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By Jeremy Glaser and Liang Feng | 02-19-2013 03:00 PM

OfficeMax-Office Depot Merger No Panacea

Although the two office-supplies companies could realize meaningful cost synergies, the combined firm would still face enormous competitive pressures, says Morningstar's Liang Feng.

Editor's note: Since the taping of this video, OfficeMax and Office Depot officially announced a definitive merger agreement.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. News reports were out this week that OfficeMax and Office Depot were considering a merger. I'm here with Liang Feng, an analyst at Morningstar, to see if this merger would make sense and what it could mean for the industry.

Liang, thanks for joining me today.

Liang Feng: Thanks for having me today.

Glaser: So, let's start just a little bit about why a merger like this would make sense. Is building a lot of scale in this space something that could be beneficial for these two firms?

Feng: So both OfficeMax and Office Depot have notably underperformed their larger industry peer Staples over the past few years. Staples has been earning operating margins around 6%-7% compared with OfficeMax and Office Depot, which are reporting operating margins of less than 2%. What we've seen happen is that these two companies have relatively high cost structures and were less prepared to deal with the drop in office-supplies spending after the recession, and they're just struggling to earn any economic profits at the time.

So a potential merger, where they could leverage some of their corporate expenses, advertising expenses, and salesforce expenses, could potentially bring about some synergies that could allow them to increase investments in their salesforces and other productivity initiatives.

Glaser: What would the combined company look like? Would it rival Staples for profitability?

Feng: This is one of the interesting points. OfficeMax and Office Depot would have about 2,000 stores, and this compares with about 1,900 stores for Staples, which includes the U.S. and Canada, but excludes other international locations. Even though [the combined company] would directly have a larger store base, they are also generating about 70% as much revenue as Staples, and that just speaks to how much more productive Staples is in both the contract and the retail division. Retail, we estimate that Staples' sales per square foot is about 25%-30% higher than both OfficeMax and Office Depot. And even if these companies can realize substantial cost synergies, these companies might not be able to generate the same returns as Staples is currently doing.

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