Description

ODP is being valued as a left for dead brick and mortar store that trades for a 4-5X FCF (if you net out the cash on balance sheet). The reality is that this is a top 20 global supply company and logistics machine whose value has been obscured by some ill-considered initiatives into other areas. This is finally being realized by the market – but before that full realization could take place, Sycamore/Staples lobbed in a bid for the whole business at $40 a share. 

Before explaining the current dynamic here and why it is still a very skewed risk/reward (even though it is trading above this offer price), let me first explain why this was interesting to begin with. 

To repeat, ODP is a logistics machine that can deliver in size within a day inside your office pretty much any office supply item you need – but was being disguised as a crappy brick and mortar retailer with unkempt stores that looked like Sears Part II.

This management team had up until a year ago, had not done much to get rid of that disguise. Rather than focus on their B2B business and their next day white glove delivery prowess, Gerry Smith chose instead to buy an IT services business called CompuCom for $1 billion in 2017. This deal ended up being a massive distraction and is likely worth a fraction of what they paid for it today.

The company only this past year began to fully pivot to B2B. But then COVID hit, which in turn decimated their demand. But while COVID hurt demand, it did not end this transition as they have hired a whole new team of managers including Terry Leeper who was the head of Product and Tech at Amazon Business.

With ODP, Leeper had the opportunity to do something that he was not able to do at Amazon – build a fully integrated B2B platform that can deliver products into the office on the same day they were ordered.

The consumer-driven model of Amazon is inherently at a disadvantage when it comes to large enterprise spending. If you’re a company and you need 1,000 reams of paper – Amazon can source it for you but they will source it from a variety of different distributors and you’ll get a bunch of different boxes delivered over the course of a few days on your doorstep. ODP on the other hand can source from one supplier and deliver 1,000 reams of paper in one pallet directly inside your office within a day.  

With that type of logistical capability, ODP can make the transition that Amazon did and go from being a 1P seller to a 3P seller – allowing their platform to be used as a middleman for suppliers looking to gain white glove, next day delivery access. As they broaden their scope of sellers, ODP can also broaden the scope of what they sell and get into other verticals – like PPE (Personal Protective Equipment) and MRO (Maintenance, Repair and Operating) – all of which is higher margin growth.

We had begun to see evidence of this capability – first in the ramp of PPE, which was a category that went from $0 in sales to a relevant % of their overall sales as well as in their adjacency category which had grown over the last year from 37% of B2B sales in Q3 2019 to 47% in Q3 2020.

Now this growth in new categories has been obscured by the headwinds that COVID presents for business as usual at offices – as many folks have fulfilled their procurement needs from Amazon as they work from home.

But individuals making ad-hoc orders on Amazon is not sustainable in the long run as businesses will look to take back control of these expense items (it is both a hassle from an internal accounting perspective to track individual ordering and you also do not get any bulk discounts).

The story of this pivot to B2B and the data points to support the early success of it (which are admittedly not yet obvious) were going to be made clear during an upcoming Analyst Day – which Gerry Smith excitedly referenced 12 times during the last conference call.

However, the events of earlier this month have thrown a wrench into that story. Staples and their PE owner Sycamore issued a letter threatening a $40 tender offer.

A few things could happen now.

One would be that ODP sells its retail stores (which is not the focus going forward) to Staples – which seems to be what they are after here. They could probably get $20 a share for that business (roughly 5x operating profit of $250mm). They could then sell CompuCom for $300mm or ~6 a share (which is a fraction of what they paid for it) to another third party and be left with a publicly traded B2B business.

The B2B business would generate $250mm in operating profit in 2021 and would be worth at least 10X based on similar publicly traded comps. This would leave the remain co worth $47 a share in addition to their current cash on the balance sheet of roughly $7 a share, which gets you to an all-in price of $80 a share today. If they can show organic growth in B2B with this new pivot then the share price should appreciate from there.

Alternatively, they could seek other buyers for the whole business or for B2B. BABA and AMZN would presumably be suitors here given ODP’s delivery capabilities or we could see Staples raise their very low bid to a more reasonable level (this would probably require the entrance of another strategic).

ODP responded to in a letter to Staples (see https://sec.report/Document/0001193125-21-010893/) and essentially said – we will sell you retail but let us keep B2B. They also let it known that they were in a process to sell CompuCom as it was. It is not clear at the moment how Staples/Sycamore react to this letter, but if something along this lines happens, that would be the most near term value accretive to shareholders – suggesting an almost immediate doubling of the share price.

Regardless, we have a temporary floor in the price as more eyes examine the potential upside here.

If some sort of transaction does not go through then we are happy owning this business for the longer term transformation being led by Terry Leeper. Either way the cat is out of the bag and this once left for dead retailer will start to be understood differently.

Catalyst

- Staples consumates a deal for either retail or the whole business.

- Another bidder comes in on top of Staples bid.