Will This Be the Next Retailer To Go Belly Up?

Office Depot
Office Depot

It happened to Borders. It happened to Circuit City. Don't be surprised if it happens to one of the three major office supply stores before long.

Market leader Staples (SPLS) announced last month that it would be closing down stores and unloading its European printing business. Wall Street analysts expect that Staples and its peers -- Office Depot (ODP) and OfficeMax (OMX) – will post declines in sales this fiscal year.

Wait a minute. Isn't the economy supposed to be improving? Shouldn't Corporate America be buzzing with orders for new printer cartridges, task chairs, and register ribbons?

That's just not happening.

Here Comes the Shakeout

In merrier times, we would expect some consolidation in this retail space. Players would combine, cashing in on merger synergies.

However, it's easier and cheaper these days to just sit back and watch the distant silver medalists of dying retail industries simply implode. That's what Wall Street is expecting.

Analysts don't see 2013 as turning out any better. They expect all three companies to post flat sales growth next year. It's even worse for Office Depot. Wall Street's targeting an annual loss for the company in 2013.

Office Depot Could Use a Little More Toner

Earlier this month, Maricopa County in California moved to claim $5.2 million in refunds from Office Depot. Maricopa had teamed up with other counties in California to sign a deal with Office Depot that reportedly promised the lowest prices available as a result of the group's bulk purchases.

But an internal audit by the county – checking up on 192,000 items -- revealed that San Francisco paid a lot less. About 32% less than Maricopa County.

Office Depot disputes the allegations, but the damage has been done. Ever since Florida reached a $4.5 million settlement with Office Depot for improper billing two years ago, the superstore chain has had to battle the stigma of overcharging.

In other words, even if Corporate America and the public sector were humming along, Office Depot would have a hard time drumming up business given its reputation.

An Activist Arrives

Shares of Office Depot rallied last month when Starboard Value LP took a 13.3% stake in the struggling retailer. The activist investor argued that there was a substantial opportunity in the chain, but changes were necessary.

Starboard Value LP advocated downsizing to smaller stores, slashing advertising expenses, and shifting to higher-margin services.

It's a great plan on paper, but don't you think that Office Depot would be doing any or all of these things if it could?

There are problems in this retailing niche. Companies just don't have to buy as much paper and printer cartridges as they used to in this age of e-mail and cloud storage. PC sales have stalled, and cloud-based enterprise solutions make it less necessary to upgrade hardware or operating systems.

The ho-hum economy isn't helping, but it's not the only problem. There's a real problem here with the office supplies superstore model itself.

Sponsored Links

For a while it seemed as if Office Depot and its peers wouldn't suffer from the "showrooming" trend that has seen brick-and-mortar chains lose out to nimbler and cheaper online retailers. Amazon.com (AMZN) doesn't have the localized fleet to provide free next-day delivery the way that Staples, Office Depot, and OfficeMax do.

However, Amazon and other online retailers with bare overhead and great prices are leaving a dent. There's a reason why the restructuring that Staples announced last month included an investment in boosting its mobile and online capabilities. Amazon is now a legitimate competitor. If Office Depot had a hard time keeping up with Staples before, just imagine how the future will be when it also has to butt heads with the cheaper Amazon?

Printing Money Isn't Easy Even When You Sell Printers

Analysts see Office Depot barely breaking even when it reports its latest quarterly results in three weeks. Don't bet on that happening. Office Depot posted a much wider quarterly deficit than Wall Street was forecasting three months ago, and there's little evidence that things are getting any better.

If there's a shakeout here it will be the weaker debt-saddled players closing down, or perhaps market leader Staples being acquired.

Investors can't make the same mistake that Maricopa County did in viewing today's low share price as a buying opportunity. If the grim scenario plays out, buyers of Office Depot's stock will also be overpaying.


Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Motley Fool owns shares of Amazon.com and Staples. Motley Fool newsletter services have recommended buying shares of Amazon.com and Staples.

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