CASE STUDY #2: Office Depot (NYSE:ODP)
SEPTEMBER 2012
Company Profile
Office Depot is a global supplier of office products and services. The company sells to consumers and businesses of all sizes through three divisions: North American retail, North American business solutions, and international. In 2011, the company’s turnover was $11.5 billion. With the support of a network of supply chain facilities and delivery operations, Office Depot processes sales through multiple channels, including office supply stores, a contract sales force, an outbound telephone account management sales force, Internet sites, direct marketing catalogs and call centers.
Chart
Investment Rationale
On Sept. 17, 2012, an activist investor, Starboard Value Fund, disclosed an ownership of a 13.3% stake in Office Depot. The shares were acquired at an average price of $1.91 per share. On the date of disclosure, the stock was trading at $2.59 per share, or 35% higher. Main financials and valuation multiples are summarized below:
| Share Summary |
Sept. 18, 2012 |
| Market Price | 2.59 |
| Shares Out (mil) | 291 |
| Market Cap (mil) | 754 |
| EV (adjusted)* | 1,479 |
Enterprise Value (EV) is calculated as Market Cap – (Current Assets – Total Liabilities).
| Balance Sheet | Q2 2012 | 2011 | 2010 | 2009 | 2008 | 2007 |
| Current assets | 2,508 | 2,744 | 3,028 | 3,206 | 3,122 | 3,716 |
| Current liabilities | 1,824 | 2,047 | 2,343 | 2,428 | 2,626 | 2,973 |
| LT Assets | 1,449 | 1,507 | 1,541 | 1,684 | 2,146 | 3,541 |
| LT Liabilities | 1,409 | 1,464 | 1,530 | 1,673 | 1,275 | 1,199 |
| Equity | 724 | 739 | 696 | 789 | 1,368 | 3,084 |
| Main Financials | 6m 2012 | 2011 | 2010 | 2009 | 2008 | 2007 |
| Sales | 5,380 | 11,490 | 11,633 | 12,144 | 14,496 | 15,528 |
| Oper Income | 19 | 34 | (37) | (265) | (1,545) | 484 |
| Net Income | (23) | 60 | (82) | (627) | (1,479) | 396 |
| EBITDA | 162 | 245 | 222 | (15) | 201 | 803 |
| FCF | (174) | 77 | 69 | 316 | 259 | 80 |
| Dividend | – | – | – | – | – | – |
| Share buyback | – | – | – | – | – | 200 |
EBITDA is calculated as Operating Income + Depreciation and Amortization. Impairment of other assets and impairment of goodwill is also included in EBITDA calculation as those charges are of a recurring nature. Proceeds from asset disposals are included in FCF calculation as they are of a recurring nature.
| Valuation | Current | 2011 | 2010 | 2009 | 2008 | 2007 |
| P/S | 0.07 | 0.07 | 0.06 | 0.06 | 0.05 | 0.05 |
| P/E | N/A | 12.57 | N/A | N/A | N/A | 1.91 |
| P/B | 1.04 | 1.02 | 1.08 | 0.96 | 0.55 | 0.24 |
| EV/EBITDA | 4.55 | 6.03 | 6.65 | N/A | 7.35 | 1.84 |
| ROE | N/A | 8.1% | N/A | N/A | N/A | 12.8% |
| FCF Yield | N/A | 10.3% | 9.2% | 41.9% | 34.3% | 10.6% |
Current market price and EV is used in P/S, P/E, P/B, EV/EBITDA and FCF Yield calculations to emphasize the price investor is paying now for company’s historical profitability. Current financial results (2012) are annualized based on first six months of 2012.
The Starboard Value Fund disclosed a letter to Office Depot management and outlined its valuation thesis and its desire to work closely with management in order to unlock value for the benefit of all shareholders. An important component of its valuation thesis was Office Depot’s 50% ownership stake in Office Depot de Mexico:
Non-core asset: Office Depot de Mexico
Office Depot de Mexico is a joint venture with Grupo Gigante, in which Office Depot owns a 50% share. In 2011, Office Depot de Mexico operated 241 retail stores primarily in Mexico, as well as Colombia, Costa Rica, El Salvador, Guatemala, Honduras, and Panama. Starboard Value emphasized in its letter that the joint venture was not recognized in Office Depot’s enterprise value because it was included in the company’s financial statements and because analysts valued Office Depot primarily based on consolidated EBITDA, which did not include Office Depot de Mexico
| Mexico JV Financials | 2011 | 2010 | 2009 |
| Sales | 1,139 | 962 | 826 |
| EBITDA | 129 | 111 | 102 |
| Office Depot 50% Share | 65 | 56 | 51 |
| Value (x8 multiple) | 516 | 444 | 408 |
Source: Starboard Value fund letter, Office Depot SEC filing, Sep 17, 2012
In July 2008, Grupo Gigante publicly offered $430 million, or an estimated x8 trailing EBITDA, to acquire Office Depot’s stake in the joint venture. Applying the same valuation multiple to 2011 EBITDA, Office Depot stake could be valued at about $516 million.
Enterprise value, if adjusted for this amount would equal $963 million and one would acquire Office Depot at an EV/EBITDA ratio of only 2.96.
Operational Improvements
The remaining part of the investment thesis emphasized the fact that Office Depot underperformed many of its peers – Office Max and Staples – both in terms of profitability as well as its share price. With annual sales of about $11 billion, there were definitely opportunities for cost cuts and margin improvement. The activist shareholder disclosure presented these aspects in detail. They are available for review through the SEC database.
Conclusion
Although the company was definitely not in optimal shape, its debt levels were manageable. The operations and profitability could have been improved, possibilities for restructuring and capital structure improvements existed (possible disposal of a non-core asset (Office Depot de Mexico joint venture).The activist investor was expected to fight and pressure management to work hard to enact changes.
Position and Return
Office Depot stock appreciated by +57% in a six-month period since the disclosure of activist investor involvement (September 2012 to March 2013). On Dec. 20, 2012, the company announced the sale of its operation in Hungary to a venture capital fund. The company announced that it had agreed to merge with Office Max to create a stronger and more efficient global company on Feb. 20, 2012.
4.4 CONCLUSION
Investments by activists are on the rise. Large hedge funds, as well as regular institutional investors, turn to this strategy in order to proactively influence the outcome of their investments. By following activists, investors you can obtain a constant stream of interesting investment ideas. Usually the interests of activists and the rest of a company’s shareholders are aligned. While following activists’ SEC filings, you gain access to detailed research presentations and other different disclosures – resources that would not be available to you otherwise. By conducting your own research and limiting yourself to companies that you can understand (using the activists’ holdings only as a starting point and as a tool for research), you can find attractive investment ideas.
* Reproduced with permission. Alex Gavrish’s book “Wall Street: Back to Basics” is available via Amazon, for more information see www.etalon-ir.com/book.html
Related articles: Cevian Capital II Ranks High on 2010 Returns
John Paulson on the Benefits of Activism
Specialist Manager Series – Selecting oil stocks with Roundrock Capital
Pages: 1 2