Staples Is for Sale, but Is It Talking to the Wrong Buyers?

By Rich Duprey Markets Fool.com

Proving once again that regulators are horrible at choosing marketplace winners, office supplies retailer Staples (NASDAQ: SPLS) is reportedly looking to private equity to save it from competition from Amazon.com (NASDAQ: AMZN).

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Since the Justice Department denied Staples' attempt to buy Office Depotlast year because the DOJ discounted the competitive threats facing it, the retailer has replaced its CEO, initiated numerous cost-cutting initiatives, announced hundreds of layoffs, and just last month said it was closing another 70 stores. The regulator ignored the retailer's warningsand focused instead on how the world's largest corporations might have to pay a little more for paper, pencils, and toner cartridges. But with its operational condition continuing to deteriorate, Staples is now reportedly in the early stages of discussions to sell itself to private equity to rescue it. However, it might be looking at the wrong buyers.

Image source: Getty Images.

An ailingretail landscape

First, private equity might have lost its appetite for retail turnarounds following a disappointing Christmas season for many. Plus, bankruptcies in 2017 have already equaled the number achieved through all of last year.

Staples is certainly different than a lot of those troubled stores. It still throws off a lot of cash and paidout $311 million to shareholders last year in dividends. The$0.48 annual dividend is currently yielding 4.9%. Yet its woes are similar to other retail outlets, and the threat posed by Amazon is very real indeed.

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Amazon Business launched in the U.S. in April 2015 and one year later had already hit $1 billion in sales. It said it was growing at a rate of 20% a month and had over 300,000 business customers. This past January, Amazon said it now had more than 400,000 business customers in the U.S. who were serviced by more than 45,000 sellers.

Image source: Amazon Business.

Incontrast, Staples recorded a net loss of $615 million in 2016 as sales declined 3% from the year-ago period.Under that kind of pressure, it's not surprising Staples might seek to be taken private.

But instead of talking to private equity, maybe it should betalking to Wal-Mart (NYSE: WMT), Costco (NASDAQ: COST), or, yes, even Amazon itself.

A retailsolution

Wal-Mart doesn't break out numbers for its office supplies business, but we know it is investing heavily in the space, not least of which with its acquisition last year of Jet.com for $3 billion. Combining Jet's expertise in order fulfillment with its substantial store footprint should help Wal-Mart meld the clicks-and-bricks dynamic.

Furthermore, its Sam's Club division began piloting an office supplies delivery service late last year, utilizing a variety of crowdsourced delivery start-ups like Deliv for small orders and Need It Now for larger ones. Many of Sam's Club's members are small- and medium-sized business, and by targeting them, it is a direct threat to Staples, whose North American delivery segment -- which includes direct sales to businesses as well as all of Staples' online sales -- generated $10.6 billion in revenue last year.

The retail king could alleviate many of the problems Staples is facing, from allowing it to reduce its retail store footprint and moving more of those items into a Wal-Mart store, to helping recapture a lot of the business-to-business (B2B) revenue that's been moving to Amazon and elsewhere. A Staples by Wal-Mart branding could further cement the connection.

Wal-Mart's e-commerce initiatives are already paying off, with U.S. division revenue soaring 36% from the year-ago period, an increase it says was largely a result of the Jet.com acquisition. Adding in Staples' own e-commerce prowess, sales of which grew 13% last year, could allow Wal-Mart to more effectively challenge Amazon.

Image source: Costco Business Center.

A big warehouse for all

A similar argument can be made in favor of a purchase by Costco, which also began trialing an office supplies delivery service around the same time Sam's Club did. Its Business Center operation is partnering with Instacart to first deliver groceries to small businesses, such as restaurants, with future expansion into office supplies afterwards.

Business Centers are a different breed of warehouse for Costco. They cater to the needs of small businesses, like convenience stores and food services businesses, and typically offer cleaning supplies, print and paper supplies, office furniture, and more, that are used by businesses, hotels, hospitals, and restaurants.

Half of all Business Center volume is by delivery, but the average sale per member is three times greater than what Costco realizes at its regular warehouse stores. There are a little more than a dozen such stores now, and it's been slowly opening them for years. Buying Staples would immediately give it the opportunity to expand that footprint exponentially, converting some to a Staples by Costco brand, others to Business Centers, and likely closing a bunch more down.

For many of the same reasons as Wal-Mart, a purchase by Costco would give the wholesale club immediate heft in thwarting Amazon's advance.

A pact with the devil

And then, of course, there is Amazon.com itself buying Staples. The e-commerce leader has not been shy about making acquisitions over the years, though they've been on a much smaller scale than a Staples purchase would be. However, it would also help give Amazon even greater credibility in the B2B office supplies marketplace. Not even the vast store footprint would necessarily be an impediment, as Amazon is already experimenting with physical locations. It wouldn't even be necessary to rebrand the stores, either, as the Staples brand still has cachet.

The $7 billion price tag that's been bandied about for Staples shouldn't be a problem for any of these retailers, and one of them buying up the office supplies leader makes as much if not more sense than private equity (PE) moving in. While PE firms are known for their ruthless cost-cutting endeavors to right a sinking ship, they also look for an exit strategy and to lard a business with debt before putting it back on the market to pay themselves a dividend.

The competitive landscape continues to tilt against Staples, a fact the Justice Department refused to acknowledge, but one that forced the office supplies retailer to have to explore this avenue of salvation. A deal with one of these could hardly be opposed by antitrust regulators since it was only a year ago they discounted the threat they posed.

If Staples is looking to get out of the limelight, it would seem it's talking to the wrong folks about it.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Costco Wholesale. The Motley Fool has a disclosure policy.