Following up with the next step after yesterday's e-mail...
Let's come back to office-supply retailer and distributor ODP (ODP) – formerly known as Office Depot.
In my e-mail yesterday, I took a look at ODP and the financials.
As I mentioned, I doubled my money owning the stock in 2001. But I haven't looked at it again until now – which is a good thing, given that the stock has lost more than 95% of its value since its peak in 2006!
The company is best known for its consumer business – Office Depot and OfficeMax stores. You'll likely recognize them – here's a picture from the company's website:
But this segment only accounts for 45% of revenues. The balance of ODP's revenues comes from its business-to-business distribution segment called ODP Business Solutions.
Both halves of the business are in decline...
In the company's recent second quarter (you can see the earnings release here and investor presentation here), revenues of the consumer business declined 10%. That was due to the closure of 60 stores and negative 5% same-store sales.
Meanwhile, ODP Business Solutions' revenues dropped a slightly less bad 6%.
Importantly, however, both segments were profitable. They reported $12 million and $18 million in operating income, respectively.
As I discussed yesterday, ODP has been a melting ice cube – a classic value trap – for years.
I generally avoid the stocks of declining businesses like this. But after reading a recent pitch for ODP by "Extreme-mispricings" ("EM") – an anonymous member of my favorite stock-idea website, Value Investors Club – I think this stock is worth a closer look.
Only Value Investors Club members can read the pitch and comments, so I'll summarize and comment on it today...
First, EM believes the ODP is looking to sell itself:
At the end of July, DealReporter reported ODP is exploring a sale with JPMorgan and has attracted interest from private equity. ODP's CEO has had 9 years to try and turn the company into a success, he's been decent at cutting costs and getting the business to throw off lots of FCF. But overall, him and the board have made too many critical missteps, [Compucom],[Varis], large buybacks at $50, etc. So if you are the board it's hard to argue with a straight face that yourself and CEO should continue to try different things vs. just realizing the value of the assets via monetization, and especially so if shareholder pressure arises.
EM also notes that ODP's CEO, Gerry Smith, has strong incentives to do a deal:
ODP CEO owns a lot of stock and would realize a massive golden parachute in a change in control. The CEO has made $10 [million] a year in average compensation over his 9 years, this isn't going to fly much longer, time to cash in.
Additionally, EM thinks there are numerous potential bidders who would pay $25 per share to $30 per share for the company. That's well above yesterday's closing price of $21.31 per share.
As the pitch continues:
There should clearly be bids on the table for ODP likely $25 at the lowest (3x [adjusted earnings before interest, taxes, depreciation, and amortization ("EBITDA")] and then base case probably [$27 to $28]. All it takes is someone to either see the synergies and/or see the potential in Veyer as essentially a carbon copy of GXO, and bids could be $30.
EM argues that the most logical buyer is $10 billion private equity firm Sycamore Partners. (Sycamore bought ODP's largest competitor, Staples, in 2017.)
But according to EM, Sycamore loaded up the company with so much debt that its ownership stake is worth very little... so it has "nothing to lose" and a huge amount to potentially gain by bidding for ODP:
Put yourself in Sycamore's shoes, you have Staples ownership but your equity value really isn't much over and above the debt load here of 5.3x leverage. So you basically have nothing to lose, you are kind of in a dogfight with ODP for a core shrinking office supplies market and again you have nothing to lose because your equity value here is almost nil. But if you made the move to acquire ODP you would pay about [$1 billion to $1.1 billion] for it, you probably would incur $400 [million] in one-time restructuring costs for integrating it. But your synergies would easily top $500 [million] and could be as high as >$1 [billion].
And as EM continues:
At the low end you would be acquiring $800 [million] in pro forma EBITDA for a total consideration of $1.4 [billion] (incl restructuring costs). You also would get ODP's inventory, and turn the competitive environment into a much better one – arguably making this a really solid distribution business.
