Description

What is Office Depot?

A quickly melting ice cube? A pre-digital brick-and-mortar relic from a bygone era when toner and paper were consumed by businesses? A business services provider slowly repurposing +1,300 retail locations in an omni-channel world? A supply chain and logistics powerhouse with a trusted brand name serving 10 million business customers?

To appraise the worth of Office Depot’s net assets and cashflows, it helps to define the nature of the business. Arguably, Staples, Inc. was the closest comparable, which was purchased by Sycamore Partners last year for ~5.3x TEV / EBITDA on a consolidated basis. Sycamore viewed the collection of businesses as i) a flailing brick-and-mortar retailer; ii) a healthy B2B distribution business; and iii) a Canadian operation that was profitable as a standalone.

Office Depot likes to argue that they are fundamentally different from Staples. Whereas Staples has split into three separate businesses, Office Depot feels they can do more with an integrated approach. Both companies acknowledge that much of their value comes from the supply chain and distribution business.

So what kind of business(es) are encompassed in Office Depot? What could the enterprise be worth when viewed through various lenses?

1)    Market view: a quickly melting brick-and-mortar ice cube about to be demolished by Amazon

Office depot has 541 million shares outstanding. At the current $2.40 share price, the equity is valued at $1,300 million. Based on the last official guidance (Q4’18 on Feb 27^th and reiterated at BAML Conference on March 12^th), Office Depot was expected to generate $350m of FCE (+25% yield).

On an unlevered basis, consider that Office Depot has ~$185 million net financial debt. Financial screens and some market participants incorrectly pick-up the Timber Notes without the offsetting asset. However, there is a tax liability on maturity of those notes as well as some pension liabilities. Altogether, Office Depot has up to ~$385m of net financial liabilities, so the Total Enterprise Value is up to $1,685 million. Based on the last official guidance for adjusted EBITDA of $575m, Office Depot trades at 2.9x.

But they warned for Q1’19 and will be updating FY2019 guidance!? True. Although some issues might be transitory and there may be further cost cuts, let’s shave the guidance of a month prior to $300m FCFE (23% yield) and $500m EBITDA (3.4x). It doesn’t materially change the market perception.

2)    PE-sponsor / Office Depot management view: a growing B2B distribution business that’s worth +7.0x. 

Much like Staples, Office Depot derives +50% of profits from its B2B division. Also, just like Staples, the capex ÷ EBITDA in that division is ~13%, supporting a reasonable multiple on stable economic earnings. As per page 62 of the Staples proxy statement, comparable company multiples range from 7.1x – 18.1x (and that was with a 35% tax rate). Assuming the absolute bottom of the range (7.0x), and B2B EBITDA of $320m equals an implied enterprise value of $2,240 million.

However, CompuCom and Corporate costs drag down performance by ~$80m. Assuming the same multiple (7.0x), results in an implied B2B enterprise value of $1,680 million ($3.10 / share).

So even if the whole retail business does $250m EBITDA (+$100m FCFE), an investor is getting that business for free today or negative ~1.5x after subtracting one more year’s consolidated cashflow.

3)    Alternate PE-view: Blended approach recognizing that retail rationalization is the key

If the sum-of-the-parts approach is too theoretical and deemed unrepresentative of the fact that Office Depot wants to be viewed as an integrated, omnichannel, supply chain and distribution business solutions provider, let’s just agree that something must be done about the 1,300 store retail footprint.

A couple of years ago, Office Depot and Staples tried to merge their companies. The FTC wouldn’t approve the deal due to anti-trust issues relating to a sub-sect of the B2B businesses. However, a large bulk of the projected operating cost synergies came from the retail operations. Assuming a retail JV could help remove costs and/or the retail operations could be hived-off in some fashion, you might be left pretty close to where the Sycamore-Staples transaction printed at ~5.0x. Assuming the lowered EBITDA figure of $500m, that’s still ~$4.50 per share.

4)    Long-term investor with rose-coloured glasses: They might be able to right the ship

These days it seems like only tech companies get full credit for their audacious TAM (Total Addressable Market) plans. For fun, let’s see how that might look if Office Depot can achieve their goals of growing consolidated sales and stabilizing margins by focusing more on business services, ancillary products and leveraging their distribution network. FCFE of ~$325 on an all-equity capital structure at a 10% - 15% yield, would result in a share price of $4.00 - $6.00 per share.

Risks:

i)              Amazon. The one-word description for increased competition and margin pressure in an environment dominated by excess liquidity and rapid technological change.

ii)             Execution. The CompuCom acquisition looks like it will require a material write-down. Q1’19 guidance warn seems fairly material fairly quick (Q4’18 was reported on Feb. 27^th and reiterated at a conference on March 12^th).

iii)            Lack of financial flexibility. Office Depot has prudently paid down and lowered their cost of debt but are still paying L+500 and limited in terms of dividends and share repurchases. Not a great sign that this is the most competitive debt available.

Catalyst

Updated guidance 

B2B sales growth and margin stabilization 

Continued buybacks / dividends

M&A