Staples Launches Public Offer for Corporate Express

Update: Today Corporate Express announced the intention to enter into a merger with Lyreco. More updated comments can be found here.

Yesterday, Staples (SPLS) launched an offer for the acquisition of Corporate Express (CXP) for EUR 8.00 per ordinary share. Shareholders can submit their shares until June 27th. Staples also made an offer for Corporate Express’ preference shares and subordinated convertible bonds due 2010. The most important condition for making the offer unconditional is acceptance of at least 75% of ordinary shares.

This acquisition process is at a peculiar stage, with both parties not negotiating with each other and accusing the other party of unwillingness to do so. For shareholders this is a very unfortunate situation, with a real possibility of a failed offer, and therefore a missed opportunity to create significant shareholder value for shareholders of both companies. However, based on the current offer, we can try to evaluate the current situation from the perspective of both companies and their shareholders.

Corporate Express shareholders have a choice to accept the offer or to allow management to continue with the execution of the strategic plan 2008-2010. With the presentation of the results for the first quarter of 2008, we were given some insight in the ambitions that Corporate Express has set for itself.

For the full year 2008, Corporate Express gave guidance for revenue between EUR 5.7-5.8 billion and an EBITDA margin of 5.6%-6.0%. This means an EBITDA amount of between EUR 319-348 million. Depreciation and amortization are expected to be EUR 100 million, and interest expenses EUR 85 million. If we add fair value changes to this, net result before taxes would be around EUR 122-151 million. With a 20% tax rate, net result would be between EUR 98-121 million or EUR 0.54-0.66 per share. It also means that Corporate Express will have to earn an average net result of EUR 30 million per quarter for the remainder of the year. If we compare this with the net result of EUR 8.5 million for this quarter, this seems quite a task.

The strategic plan calls for a 6% average annual organic growth rate for the period 2008-2010 and an EBITDA margin of at least 7% by 2010. Based on the current progress and the stated ambitions, Corporate Express believes revenue of EUR 6.8 billion is achievable for 2011 with an EBITDA of EUR 475 million. With depreciation and amortization increasing in line with sales, and finance costs assumed to stay constant, this would imply a result before taxes of around EUR 275 million. With an effective tax rate of 25%, this should lead to a net result of EUR 206 million, or EUR 1.13 per share for the year 2011. If market conditions are favorable for stocks by the time such results are announced in 2012, this could well mean a value of around EUR 16.00 per share. Declining the offer and allowing the company to achieve its plans, would potentially create value twice the value of the offer of EUR 8.00 made by Staples, after a period of 4 years. This would imply an annualized return of almost 19%, which is by all means attractive.

Success of the strategy is however not at all guaranteed, and there is plenty of risk in the execution of the strategy. Ron Sargent, the CEO of Staples, makes the risk of failure of the strategy one of the key reasons why Corporate Express shareholders should accept his offer, when he states in the offer memorandum:

"I firmly believe that our offer of EUR 8.00 per share delivers superior value to Corporate Express shareholders, and does so without the risks found in Corporate Express’ long-term business plan. Rather than the uncertainty of potential value for your investment, our offer provides shareholders with the certainty of realizing immediate and premium value for your investment."

There are indeed risks that may prevent Corporate Express from reaching its targets. If the company only reaches 80% of its ambitions by 2011, which would still be a reasonable accomplishment, net income per share would be somewhere around EUR 0.90, and with a likely lower P/E ratio, the stock price could be around EUR 11.00. Compared to the offer of EUR 8.00, this would only give an annualized return of 8%, and makes the offer from Staples much more attractive.

It is possible that investors will perceive the risks associated with the stand alone strategy of Corporate Express quite high. This may cause the share price to drop significantly following a potential breakdown of the acquisition.

From the perspective of Staples the picture looks completely different. The company sees a target that can add significant value. Besides the strategic fit, they undoubtedly see potential for cost savings and further synergies. If the added value from the acquisition is estimated to be a modest EUR 100 million a year, and the estimated low end net result for Corporate Express in 2008 is EUR 122 million, Staples would add 222 million to its annual results. In US-dollars this is about $350 million. Since the purchase of Corporate Express ordinary shares would be financed with debt, there could be an additional interest cost of around $140 million, or around $100 million after tax. This would mean an additional net annual result from the acquisition of $250 million, which is almost 25% of Staples’ net result for 2007.

With a P/E ratio currently at 17, it is very likely the market has already priced some of the advantages of the acquisition into the share price. Because of the acquisition of Corporate Express, there will be a significant level of debt on the balance sheet of Staples, and this may also have some effect on the P/E ratio. However, one could argue that the post acquisition share price of Staples could be about $5.00 per share higher than the share price would be without the acquisition, based on reasonable and achievable synergy targets that do not seem to be too stretched.

At this moment we find ourselves in a situation where the companies do not engage in serious talks and the offer is considered hostile by Corporate Express. They state that the offer does not do justice to the real value of the company, and undoubtedly they believe a higher share of the synergy effects should be priced into the offer. Staples believes they are paying a considerable premium over the share price of Corporate Express prior to the date the offer was made, and they will surely feel it is them who are creating the synergy effects and should receive full value for them. A recurring net synergy effect of EUR 100 million could have a market value for Staples of up to EUR 1.5 billion, which would be around EUR 8.00 per Corporate Express share. Assuming this is a reasonable estimate, Staples is offering EUR 2.50 of this value to Corporate Express considering an offer of EUR 8.00 per share and a share price of EUR 5.50 before the offer was made.

