Summary
- ODP is cheap, with multiple upcoming catalysts to unlock the value.
- Strong balance sheet and FCF generation.
- Fatigued investor base is running out of patience. Management is incentivized to create value and has several tools for it.
- One of the most interesting special situation set-ups at the moment.
The ODP Corporation ( ODP ) provides office supply/business products through retail and B2B channels. At the moment the company offers one of the most intriguing and under-followed special situation set-ups in the market. ODP is super cheap with the strongest balance sheet in years and is currently on the brink of several major catalysts that are likely to propel the valuation upwards. More specifically, ODP is likely to promptly launch a large tender offer (around 15%-20% outstanding shares) at premium prices. Following that, there seems to be an imminent separation of its retail division either through sale or spin-off. Finally, the company is currently developing a new B2B marketplace platform called Varis, which is expected to launch this year. Beta stage launch has been successful so far and management believes in the significant further upside potential of Varis. Successful launch of the marketplace could be yet another catalyst for ODP.
All of these events should serve as strong catalysts to bring back investors' confidence and re-rate the stock. I expect the timeline here to be quite short, which should result in a very material IRR.
ODP Is Cheap
First of all, let's establish the fact that the company is cheap.
ODP trades at just 3.3x 2022E adj. EBITDA and about 8x 2022E adj. FCF (which is somewhat depressed).
Author's calculations
In comparison, its closest competitor Staples was taken private several years ago at 5.3x EBITDA, implying a $53 share price (48% upside) for ODP at the same multiple. A more conservative SoTP approach indicates a price target of c. $46/share - 29% upside. Please note that the company was trading at this level back in May and this price target is likely not ambitious enough.
The valuation table is provided below.
All somewhat comparable peers (although much larger and with higher margins) - GIC, WCC, MSM, GWW, FAST are also trading at much higher EBITDA multiples of 9.2x-19.4x.
Staples' sale proxy Seeking Alpha Charting
Undersubscribed Low-Ball Tender Offer
This valuation dissonance hasn't gone unnoticed as for the last two years management has been aggressively repurchasing shares - $307m last year at an average price of $43.35/share. Moreover, just recently they authorized another $600m buyback program and immediately put half of it to use launching a large $300m tender offer for 17%-20% of outstanding shares at a $31.5-$36/share price range. Following the announcement, the ODP share price immediately shot up above the tender range and even reached $38+/share on the expiration date (August 12). Unsurprisingly, the tender was materially undersubscribed - only 14k shares were tendered or about $0.5m of value (vs $300m total tender size).
By not participating in the tender shareholders have sent a very clear signal to management - they consider ODP to be undervalued to the point that any opportunistic/lowball offers to buy back material amounts of shares will not be tolerated. Interestingly, the largest active shareholder HG Vora (fund focused on event-driven situations, owns 10% of ODP) said it wasn't interested in tendering right in the initial announcement. It's worth noting that HG Vora already sits on 50% gains since acquiring the stake in 2020.
$599m buyback authorization is still on the table and ODP currently has the strongest balance sheet in years with $417m cash + $953m undrawn lending facility and only $194m in debt (reduced from $1bn in 2017). It also generates strong FCF - $271m in 2021, $216m in 2019, while $200-$225m of adj. FCF (adjusted for reorganization expenses) is expected in 2022.
Interest From Staples And Separation Of Retail Division
This failed tender has put the management in a bit difficult situation.
For the last 1.5 years, ODP has been rebuffing multiple takeover interests, including an intention to launch a hostile tender, from its peer Staples, which is currently owned by Sycamore.
In May '21, ODP decided that instead of selling the company, it would rather pursue a tax-free spin-off of its retail business. This seemed like a highly positive move that would finally separate ODP's much higher quality B2B operations from the melting ice-cube retail business (albeit it still generates loads of cash as it slowly melts down). The spin-off was planned to be completed in H1 2022.
Then in June '21, shortly after the planned spin-off announcement, Staples amended their offer to buy only the retail business and leave the B2B operations to ODP. The offer for the retail division was at $1bn or around $18 per ODP share.
After several months of silence, in January '22 ODP finally released an announcement that aside from Staples' proposal it had received another offer for the retail segment from a certain interested party. Management decided to delay the spin-off to explore the retail segment sale. However, it was said that:
If the consumer business is not sold, then ODP's Board of Directors will reevaluate the advisability and timing of the public company separation.
