Office Depot Takes Over OfficeMax to Take on Staples, Amazon (Update1)

(Includes statement announcing terms of deal, updates stock prices.)

NEW YORK ( TheStreet) -- Office Depot ( ODP) said it would merge with competitor OfficeMax ( OMX)in a press release, a move that may shore up the earnings of both companies and put them in closer running with Staples ( SPLS), the leading office supplier in the U.S.

Still, the status of the deal and its terms were in doubt for about an hour on Wednesday morning.

Office Depot removed the press release, which stated the terms of the merger at the end of a discussion of earnings. The New York Times reported the company prematurely put up the press release and was still finalizing the deal.

According to the release initially posted on Office Depot's Web site, the company will be acquiring competitor OfficeMax in an all-stock transaction that values OfficeMax at about $13.50 a share as of Tuesday's close.

OfficeMax stockholders will receive 2.69 Office Depot common shares for each OfficeMax share, the press release states. "Combining our two companies will enhance our ability to serve customers around the world, offer new opportunities for our employees, make us a more attractive partner to our vendors, and increase stockholder value," Neil Austrian, Office Depot's CEO, said in a statement.

On Tuesday, Deutsche Bank analyst Mike Baker said that while OfficeMax was the more likely acquirer given its size, an Office Depot acquisition of the company might create more value for investors.

"Although we think the more likely deal is OfficeMax buying Office Depot, if ODP were to buy OMX in an all-stock deal, it would be more accretive," Baker wrote in a client note that highlighted a possible 30-cent earnings-per-share boost for Office Depot, the healthier of the two companies financially.

A potential merger could help alleviate the operating struggles of big-box office retailers OfficeMax, Office Depot and Staples amid overexpansion and a change in the marketplace with the rise of smaller suppliers including W.B. Mason and new entrants as big as Wal-Mart ( WMT), Costco ( COST) and Amazon ( AMZN).

"An Office Depot and OfficeMax combination would spur a rationalization of excessive office products retailing real estate and render the sector more capable of managing through a challenged product cycle and competing with new entrants such as Amazon.com," Brian Nagel, an analyst with Oppenheimer, wrote in a client note evaluating reports of the deal.

The proposed merger will bring the second- and third-biggest office suppliers together, creating a company with combined revenue of $18 billion, still below the $25 billion in sales that Staples reported in 2012.

The new company's board will consist of an equal number of directors designated by Office Depot and OfficeMax, according to the statement.

Shares of Office Depot and OfficeMax spiked in trading Tuesday on the reports of advanced merger talks. In trading Wednesday, Office Depot fell nearly 6% to $4.72, while OfficeMax recently climbed over 4%. Staples, which could be a beneficiary of a deal, rose nearly 3% after a 13% gain Tuesday

The key to a potential merger and an improving outlook for all players involved centers on store closings, operating synergies and asset disposals, according to industry analysts. Meanwhile, the work of activist funds such as Starboard Value, Office Depot's largest shareholder, may have helped to put the companies in a position to try a merger.

"We believe that a merger has made sense for years and that the recent monetization of key assets provides the necessary cash flow to pay for the integration costs," Gary Balter of Credit Suisse wrote in a note to clients that cites OfficeMax, Office Depot and Staples.

"The synergies will not include higher pricing given the Internet and other pressures, but fewer store locations fighting for sales, lower distribution costs for OMX and ODP, and potential share gains by Staples during the near-term disruption of integrating two disparate systems."

Already, Office Depot is in the process of implementing a three-year plan to cut costs that the company projects will add $300 million to its earnings before interest and taxes. OfficeMax, meanwhile, announced earlier in February it would spin off a controlling stake in its Boise Cascade unit to investors, in a deal that will fetch the company $129 million while retaining a 20% stake in the company's voting stock.

"The merger is expected to deliver $400 million-$600 million in annual cost synergies by the third year following the transaction's close by leveraging both operating and G&A efficiencies, " Office Depot said in a statement.

"With Office Depot and OfficeMax having closed numerous stores in recent years, plus a potential $1 million to $2 million cash cost to close additional stores, we suspect a lot of the future closing opportunities will come as leases come up for renewal," Daniel Binder, an analyst at Jefferies, wrote in a note to clients that forecasts roughly 52% of Office Depot's stores overlap with those of OfficeMax.

Were the merged entity to close or discontinue those stores, Binder calculates Staples could gain up to 30% of those sales, or up to $60 million in revenue annually.

To help pay for the deal, Office Depot may also need to dispose of a joint venture in Mexico.

A potential risk to the deal comes from antitrust authorities including the Federal Trade Commission and Department of Justice.

In 1997, the FTC's head, William Baer, opposed a merger proposal between Office Depot and Staples, citing the prospect of anti-consumer effects such as rising prices. Baer, who now heads the DoJ's antitrust division, is likely to play a key role in evaluating any proposed merger.

Still, the struggles of OfficeMax and Office Depot in recent years may indicate a changed office-supplies marketplace that could push a deal forward.

"The competitive landscape within the office-products retail channel has dramatically changed since the FTC nixed the proposed 1997 merger between Staples and Office Depot," Jefferies' Binder wrote.

"The rise of large players in the Internet retail channel and the entrance of club and mass channel to the office product market resulted in a significant increase in price transparency and competition," he added, while noting that Wal-Mart and Amazon have undercut prices up to 10% in some instances.

Shares of Office Depot, which has been struggling to compete with larger rival Staples, plunged 67% over the past five years prior to Tuesday trading, when reports of a deal first surfaced.

-- Written by Antoine Gara in New York

For more on M&A speculation, see Morningstar's 11 M&A stock picks for 2013.

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