Why the Office Depot Inc (ODP) Supply Industry Is so Hot: OfficeMax Inc (OMX), ACCO Brands Corporation (ACCO)

Certain industries have recently been closely watched by the Street as having great potential for consolidation. The merging of different players within an industry has been happening for different reasons. For example, potential sequestration has been responsible for consolidation in the defense industry. Similarly, the Street views saturation as the main reason for potential industry consolidation in the office supply retail industry. In this context, thr following stocks need special mention.

ACCO Brands Corporation (NYSE:ACCO) : The stock has value. Although unlocking that value is becoming increasingly difficult in the office supply segment, the risk in the near term is still to the upside and is enough to justify an Outperform rating. In November last year, MeadWestvaco Corp. (NYSE:MWV),  a global leader in packaging, announced a spin-off its Consumer & Office Products business and signed an agreement to merge the business into ACCO. ACCO has upside potential in MWV synergies, and these synergies are expected to ramp up in 2013. To the downside, ACCO Brands Corporation (NYSE:ACCO) is protected with low-teens free cash flow yield, which will likely go towards debt repayment. Despite the Outperform rating, the Street will remain watchful of one potential concern in 2013; in particular, Staples, Inc. (NASDAQ:SPLS), the largest office supply retailer is going through a turnaround, one that could put pressure on suppliers like ACCO Brands Corporation (NYSE:ACCO).

However, it is not ACCO that has been the hot stock in this space. It has been Office Depot Inc (NYSE:ODP) and OfficeMax Inc (NYSE:OMX). On an individual basis, (i.e. before the merger), the Street was increasingly bearish on both the stocks given that it believed that the demand for office equipment is expected to remain low for the near future:

1)      Most of the people now buy online what these two companies have to offer given the increasing trend of online shopping.

2)    The increased usage of ‘soft technology’ has meant lesser usage of ink and paper, which means that the decline in demand for products offered by these companies might be secular.

However, the bullish aspect is that both these companies have been working on reducing overhead and cost of goods sold by focusing on private label goods. However, it remains a doubt if these additions could help to offset the shrinking revenue base. Another positive point is that the outlook in Europe doesn’t seem as bad as it was a year ago.

Merger

It was obvious why I mentioned these companies together. Both announced their merger on Feb. 20. It was interesting to witness as rumors led to a more than 20% rise in both the stocks. However, most of these gains were shed away after the merger was announced, and investors were left in confusion after the conference call announcing this merger. The following things were missing in the call:

1) What is the new company called?

2) Who is running the new company?

3) Where will the yet-to-be-named company run its operations?

4) Can a board split 50-50 between OfficeMax Inc (NYSE:OMX) and Office Depot Inc (NYSE:ODP) pedigree get things done?

Still, the Street has given a positive outlook for the merger.