Unfortunately, the timing was unfortunate as shortly after that the Ukraine war started and the markets spiraled down. Hence, in June '21, management said that the sale/spin-off will be put on hold until the market environment improves.
Worth noting that Staples/ODP merger saga/thesis has been around for many years now - Staples tried to acquire ODP two more times before - in 1997 and in 2015 but both times got blocked by regulators (mostly due to the overlap in B2B). However, the market environment has changed since then and in the latest filings, Staples said that after a review process it was confident that the acquisition of the retail business would get easily approved.
Besides that, the sale/spin-off of the retail segment might be imminent - the complex internal separation of B2B/retail operations has already been completed and management is ready to proceed with either transaction as soon as the market conditions improve. From the June press release:
However, the completion of our internal reorganization will make such a potential separation substantially simpler should the Company determine to resume the separation process following a change of market conditions in the future.
Strong Management's Track Record
ODP investors are clearly fatigued - both by the extremely prolonged merger saga, lagging reorganization process which got impacted by COVID (more on this below), and now delay of the spin-off. Shareholders are thirsty for strong value creation initiatives.
The good thing is that following certain screw-ups several years ago, the renewed ODP management now seems strong, competent, and focused on shareholder value creation. During the last few years, it has done many positive steps - refocused on growing the B2B business, significantly reduced retail stores and SG&A, significantly reduced debt, and cleaned up the corporate structure by finally getting rid of the failed IT segment + preparing separation of the retail segment. It also started returning capital in large amounts and did some other smaller value-creating initiatives, e.g., recent sale-leaseback of the corporate HQ .
Management should be incentivized to appease shareholders and continue its recent track record, so another large tender offer at a premium to current prices seems like a natural move here.
Varis
The most interesting new initiative of ODP is B2B marketplace Varis. It is still in the beta stage and is expected to fully launch this year. So far the company seems to be receiving very positive feedback from the beta launch. From Q1 call:
At Varis, in Q1, we initiated a private preview launch on the Microsoft platform and continue to expand our key supplier network. Most recently, we were the keynote speaker at a major Microsoft Business Central Integrators Conference where Varis was prominently featured as the key procurement technology on Microsoft Dynamics 365 platform.
From Q2 call:
We're receiving good feedback from the private preview launch on the Microsoft Dynamics 365 Business Central platform, and we're incorporating feedback we are receiving. We're continuing to attract new customers to the platform, both buyers and suppliers, and we are super excited by having Prentis and team give an update at our upcoming Investor Day.
Varis will aim to be a competitor for Amazon Business. It is a very big goal, to say the least, however, ODP has pretty much hired the whole Amazon Business team to develop the platform, which adds considerable confidence in the potential success:
So far, even at beta stage Varis, generates $5m annual revenues and management believes it has significant further upside.
I haven't included Varis in my SoTP calculations above, but this is a nice bonus and potential extra catalyst to the overall thesis.
Business And Reorganization
The company started as an office products retailer in 1986. Currently, it operates two divisions:
- Retail - around 1020 brick-and-mortar stores under Office Depot and OfficeMax brands. Offers office supply products as well as adjacency products such as cleaning and breakroom supplies, personal protective equipment, technology, and furniture. The company has started to focus on adjacency products only in 2017, and since then, it has grown.
- Business Solutions Division ((BSD)) - similar products to retail, but focused on small, medium-sized, and enterprise businesses as well as schools and local government agencies. Operates through dedicated sales force, catalogs, telesales, and internet websites. Two main sales channels are a contract and direct (through eCommerce platform, phone, etc.). BSD segment also includes adjacency products like workspaces, technology, cleaning, and breakroom as well as copy and print products. The company has started focusing on it only in 2017 and since then this sub-division has grown to 44% of total BSD sales.
ODP operates a vast network of distribution centers and cross-dock facilities in the NA - 67 in total.
Overall the company has two main advantages:
- Delivery time . ODP's supply chain can provide next-day delivery for approximately 98.5% of the US territory.
- Convenience/single supplier . Unlike other online retailers, ODP can deliver the required quantity of office supplies/related products from a single supplier.
Seasonally, Q2 and Q4 quarters are the weakest, while Q3 (back to school) and Q1 (back to business) are the strongest.
In 2017 the company randomly acquired IT business CompuCom, which turned out to be a disaster and polluted the company's image for several years, until it finally got sold in December '21 for $305m.
