The proposed merger of Office Max and Office Depot with combined revenue of $18 billion is being hailed as a merger of equals, but in many ways it is also could be viewed as a move to save two brands that are facing unprecedented competition.
The all-stock deal is the latest example of retail M&A necessitated by the emerging impact of ecommerce.
From a commercial real estate
perspective, the merger will likely result in a quickened pace in M&A activity as retailers continue to shrink their real estate footprints by closing redundant or underperforming locations. However, the merger may also leave the combined company with significantly improved financial strength and flexibility through its increased scale and significant synergy opportunities, according to the two companies’ combined press announcement of the deal.
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According to CoStar Group data, there are more than 300 ZIP codes where the two office supply retailers have redundant store coverage, and that analysis doesn't take into acount where stores may be in close proximity but in different zip codes.
A New, Radically Different Retail Environment
“The entire office supply sector has been hammered in recent years by two factors that really both come down to one thing; the increasing encroachment of e-commerce,” said Garrick Brown, research director of Terranomics and Cassidy Turley.
“Of course, direct competition from the internet is the first trend that has battered the bottom lines of every major office supply retailer. The second, to varying degrees, is how much each retailer had expanded their offerings to include tech and consumer electronics offerings over the past decade or so,” Brown said.
“Beginning in the late 1990s, but particularly in the early portion of the last decade, we saw many chains increasing their stores to offer more computers and other consumer electronics products. This portion of the retail market in particular has been extremely hard hit by both online (Amazon.com) and discount (Wal-Mart) competition,” he said. “And so, over the past decade, we have seen the average bricks-and-mortar footprint for office supplies chains swell to nearly 30,000 square feet -- only to shrink back to 20,000 feet or less. Nearly every major chain is now experimenting with footprints of 10,000 square feet or less as they consolidate and focus on their core offerings of office supplies.”
Ravichandra K. Saligram, CEO and president of Office Depot discussed that trend in the company’s conference call announcing the merger.
“Compared to the last decade or so, this industry has completely changed. First, each of the competitors has been evolving their product lines into products, into services and solutions, which means a very broad range of competitors,” Saligram said. “So today, we compete even in just the retail front, with mass merchants. We compete with the Targets, the Wal-Mart’s, the Costcos, the Best Buys, et cetera.
“From a brick-and-mortar world, we've gone into the evolution of a truly multichannel world. You have telesales, you have the Internet, and you have mass merchants,” he said. “And each of the formats of the competitors, even in the superstores, have changed versus '97 when they were all very identical. At that time, people thought of these as category killers. That's completely changed.”
“The Internet changed everything and I think all you had to do in 1997 was walk in a Wal-Mart and they may have had 100 to 200 square feet of office supplies. Today, they've got thousands of square feet of office supplies,” Office Depot’s chairman Neil Austrian added. “A customer has total flexibility in terms of where they can or can't buy office supplies. And if you don't want to go to brick-and-mortar, it's on your doorstep the next day.”
As of late last year, OfficeMax had about 960 units in the U.S. (it closed about 25 last year, while opening just one new store nationally). As of November 2012 it planned to close about 45 stores in this fiscal year, while opening just one new unit. In all, it is estimated that the amount of space they returned to the marketplace in 2012 via closures, remodels and relocations (almost always to smaller footprints) was about 700,000 square feet.
Meanwhile, Office Depot had a little more than 1,100 stores as of late last year. In 2012, the retail chain opened two new stores, but closed 19 locations nationally and announced long-term plans to close as many as 20 stores annually as leases expire. Likewise, Office Depot has been aggressively shrinking its store size -- new stores, remodels and relocations are all coming in between 5,000 and 15,000 square feet, well down from a previous average of 23,000 square feet. Their plans currently call for reducing 500 larger-format stores to the new smaller formats over the next five years, including 100 this year. This move alone could see their space usage decline by as much as 1 million square feet over the next year.
Assuming a merger does take place, many expect additional closures of stores where redundancies exist, but for now the retailers are mum.
“I think you could expect to see a retail strategy evolve once the merger is approved. I think to do anything prior to that would probably not make a lot of sense at this point in time,” Austrian said.
But it’s just about all the real estate industry is talking about when it comes to this merger.
DDR Corp. owns 50 OfficeMax stores totaling 1.2 million square feet with average remaining lease term through February 2016, and 15 Office Depot stores totaling approximately 365,000 square feet with average remaining lease term through January 2017.
Between the two retailers, DDR owns 65 stores, of which 59 are located in assets that are 95.5% leased, with an average trade area population of 448,000 and household incomes over $80,000. The average rent per square foot for both retailers is currently $11 and approximately 30% below DDR's prime portfolio average, according to the REIT.
With an average remaining lease term of nearly four years, DDR said it has limited risk to cash flow interruption, and “enjoys the opportunity to recognize termination fee income and unique mark-to-market opportunities in this supply constrained environment.”
"We are excited about the opportunity presented by the Office Depot and OfficeMax merger, and we will maintain a close dialogue with both retailers to assist them in their transition and pursue opportunities to recapture valuable space,” said Paul Freddo, senior executive vice president of leasing and development for DDR.
"Consolidation in the office supply sector has been highly anticipated and based upon our market knowledge, store spacing, and store performance, we expect the opportunity to recapture certain locations. If executed as proposed, the merger will enable us to realize positive rental increases by backfilling the newly available space with a variety of today's fastest growing, high credit quality retailers, including T.J.Maxx , Marshalls, HomeGoods, Ross Dress for Less, Bed Bath & Beyond, buybuy BABY, Cost Plus World Market, Nordstrom Rack , and many others." Freddo said.
Office Supply Merger Positive for Staples
Fitch Ratings said it views the potential merger between Office Depot and OfficeMax to be moderately positive for their competitor Staples due to continued top line weakness at the two merging companies.
“We believe that weakness could be exacerbated by merger-related disruptions and potentially by accelerated store closings,” Fitch analyst noted.
This merger (of the second and third largest players in the office supplies store chains) will create a combined entity with $17.6 billion in sales and almost 2,200 stores, which is below Staples' $24.4 billion in sales on a base of 2,290 units.
In the U.S., the combined OfficeMax and Office Depot will have close to 2,000 stores with more than $13 billion in sales (both retail and delivery) versus 1,900 at Staples with sales of around $16.6 billion.
“We believe consolidation of the second and third office supply chains may alleviate some competitive pressure in the Staples' North American Retail segment in the near term as the combined entity continues to rationalize its footprint through store closures on top of any mandated Federal Trade Commission (FTC) closures,” Fitch reported. “ODP and OMX have closed about 10% (approximately 250 units) of their 2008 footprint versus relatively flat units at Staples.”
The OfficeMax / Office Depot merger transaction is expected to close by the end of calendar year 2013, subject to stockholder approval from both companies, the receipt of regulatory approvals and other customary closing conditions.
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