Shares of Office Depot (ODP) have almost doubled since the beginning of September when the hedge fund Starboard Value started accumulating shares. The hedge fund has bought 42.1 million shares between $2.16 and $2.45 per share over the last few months and controls 14.8% of voting rights. The group is now the largest single shareholder with twice as many shares as any other owner.
A recent decision by the directors of Office Depot suggest that Starboard may not hold on to its shares for too much longer, leading to significant selling pressure. The board passed a "poison pill" amendment that would distribute one share of preferred stock for each outstanding share of common stock in the event that a person or group acquires 15% or more of the common shares. The move is a common takeover defense used by company's to dilute outstanding ownership and prevent an acquirer from gaining too much control.
Starboard immediately shot back with a letter denouncing the rights plan as a scheme to entrench the current board at shareholders' expense.
Starboard's website describes the company as an investment advisor that, "invests in deeply undervalued small cap companies and actively engages with management teams and boards of directors to identify and execute on opportunities to unlock value." While the fund's management has not released any sale plans, the move by the Office Depot board suggests that it is not interested in working with outside groups. It is doubtful that Starboard would find much value in a company in which it could not use its turnaround experience.
A tough time for big box retailers
Revenue at Office Depot has fallen every year since 2007 to $11.49 billion in fiscal 2011, for a 7.3% annualized loss. The shares trade for a price-to-sales ratio of 0.8 times on a trailing basis and trade for more than book value at 1.29 times. Most return and profitability metrics are negative since the company has no earnings, though its gross margin of 30.5% is average for the industry. An increase in cash flow in the last quarter was almost entirely due to an increase in depreciation expense and unusual items.
The shares have a beta of 2.92, meaning volatility is much higher than the general market. Short interest in the company is high at 15.9%, especially considering 73% of shares outstanding are held by large block owners.
To be fair, revenue has also fallen at rival OfficeMax (OMX) since 2007, albeit at a slower 5.9% annual pace. One key difference is that OfficeMax has returned to profitability over the last two years with trailing adjusted earnings of $0.79 per share. The shares trade for 12.1 times trailing earnings, just below the industry average of 14.7 times. Price to sales for the shares is extremely low at 0.12 times on a trailing basis, and the company trades for less that book value at .81 times. While the company's gross margin of 25.6% is lower than that of Office Depot, its operating margin of 10.7% is above 89% of peers in the group.
Shares of OfficeMax are also significantly more volatile than the market with a beta of 1.98, or about twice as volatile as the market. Short interest in the company is also high at 14.7% with 97% of float owned by institutional investors.
Shares jumped recently to their highest point in 18 months on news of the Boise Cascade LLC IPO filing. OfficeMax owns a 20.4% stake in the building products distributor and could see upwards of $130 million from the offering.
Besides recent weakness in the big-box retailer space, the possibility of a fiscal cliff could have businesses postponing spending on office equipment. OfficeMax looks more financially healthy and able to withstand further weakness in the space while the recent decision by the board of Office Depot limits opportunities for the company and shareholders.
Watch for higher volume on downward pressure
Starboard will not publicly disclose plans to sell their shares until they file with the SEC after the fact. With a profit around 30% on their average share price, the fund may decide that it is better to take a quick gain than fight a hostile board. The unwinding of a 15% stake in the company would mean significant downward pressure on the shares. Investors may want to look to peers like OfficeMax for exposure to the sector or protect their position with options strategies.