Staples Seen Reversing Romney Deal Over Valuation
Staples Inc. (SPLS), the office-supplies retailer that Mitt Romney’s Bain Capital LLC helped take public more than two decades ago, is now offering private-equity buyers a bargain that will be tough to pass up.
After falling to a record low valuation in August, the company now has an enterprise value that’s 4.5 times earnings before interest, taxes, depreciation and amortization, still cheaper than 93 percent of similar-sized U.S. specialty retailers, according to data compiled by Bloomberg. At 14.8 percent, Staples’s free cash flow yield is higher than 65 of 67 peers, the data show.
Staples, facing the first annual sales decline since at least 1990, announced store closures in September and reduced 2012 forecasts in August. Private-equity firms may see more ways to cut costs and rejuvenate the business, Edward Jones & Co. said, while the company’s cash generation could be appealing to potential buyers, according to Pekin Singer Strauss Asset Management Inc. and Dreman Value Management LLC. The $7.9 billion company may lure bids up to $18 a share, or 55 percent more than last week’s close, Olstein Capital Management LP said.
“The cash flow generating ability of this business I would think would lend itself to an acquisition by a private-equity firm,” John Sullivan, an analyst at Purchase, New York-based Olstein, which oversees about $570 million including Staples shares, said in a telephone interview. “It’s so undervalued.”
Owen Davis, a spokesman at Framingham, Massachusetts-based Staples, declined to comment on whether the company has been approached by potential buyers.
Revenue growth has stalled at Staples. After increasing 19 percent in the fiscal year that ended in January 2009, the pace averaged 2.7 percent in the ensuing three years as workers used fewer traditional office products, such as pens and folders.
The retailer has also been hurt by slower job creation amid the recession in Europe and high U.S. unemployment. Analysts project a 1 percent sales decline this year, the first annual drop in records dating to 1991, according to the average estimate compiled by Bloomberg.
Staples was founded in 1986 with help from Bain, and Romney became a director at the office-supplies retailer that year. In 1989, Staples went public, and Romney left its board in 2002. In the 1990s, Staples posted annual sales growth as high as 105 percent, according to data compiled by Bloomberg.
Shares of Staples jumped 3.6 percent on Sept. 13 after Fortune reported that private-equity firms including Bain were considering buying the retailer. The discussions were preliminary and an offer wouldn’t be made until late this year, Fortune said, citing people it didn’t name.
Today, Staples added 0.6 percent to $11.70.
The company’s enterprise value, or equity plus net debt, is now 4.5 times trailing 12-month Ebitda, after slipping to an all-time low of 4.15 on Aug. 28, data compiled by Bloomberg show. U.S. specialty retailers with market capitalizations larger than $500 million trade at a median multiple of 9.3.
“The company is cheaper than we’ve ever seen it before,” Adam Strauss, Chicago-based co-manager of the Appleseed Fund (APPLX) at Pekin Singer, which oversees $900 million, said in a phone interview. “It’s an incredibly good value right now.”
The Appleseed Fund, which owns Staples shares, outperformed 98 percent of rival funds in the last five years, according to data compiled by Bloomberg.
Private-equity firms may be lured by Staples’s low price and abundant cash generation, hallmarks of leveraged-buyout targets, Strauss said. Its free cash flow represents 14.8 percent of the company’s market capitalization, almost triple the median yield of 5.1 percent for the industry, the data show. Only GameStop Corp. (GME) and Express Inc. have higher yields at 16.9 percent and 15.3 percent, respectively.
While the management team at Staples is taking the right steps to turn around the business by shutting stores, restructuring is “what private equity does best,” said Matt Arnold, a St. Louis-based analyst at Edward Jones. Staples said in September that it would shut 45 locations in Europe and accelerate the closing of 15 U.S. stores as part of a plan to save $250 million annually.
“There are plenty of private-equity firms out there that are specialists in taking a retailer like this out of the public eye and making it a stronger operator,” he said in a phone interview.
Staples’s balance sheet is also “pretty decent,” Arnold said. With total debt almost equal to Ebitda, Staples has a lower leverage ratio than Office Depot Inc. (ODP) and OfficeMax Inc. (OMX), which also sell office supplies, data compiled by Bloomberg show. OfficeMax has the highest ratio among similar-sized U.S. specialty retailers at 9.2 times more debt than Ebitda.
Still, Staples isn’t mismanaged and a private-equity suitor may have a hard time finding ways to milk out more costs and run the company better, according to Bradley Thomas, a New York- based analyst at Keybanc Capital Markets Inc. Plus, management doesn’t appear willing to sell, Thomas said.
“There are just no silver bullets,” he said in a phone interview. “You’ve got an A management team here that’s really just been dealing with a difficult environment for business spending and office spending. I don’t know that you’re going to find people that can do a better job.”
Caris & Co.’s Scott Tilghman said OfficeMax may be the more viable target given its market capitalization of $668 million, less than a tenth the size of Staples. Of the three office- supplies companies, OfficeMax also is the only one projected to end the year with net cash, according to analyst estimates compiled by Bloomberg.
Julie Treon, a spokeswoman at Naperville, Illinois-based OfficeMax, didn’t return a phone call requesting comment.
Edward Jones’s Arnold says Staples is still the most appealing target because it’s the most profitable of the three. Staples earned almost 4 cents on every dollar of sales in the last 12 months, versus a penny at Office Depot and even less at OfficeMax, according to data compiled by Bloomberg.
“The strongest operator that has the strongest market share, you would think that qualitatively, on top of the quantitative aspects -- like strong cash flow generation and a high free cash flow yield -- that it would seem to be an interesting candidate,” Arnold said.
Staples’s delivery unit, which sells and delivers office products to businesses that place orders online, has turned it into the second-largest Internet retailer, trailing only Amazon.com Inc. (AMZN)
“While Staples’s retail business needs some help, the delivery business should continue to do very well,” Strauss said.
Private-equity buyers betting on Staples’s ability to turn around its operations may be willing to offer as much as $18 a share for the company, according to Olstein’s Sullivan.
A bidder can pay a premium and “still kind of steal the company,” he said in a phone interview. “The business is worth significantly higher than it is trading.”
With the U.S. unemployment rate dropping below 8 percent last month for the first time since 2009, Staples may be poised to benefit from a rebound in the economy as its corporate customers boost spending, according to David Dreman, chairman of Dreman Value Management in Jersey City, New Jersey.
Staples is “running through tough times, but small businesses are running through tough times,” Dreman, who oversees about $5 billion including Staples shares, said in a phone interview. “As the economy picks up, which I think it will do, it’s a pretty attractive stock.”
While Dreman said the company could be worth about $20 a share, bids are more likely around $16 or $17, he said. Dreman said that might not be enough to convince management to sell. The stock peaked this year at $16.84 in March.
Strauss said there’s plenty for private-equity buyers to like about Staples.
“We love companies that have good balance sheets and strong free cash flow, and private-equity companies also look for those same things,” Strauss said. While unemployment and weak business spending is a challenge, “when that eventually turns around, the earning power of this company is just enormous.”
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