Description
Business Description
Office Depot ("ODP" operates in three divisions: Retail (~45%), Business Solutions (~45%), and CompuCom (~10%).
The Retail division operates retail stores, which offer office supplies and services in the U.S. As of December 31, 2017, ODP operates 1,378 office supply stores, and 50+ distribution centers, and can reach 98.5% of the US population on "next day delivery".
The Business Solutions division sells office supply products and services through sales forces, catalogs, and telesales, as well as Internet, and services both B2C and B2B.
The CompuCom division provides end-to-end managed services, technology and consulting services to enable the digital workplace for both enterprise and SMBs. Roughly 14% of ODP's sales is Services today, and management aims to grow that to 20% by 2019/2020.
The new management team is trying to position ODP as a one-stop-shop for all business services, through its "Workonomy" initiative.
Why Does The Opportunity Exist?
ODP has had a couple of quarters of disappointing results and muted FY18 guidance, which has resulted in a heavy sell-off of the stock over the past year. In the past year or so, they have revamped their entire management team, and investors are worried about the lack of continuity amongst the new leadership.
ODP has historically been seen as a office retail business, and hence the market values it at a "office retail" multiple despite ~55% of their business being non-traditional retail today, especially with the recent acquisition of managed-services provider, CompuCom. Prior to this year, the company has been focused on the strategy of shutting stores, and running their remaining retail stores for cash. However, the new management team is focused on transforming ODP into an integrated services omni-channel business, and also aims to maximize FCF.
As a result of the sell-off and management's new focus, some large value investors are starting to get involved. At current prices, dividend yields are ~3.5%, which provides a decent margin of safety. Finally, CapIQ and some sell-side analysts are building out Enterprise Value incorrectly, by including the non-recourse debt, but not including the corresponding Timber notes receivable (i.e. claim of the non-recourse creditors).
Investment Thesis
New management team with focused goal of changing the market's perception of ODP - to be valued as a B2B company instead of retail. Management team also focused on maximizing FCF. Current prices imply a high teens FCF yield.
Tough 2017 due to corrective measures and change in strategy led to overreaction (down ~50%), but with recent acquisition of CompuCom completed, ODP has the assets to shift to a B2B/services "one-stop-shop", and away from pure retail.
At current prices, stock is undervalued regardless of valuation methodology, with a relativly protected downside. Even if management misexecutes and misses their targets, our conservative base case still implies a >30% IRR.
Div yield of ~3.3% today, vs div yield ETFs with average yield of 2.5-3%. They should have no trouble servicing the dividend, and could easily raise it if not for TL covenants. 'Div yield investors' could support a floor valuation at current prices.
Sycamore Partners took Staples private at 0.4x Sales, ~40x EBITDA, with similar thesis to what ODP is currently trying to do; quick LBO analysis shows that a PE owner looking for a 15% IRR over 5 years could buy ODP at a ~30% premium.
How Could We Be Wrong?
- Same-store-sales declines accelerate due to faster-than-anticipated behavior change ("Amazon effect").
- Aggressive retaliation from competitors in business solutions and managed services space prevents ODP from growing BSD and CompuCom profitably.
- Higher-than-expected capex and opex (e.g. variable compensation) as management might underestimate extent of transformation required with "Workonomy" initiative
- Unproven management team, with tenures of <2 years at ODP. Any signs of misexecution (e.g. missing synergy targets) could lead to lower confidence in turn-around
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
- Re-rating as B2B company
- M&A takeout