Officemax: A Distant Third

With sales and profits way under par, investors are itchy

Just a year ago, OfficeMax Inc. was the scrappy up-and-comer in a tightly competitive discount office-supply market. Founded 10 years ago with $3 million in venture capital from local doctors and lawyers, the suburban Cleveland company had grown exponentially into a $3.7 billion business. By mid-1997, OfficeMax was gearing up to compete as No. 2 with the looming merger of its larger rivals, Staples Inc. and Office Depot Inc.

When that merger fell apart in the wake of a Federal Trade Commission suit, it seemed OfficeMax had dodged a bullet. But try telling that to investors. They've grown impatient waiting for management to figure out how to crank up profits at its rapidly expanding roster of new stores--150 of them last year, 120 more in 1998. Since the beginning of this year, Wall Street has knocked OfficeMax's stock price down 24% while driving Staples' up 95% and Office Depot's up 35%.

THINNER MARGINS. Why the gloom? This is, after all, a company that is expected to see both sales and operating income grow by 17% this year, to $4.4 billion and $170.8 million, says BT Alex. Brown Inc. analyst Christopher E. Vroom. While that may be good in many industries, it still lags considerably behind the performance of rivals. Staples' sales are expected to grow by 38%, to $7.2 billion, and operating profits by 49%, to $404.8 million, Vroom says. Office Depot's sales should jump 34%, to $9 billion, and profits 71%, to $518 million. OfficeMax "is definitely a third-tier name," says Shayne M. John, an analyst for NCM Capital Management Group Inc. in Durham, N.C., which holds about 143,000 shares. "The only reason we own it is because it is cheap."

OfficeMax executives declined to be interviewed by BUSINESS WEEK. But a closer look reveals that while OfficeMax has maintained a frenetic pace of new-store openings, it has not squeezed nearly as much out of each store as have the other chains. Sales per square foot are $220, vs. $347 for Office Depot and $471 for Staples. One reason is that on average, OfficeMax stores are younger, and younger stores are less productive. But the older stores aren't doing any better: Same-store sales grew a puny 2% in the third period, vs. 5% for Office Depot and 12% for Staples.

Indeed, immaturity explains only part of the problem. OfficeMax also is struggling with less efficient supply and inventory systems that limit its ability to rapidly cut costs or shift its product mix. That became painfully clear over the past year, as sub-$1,000 personal computers took the market by storm. OfficeMax drew a bigger portion of revenues from computer sales--13% a year ago, vs. 7% at Staples and 9% at Office Depot, says Donald T. Spindell, an analyst at A.G. Edwards. So the new PCs' thinner margins hit it harder.

But experts say the real difference was that the other two office-supply chains were quicker to adjust as the market shifted to the cheaper computers. To keep profits up, Staples pushed sales of printers and copiers. Office Depot cut the number of items it had to track--paring its desktop line, for instance, by dropping Packard Bell NEC and IBM products and selling primarily Hewlett-Packard and Compaq Computer gear. OfficeMax, meanwhile, was caught flat-footed. Only recently has it, too, chopped the number of its PC suppliers.

Investors and analysts say the PC snafu also points up a lack of depth in OfficeMax' executive ranks. Control is still concentrated to a large degree in the hands of Michael Feuer, the intense, charismatic chairman, CEO, and co-founder. That is a vestige of the chain's entrepreneurial roots. In 1988, Feuer, then an exec at a fabric-store chain, and a partner came up with the idea to start an office-supply chain offering discounts of up to 70% to small and home businesses. He became famous for his microscopic attention to detail. After a 12-hour day at the office, he used to slip into a pair of blue jeans and go to a store and observe, incognito. If a customer didn't buy anything, Feuer would follow him or heR to the parking lot and demand to know what the store was doing wrong.

"TOO BIG." Within five years, Feuer had built OfficeMax up to 300 stores and $1 billion in sales. The frantic growth continued after Kmart Corp. bought the company in 1991 and spun it off three years later with more than $1 billion in cash. But now Feuer has 793 outlets, and management hasn't kept pace. "This company has gotten too big" to operate under the old structure, says NCM Capital Management's John. "The management strength is very lackluster."

Scrambling, OfficeMax is finally taking some steps in the right direction. It has hired 20 new senior managers in the past two years, including Thomas M. Piteo, vice-president for store planning, brought in from Best Buy Co. OfficeMax is moving to drum up new revenue sources by remodeling stores to offer more document-copying and furniture sales. A prototype smaller store, named "PDQ," is being developed to arrange goods for quick shopping. New software should better manage inventory starting early next year.

Those are hopeful signs, and investors have rewarded the company by driving the stock up from 7 in mid-October to almost 11 today. But the shares also got a boost from takeover talk, after OfficeMax said on Sept. 14 that it had had discussions with an unnamed party. The talks ended, OfficeMax said, because it was unclear "whether the proposed transaction could be consummated." Some analysts and investors still hold out hope that a buyer will emerge. "They are likely to remain in the No. 3 spot unless someone takes them over," says Vroom of BT Alex. Brown. For as fast as it grows, OfficeMax only seems to fall further behind in the race.