Assuming a 6x multiple on the $800 [million] in pro forma additional EBITDA, this would create $3.4 [billion] in NET EQUITY value that drops straight to Sycamore. So Sycamore can turn their measly [$200 million to $400 million] or so in current equity value in Staples into an incremental $3.4 [billion-plus].
Ah, but what about antitrust concerns?
After all, Sycamore Partners made multiple proposals to buy ODP for as much as double today's share price in 2021. But ODP ultimately rejected the overtures, concluding that the merger of the two largest office supply companies would be blocked by antitrust regulators (which is what happened in 2016).
Now, EM argues that:
... the regulatory landscape has done a complete 180, with the harshest anti merger antitrust leadership being replaced by a very pro-business/friendly antitrust admin. Union Pacific recently announced a deal to acquire Norfolk Southern, President Trump recently fired Surface Transportation Board member Robert Primus, known for opposing rail mergers, likely shifting the board's balance toward a more consolidation-friendly majority.
EM also believes that ODP and Staples have a better case to make today than they did before:
... I think the odds are greater than 50/50 that an ODP merger would go through. They likely have a good argument in my opinion, they need to combine to be able to provide a formidable competitor to Amazon (and WMT) otherwise those top two are just going to bulldoze other players out of business and completely dominate, it's also a declining office supplies market so consolidation is necessary.
Even if Sycamore isn't sure regulators will approve the merger, EM argues that it will try:
Staples could offer a [$125 million to $140 million] breakup fee in the event they can't close on a deal, again Sycamore has nothing to lose so why not risk 2% of the Staples enterprise value here. Then if ODP doesn't get bought it can clip the breakup fee and sell to the second bidder.
If you're Sycamore, and even if there's only a 40% chance you can get the deal through regulators, you still 100% have to try, you are on a free roll – you are risking almost nothing to create [$3.4 billion to $6 billion] in value that drops straight to your firm.
EM thinks that if ODP can get other bidders in the $25 to $28 range, then the company can use this to extract a price in the high $30s from Sycamore:
I believe it makes sense that ODP runs its full process requesting bids from all types of buyers, because you want to see what you can get in a deal that incurs no regulatory risk. i.e. they will likely have buyers in the [$25 to $28 per] share range. They can use this as leverage to get a higher price from Staples/Sycamore in my opinion (i.e., why would I sell to you at $33 when I could just take the risk-free deal at [$27 to $28]? You need to pay me high $30s per share, which is still a complete no brainer for Sycamore).
And what if no deal occurs? Well, EM thinks the downside is modest:
Your downside in a no deal scenario is likely [$15 to $20 per] share. ODP will continue to milk cash from its consumer business as it generates operating cash flow and they consolidate stores and turn inventory into cash. The Business Services Division has been competitive with Staples who was recently aggressive in the market as they were refinancing, tariffs now give the two an excuse to bump up price a bit.
Finally, as I concluded in my e-mail yesterday:
Overall, the financial picture isn't pretty – but it's not a disaster, either. While declining, the company's operating income and FCF remain positive, and net debt is manageable.
Only three analysts follow the company, which is a plus, in my opinion. They expect ODP to earn $2.92 this year (down from $3.30 last year) and $2.88 in 2026. That means the stock is trading at a mere 7.2 times this year's and next year's expected earnings.
As I said, at that multiple, any good news could send ODP's stock soaring.
To be clear, it's generally not a good idea to invest in melting-ice-cube businesses in the hopes of making a quick profit on an acquisition. But ODP could be a rare exception to that rule...
I think it's almost certain that ODP is shopping itself... there's no question that it's a no-brainer for Sycamore to try to acquire ODP to merge it with Staples... and I think ODP's positive free cash flow and decent balance sheet protects the downside.
Of course, with a more speculative, riskier stock idea like this, that makes proper position sizing even more important.
Meanwhile, I would also want to evaluate the stock with my team here at Stansberry Research...
If we decide the stock looks compelling enough to add to the model portfolio in our flagship Stansberry's Investment Advisory newsletter, our subscribers will be the first to know – as always.
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Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.