During 2018-2020 ODP overhauled almost the entire senior management team - 7 out of 8 officers, except the CEO. The new management seems competent and has a solid background, e.g. senior positions in Amazon, Lenovo, etc. In 2020 the company started a reorganization plan aiming to refocus on B2B business, reduce retail footprint by closing a significant amount of stores until 2023, cut expenses and sell CompuCom business. IT segment has been sold already, while since 2020 the number of stores went down from 1307 to 1020. However, the growth and focus on B2B business have been impacted by COVID, temporarily reduced demand, supply chain issues, and, more recently, inflationary pressures. However, management remains confident that the headwinds are temporary and ODP is positioned to withstand any short-term issues.
Seemingly as part of this reorganization management now also wants to separate the retail segment, which is a big positive. As an intermittent step to that, it has recently completed internal restructuration of the operating segments to clearly separate the retail and B2B operations. B2B business was split into three parts and following Q3'22 ODP will report the financials under this new structure (from the press release ):
- Office Depot - a leading provider of retail consumer and small business products and services distributed via approximately 1,000 Office Depot and OfficeMax retail locations and an award-winning eCommerce presence (officedepot.com).
- ODP Business Solutions - ODP's leading B2B solutions provider serving small, medium and enterprise level companies (odpbusiness.com). This includes the contract sales channel of ODP's prior Office Depot Business Solutions Division; Grand & Toy, operating one of the biggest distribution networks serving customers in Canada coast-to-coast via its direct sales force and best-in-class e-commerce platform (grandandtoy.com); and the Company's Federation Entities, which comprise more than a dozen regional office supply distribution businesses acquired by ODP as part of its transformation to expand its reach and distribution network into geographic areas that were previously underserved, and which continue to operate under their own brand names.
- Veyer - a world-class supply chain, distribution, procurement and global sourcing operation (veyerlogistics.com). It currently serves both BSD and retail segments of ODP. Veyer is expected to grow into a sourcing/distribution platform for other third-party customers in the future in addition to Office Depot and ODP Business Solutions that it currently serves.
- Varis - ODP's B2B digital platform technology business focused on transforming digital commerce between buying organizations and suppliers (govaris.com).
Management believes this new segment structure will increase the visibility into the businesses and might even also act as a smaller catalyst before the upcoming retail business sale/spin-off.
Financials
Historical financials are provided in the table below.
H1 2022 FCF is impacted by unusually large working capital investments due to the anticipated strong back-to-school season in the third quarter.
Segment performance:
Financials presented under 'Other' segment include Varis (an upcoming B2B digital platform business) as well as certain small operations from the legacy international segment.
BSD segment recovery has already started with the H1'22 revenue +8% YoY and division operating income at +63% YoY. The retail segment's first half of the year results were weaker with revenue dropping 10% YoY, but a large part of that was caused by retail store closures.
The company expects a stronger rebound in H2'22 which will partly be offset by current macro headwinds.
ODP's SG&A as a percentage of sales:
Net cash:
The Activist
HG Vora is an investment advisory firm with ~$11bn in assets under management. The focus has been on the real estate and entertainment sectors. That said, the shareholder activism track record seems solid:
- The activist accumulated a 9% stake in LaSalle Hotel Properties in mid-2018. The company was bought by Pebblebrook Hotel Trust just a few months later, in Nov'18. The merger also involved LaSalle disposing of several of its hotels. The transaction consideration was at a 48% premium to the unaffected share price.
- In 2017, HG Vora acquired a 5% stake in Quality Care Properties. In July '18, the company was acquired by Welltower for $20.75 in cash - a ~60% premium to pre-announcement prices.
- 9.5% of outstanding shares bought in Pinnacle Entertainment in 2016. The company was acquired by Penn National in early 2018 at a 36% premium to the unaffected share price.
HG Vora currently holds one board seat (out of nine) in the company.
Risks
Given the cheap valuation, strong balance sheet, strong FCF generation and recent track record of the management, the main risks here are mostly macro-related:
- Market environment might deteriorate, causing delay in retail segment sale/spin-off.
- The company could suddenly decide to use the cash elsewhere (e.g., other M&A opportunities). However, given ODP's history with CompuCom and the recent focus on shareholder value creation, this seems highly unlikely.
- Return to office will be slower than expected. Seems unlikely given that the number of persons working from home has already dropped significantly over the last year.
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The ODP Corporation: A Bargain With Multiple Catalysts