Like many companies that scale their business to the critical juncture of either being acquired, or expanding by investing in their own people, customers, technology, and other functions, Office Depot faces the challenge: Either grow or die.
In May 2016, the company considered a takeover bid valued at $6.3 billion from Staples. Now Office Depot stands poised to acquire CompuCom in a transaction currently valued at $206.55 million. Here we take a closer look at what’s on the table for this Office Depot acquisition.
CompuCom has been a relative mainstay in the IT solutions and hardware and software resale, integration, and support space for decades. They have maintained their customer base while increasing their recurring revenue in desk-side and software support outsourcing. Historically, a material part of their overall revenue has come from Microsoft licensing, creating an estimated 3% gross profit margin.
The company has built a solid reputation on serving their larger accounts through their execution and methodologies and their solid relationships with partners such as HP, IBM, Cisco, Dell, and Microsoft. At the same time, plans to penetrate the small- to medium-business market or middle marketplace have never been formalized.
Meanwhile, Office Depot has wedged their way into the office supplies industry while offering smaller businesses basic IT solutions (e.g., product, software, limited support). While the reasons for the cancellation of the $6.3 billion Staples offer remain unclear, Office Depot seems to be all in on a strategy to support a universe from a few users up to 10,000-plus users in the enterprise/large account space.
Now, with Office Depot’s current bid to CompuCom, which is at the definitive agreement stage, the newly combined organization could be primed to go broader and deeper in a new universe and execute in ways many IT firms have aspired to for decades.
Questions remain: The potential and the footprint are there, but will the new organization have the systems (e.g., IT, back office), integrate-able methodologies, and leadership to execute effectively? And, can Office Depot invest capital in the current infrastructures of both companies? Should they leave them separate? Integrate? Or partially integrate with boundaries and rules of engagement? Can and should they make more acquisitions to penetrate that small- to medium-business market or middle market space?
Valuation, Opportunities, Threats
Office Depot plans to use $45 million in common shares of stock and debt to finance the acquisition. On the surface, this seems to be a win-win for both the acquirer and the seller for a number of reasons. Let’s break this down a bit:
- At $206 million in EV/Total Consideration, the acquisition looks good for Office Depot. Reports indicate the PE firm Thomas H. Lee Partners (TH Lee) paid around $1 billion when it acquired CompuCom from the PE firm Court Square. The low margin HW/SW business probably dragged down the valuation and Office Depot likely acquired it based on the “pure/CompuCom delivered” services revenue estimated at $200 to $225 million.
- At a relatively low valuation for Office Depot (5-6x’s EBITDA/Enterprise Value), using the stock as acquisition currency would seem expensive. The available financials for CompuCom are a bit dated, but if CompuCom can contribute in the vicinity of $70 million in EBITDA, it would boost the overall company’s EBITDA by at least 10%. In addition, the stock appreciation upside would be nice for both acquirer and seller, not including any hard and soft synergies between the two companies.
- Office Depot is not using much cash in this deal and could be paving the way for future investments and acquisitions in order to scale and realize more synergies. For example, they can leverage current Compucom help desk and maintenance support services that service current customers just below from the data center down to a hand-held device.
- Office Depot’s LT debt/LT Capital is currently at a ratio of approximately 34.3%. This means they should be able to stomach this deal and maybe more.
I believe a decent integration effort for the new company will take 15 to 24 months, making more investments in the current infrastructure and back office, even centralizing more service and support functions, and maybe even making more acquisitions in the small- to medium business space to scale the current offerings that CompuCom brings to the table. Historically, CompuCom had developed and centralized a number of service delivery methodologies and support functions to support the internal organization and larger national customers.
While questions remain, the potential before both Office Depot and the newly combined organization could be huge. If your company is at the critical junction of grow or die, contact us for strategic advice, options, and opportunities.
Steve Pomeroy is the founder of Big Change Advisors, a Los Angeles M&A advisory firm of business advisors and capital sourcing advisors for startups and middle-market companies. Since 1992, Steve has completed over 38 transactions including M&A, Capital Sourcing, and Public Offerings representing over $800 million in total transaction value. Through Big Change Advisors, Steve donates a percentage of all fees – or invites clients to donate a portion of Big Change Advisors fees – to help serve the homeless through the Los Angeles Mission. To request a free consultant, contact Steve here.