Both companies are now in a situation where they need to make this offer succeed. For the management of Corporate Express, the pressure would be tremendous for the coming years to make good on the promises of the strategic plan, while Staples shareholders are already starting to anticipate the benefits of the acquisition. If the deal collapses, because Corporate Express shareholders refuse the current offer, both parties lose. It is also understandable that Staples does not want to change its course of action, without a willing negotiation partner. A negotiated and agreed final offer would probably identify many tangible synergy effects and would allow an integration plan to be implemented swiftly. I have no doubt that such a negotiated final offer could be higher than the current offer.

Unfortunately this requires two parties who are willing to engage. The signals we are getting from both parties are not encouraging, and put a lot more uncertainty on the final outcome of this acquisition attempt. In today’s earnings conference call, Ron Sargent expressed his frustration with the unwillingness of Corporate Express to negotiate and allow due diligence. He also stated that if Corporate Express shareholders reject the current offer, Staples would move on. I am willing to believe that this is almost true, since there is still the opportunity to raise the offer one more time with the extension of the acceptance period.

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Corporate Express Performance Q1-2008

This morning CE published the results for the first quarter of 2008, which can be found here on their website. At noon there was also a presentation of the results. The video, audio and presentation slides can be found here. I am disappointed with the net result of just €0.05 per share. I feel sorry for Mr. Ventress, who tried so hard in his presentation to show that his strategic plan is working and that results are forthcoming. In my opinion it was just not convincing enough, which makes an acquisition by Staples the more appealing choice.

But before I say more about that, let's have a look at the results. The most important part of the business is Office Products and we will take a look at Q1-2008, Q1-2007 and Q4-2008:



I understand that from an operational standpoint CE is not unhappy with the results for Office Products. There was organic growth in North America, and in Australia. Unfortunately the problem with these markets is that North America is confronted with a sharply declined exchange rate for the US-dollar, and Australia seems to operate in a deflationary environment. So a shareholder, calculating in Euro's, saw a decline in revenue both compared to Q1-2007 and Q4-2008. A shareholder would also notice a declining gross margin, which means that operating results in Euro's are down. CE makes a point of reporting operating results including and excluding special items. Since however special items seem to be recurring, although the subject item is always different, the existence of special items doesn't seem so special, and are part of normal operations. An operating result of 3.8% as a percentage of sales is lower than last year and only marginally higher than Q4-2008.



Sales for Printing Systems are down. CE is pleased with the performance, since the decline should be largely attributable to orders being postponed in anticipation of DRUPA, which is the largest printing equipment exhibition in the world, that is held once every four years, and will be held in Q2 this year. A shareholder unfortunately sees declining sales and a declining gross contribution margin.



Corporate costs are in line with guidance already given by CE. There was again a significant benefit from pension assets. Although this is part of operational results, and we have been given guidance by CE for this, I would not dare to discount an uncertain benefit such as this beyond this year.

Interest costs were substantially lower than Q1-2007, which is mainly related to the sale of ASAP, which allowed a significant reduction of debt. Unfortunately there was a large negative non-cash fair value change of €12.2 million. profit tax expenses were €3.9 million, and CE expects the effective tax rate to be 20% for this year

After looking at the separate elements of the results the total picture looks like this:



This net result of €8.5 million translates in a net result per share of €0.05. It is clear that CE is focusing on organic sales, special items and fair value changes to demonstrate that results are quite encouraging, but in the end this net result is the number that is relevant for shareholders.

When I was watching and listening to the presentation I could not help but think that the main point of the exercise was to demonstrate that shareholders should not accept the offer from Staples, at least not with the current value. Quite an effort was made by CE management to show that the strategic plan is well underpinned, and can lead to the desired targets of 6% organic sales growth for the period 2006-2010 and EBITDA above 7% by 2010. They also admitted however to the US market experiencing an unhealthy market decline, and the strategy needing growing economies to be successful. Without a strong increase of the US-dollar and price increases in Australia the task seems very difficult to me.

The presentation also showed that a lot of effort still has to be made, and many things have to go right, before the mission will be accomplished. I don't think that the market is prepared to value the company on the basis of a promise of improvement, but will value the company based on actual delivery, and unfortunately delivery in Q1-2008 does not justify yet a high value based on a stand alone strategy.

For the full year 2008, CE gave guidance for revenue between €5.7-5.8 billion and an EBITDA margin of 5.6%-6.0%. This means an EBITDA amount of between €319-348 million. Depreciation and Amortization are expected to be €100 million, and interest expenses €85 million. If we add the fair value changes to this, net result before taxes would be around €122-151 million. If we take a 20% tax rate, net result would be between €98-121 million or €0.54-0.66 per share. It also means that CE will have to earn an average net result of €30 million per quarter for the remainder of the year. If we compare this with the net result of €8.5 million for this quarter that seems quite a task.

I am afraid after all this my conclusion has not changed much. I still believe shareholders should prefer an acquisition by Staples for a price above the current offer. I believe there are many risks to the strategic plan of CE, and we need much more convincing by solid quarterly results that the strategy is working. Unfortunately this takes time, and leaves room for disappointment. If I would accept the lower limit of the net result of €0.54 per share as achievable, a risk free offer now of 16 times this profit sounds quite appealing.

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