NEW YORK (TheStreet) - Staples (SPLS) shares surged 9% on Thursday after hedge fund and activist investor Starboard Value disclosed in a regulatory filing that it acquired a 5.1% stake in the struggling office supplies chain.
Starboard believes the shares "when purchased, were undervalued and represented an attractive investment opportunity," according to the filing.
Starboard also disclosed that it upped its stake in Office Depot (ODP) and now owns 9.9% of its outstanding shares. Wall Street is speculating whether Starboard is preparing to propose a merger between the two chains.
Shares of Office Depot were up 13.5% to $7.63 at last check, while Staples shares were up 9% to $16.17. Here's what analysts were saying.
Simeon Gutman, Morgan Stanley (Upgrade Staples to Equal Weight; $14.50 PT)
Given these developments and that they stem from an activist investor with a successful track record in this very segment, we view SPLS as now in play; hence, our upgrade to E/W and a new price target of $14.50 (up from $13). The bottom line is that downside seems protected as fundamentals now take a backseat to activist involvement and possible value creation.
The most likely angle for Starboard is a merger of SPLS and ODP, in our view. Our back of the envelope math for a combination assuming 2% pro forma synergies implies 50% accretion. But merger synergies could be even higher given how much overlap there is between the companies. The greatest risk to a merger is anti-trust, not an uncommon issue for this segment or for these two companies. Yes the landscape is different and the FTC's market definition and approach in ODP-OMX suggest a more expansive view. Ultimately, the pricing power of the two combined entities (OMX-ODP) was not seen as anti-competitive. Given online encroachment and a rapidly evolving office supply segment, SPLS/ODP should be no different. However, this would be a #1 merging with a #2, which is not the same as before (#2 and #3 merger) and thus, it may attract greater scrutiny.
Either way, we believe the possibility of a merger with the kind of upside we estimate bodes well for this stock in the near term.
Kate McShane, Citigroup (Neutral)
In the 13-D, Starboard Value simply states that SPLS shares were "undervalued and represented an attractive investment opportunity." The same wording was used in another 13-D filing for ODP. Starboard Value now has a 9.9% stake in ODP and a 5.1% stake in SPLS. We assume the meaningful stakes in both retailers hint at a possible merger in the works, following Starboard's involvement in the ODP/OMX merger. If they cannot achieve this, due most likely to FTC concerns, we think they will push to have one or both of these companies sold.
Though the sentiment and macro environment appear to be improving for office supplies, we remain on the sidelines on the uncertainty around successfully restructuring operations.
TheStreet Ratings team rates STAPLES INC as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:
"We rate STAPLES INC (SPLS) a BUY. This is driven by multiple strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its compelling growth in net income, attractive valuation levels, good cash flow from operations, largely solid financial position with reasonable debt levels by most measures and notable return on equity. We feel these strengths outweigh the fact that the company shows low profit margins."
Highlights from the analysis by TheStreet Ratings Team goes as follows:
- The net income growth from the same quarter one year ago has significantly exceeded that of the S&P 500 and the Specialty Retail industry. The net income increased by 60.3% when compared to the same quarter one year prior, rising from $135.23 million to $216.79 million.
- Net operating cash flow has increased to $604.60 million or 14.60% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth rate of -11.01%.
- SPLS's debt-to-equity ratio is very low at 0.19 and is currently below that of the industry average, implying that there has been very successful management of debt levels. Although the company had a strong debt-to-equity ratio, its quick ratio of 0.76 is somewhat weak and could be cause for future problems.
- SPLS, with its decline in revenue, underperformed when compared the industry average of 8.9%. Since the same quarter one year prior, revenues slightly dropped by 2.5%. Weakness in the company's revenue seems to not be hurting the bottom line, shown by stable earnings per share.
- You can view the full analysis from the report here: SPLS Ratings Report