81 billion, and by October 2014 it had fallen to $22.7 billion. Staples is already losing money big time in the office supply business, and now it wants to double that business.

Janney Capital Markets analyst David Strasser is predicting that Staples could close 1,000 stores if it buys Office Depot, Philly.com reported. Strasser made that prediction because half of all Office Depot stores are located within five miles of a Staples.

Worse, it plans to burden itself with hundreds of stores that are not making money. The knuckleheaded thinking behind this deal is that merging two noncompetitive companies will somehow make them competitive. Basically, the management at Staples is hoping that merging Staples and Office Depot/OfficeMax will magically bring back the foot traffic they’ve lost.

 

Nor is that the only piece of screwy thinking at Staples. The New York Times Dealbook reported that Staples expects $1 billion in savings from the deal. That’s right; they’re going to spend $6.3 billion to save $1 billion; the math seems to be as fuzzy as the grasp of retail realities.

What’s worse is that the expected savings will come from layoffs and reduced marketing costs—a clear euphemism for shutting down money-losing stores. It won’t be coming from increased sales.
Nor will this merger be a very good deal for Office Depot shareholders. Office Depot’s actually been doing sort of well recently. Its TTM revenue actually grew from $10.38 billion in September 2013 to $15.75 billion September 2013. It looks as if Office Depot has been turned around; now Staples plans to effectively pillage it.

The bottom line is that deal makes absolutely no sense. It won’t make Staples or Office Depot more competitive nor will it save these chains from a radically changing office supply market.

Both Staples and Office Depot have been hammered hard by online competition. In particular, they’ve been caught in the crossfire of the growing Internet war between Walmart (NYSE: WMT) and Amazon.com (NASDAQ: AMZN). Both of those online giants offer free shipping deals and really low prices on a lot of the office essentials that the office suppliers used to specialize in.

I’m a small businessman who conducts a lot of online sales, yet I buy most of my supplies from Walmart.com and its Sam’s Club subsidiary. Sam’s Club sells boxes of bubble mailers, which I use for shipping, for less than $10 apiece; neither Office Depot nor Staples sells those. Walmart also sells ink cartridges for a lower price.

Nor is it just Walmart and Amazon.com; Apple Inc. (NASDQ: AAPL) has figured out how to steal the consumer electronics business. Like Walmart and Amazon.com, it sells heavily online and is now the number two online retailer after Amazon.com. This is occurring at a time when the office suppliers are reeling from intense competition from Costco (NASDAQ: COST) as well.

The whole Office Depot/Staples merger reminds me of the Sears Holdings (NYSE: SHLD) debacle that combined Kmart and Sears. Instead of a competitive and profitable company, that merger took successful retailers and created a basket case. My guess is that Office Depot/Staples will be as big, unwieldy and potentially as unprofitable as Sears Holdings.

An Obsolete Business Model

Staples and Office Depot’s problem is an obsolete business model. The two chains are category killers—discounters that specialize in one sector of retail. That business model worked well when people did their shopping at brick and mortar stores.

It does not work when a person can go online and find lower prices. To make matters worse, online retailers can save something as precious as money for small business people: time. Instead of taking an hour or two off from working and spending money on gas to drive to the store, you can simply order online, and UPS, FedEx or the Postal Service will bring the order to you.

The customers have voted with their dollars and redirected their spending to online retailers, something that should benefit Staples, which is still the world’s number three online retailer, according to The Wall Street Journal. Amazon is the world’s number one online retailer, and Apple is number two. Walmart is currently number four but moving up fast.

Staples actually has a pretty good online business; its online revenues were around $10.4 billion in 2013 and make up 45% of the company’s revenue. Staples was the number two online retailer until 2013, when Apple took its spot. Staples’ online sales grew by just 1% in 2013, while Walmart’s grew by 30%. One has to wonder if anybody at Staples can read a balance sheet. It is losing its main source of revenue, yet it is planning to spend its money on retail stores where foot traffic is falling.

Staples’ own business shows that the future of office supplies is online. If Staples were smart, they’d shut down more stores, expand online and perhaps spend some of that $6.5 billion to build some giant fulfillment centers like Walmart is and invest in technologies like robotics like Amazon.com to make online retail more efficient.

Instead, Staples seems to be neglecting its online business in favor of this idiotic merger. My prediction: if the merger goes through, there will be bigger losses at Staples as it tries to divest itself of all those stores. The revenue and the stock value of the new Staples will plummet because of those losses. Those losses will come as Staples faces more competition online.

Amazon.com has just launched a new business supply initiative, and Walmart is planning to spend up to $2.6 billion online in the next two years. That spending includes five 1.2 million square foot fulfillment centers designed to increase its online footprint. Those centers will carry one half million SKUs of merchandise, much of which will be office supplies.

We are facing a retail apocalypse because dinosaurs like Office Depot/Staples are not adapting to changing times. One has to wonder how much money Staples will pour down the Office Depot black hole to the cheers of the “activist investors” until it destroys two good businesses. Hopefully the regulators at the Federal Trade Commission (FTC) will say no to this catastrophe in the making. The last thing we need in this country is thousands of empty office supply stores.