The Follies of the Staples-Essendant Deal: Too Good to Be True…

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The Follies of the Staples-Essendant Deal: Too Good to Be True…

 news 2016-02-23 at 10:22:38 am Views: 386
  • #45199

    The Follies of the Staples-Essendant Deal: Sounds Too Good to Be True…
    By Pierre Mitchell 

    Staples recently announced it plans to divest $550 million of corporate B2B contracts to one of its main suppliers, the wholesaler Essendant. Staples is trying to appease the Federal Trade Commission (FTC), which filed suit against Staples late last year to prevent its planned acquisition of Office Depot.

    In a press release, Staples said it plans to “sell more than $550 million in large corporate contract business and related assets to Essendant. Essendant will pay Staples approximately $22.5 million … and approximately half of the revenue will come from Fortune 500 companies.”

    In support of the deal, Staples CEO Ron Sargent said the move with Essendant "strengthens a national competitor, further enables office products dealers and helps minority and women-owned businesses compete for national commercial customers." Staples has cleared its regulatory hurdles in the E.U. and wants to do the same in the U.S., especially since it will have to pay a $250 million breakup fee to Office Depot if the deal doesn’t go through.

    As George R.R. Martin, author behind the novels that led to the HBO series Game of Thrones, once wrote, “When you play the game of thrones, you win or you die.”  And in this case, Staples appears to be fighting a battle to the breakup fee death, defending its own version of The Wall.

    But bad fantasy analogies aside, if you read what Sargent says, it all sounds so good. And it probably is. As the saying goes, “If it sounds too good be true…”

    The Story Behind the Story
    To understand what is likely going on here, you have to read behind Sargent’s carefully honed words. To do so, I’ll pose a set of questions for you, the reader, to consider, and answer some of them with my own analysis, which I have vetted and enhanced with multiple conversations with other industry insiders on this topic.

    Is Essendant a “national competitor”?  

    My view: No, not to Staples. It is, however, a competitor to S.P. Richards.
    (I’ll return to this later.)   

    Essendant is a major supplier to Staples and doesn’t have anything close to an equivalent service offering to Staples. Do you really think Staples wants to create a competitor and disintermediate itself?  Sort of puts a damper on its strategic buyer-supplier relationship, no?

    Weighing in on Sargent’s comment, Kaveh Bakhtiari, senior manager of investor relations at Essendant, likened the wholesaler’s relationship with Staples to “coopetition.” On the question of whether this remedy would actually mollify the FTC's main complaint that there is no national competitor for Staples, Bakhtiari said “it doesn’t really do it for the FTC.” But the agreement does give Staples something “a little more substantive” to present next time it appears in court.

    Staples did not immediately respond to a request for comment.

    $550 million is a big number and a big carve out. Isn't this a sizable piece of business?  
    My view: This number is likely the total contract value of those contracts. So, if they are five-year deals like Staples likes to sign, the $550 million represents a $110 million annual run rate. If Staples’ commercial business is about $8 billion (like it was in 2014), and you even conservatively assume a two-year contract duration, then this carve out still represents less than 3% of its total commercial business.

    Let that number sink in. Doesn’t seem like much of a carve out, does it? And it’s a fair bet that this list of contracts was sorted in order of least profitability, so it might actually be an awesome way for Staples to jettison a number of poorly performing customers. I’d also bet the lion’s share are also customers with small footprints that can be supported by smaller players that aren’t true national level competitors, of which there are basically two right now — and maybe going to one if the deal gets consummated.

    Can Essendant really fulfill these contracts?  
    My view: If Essendant keeps them, the answer is probably 5% yes and 95% no. Essendant has some ability to sell direct to enterprise buyers but has nothing remotely similar to the capabilities that a Staples Advantage program delivers. This begs the question of what will actually happen to those buyers who find their contracts have been re-assigned from their retail supplier Staples to a wholesaler named Essendant?  

    First of all, my guess is that it only contains contracts with no penalties or restrictions on contract re-assignment. (Lesson to buyers: If you worry about your supplier getting acquired to your disadvantage, consider using an assignment clause.) It’s unclear how Essendant will provide continuity of existing services via Staples.

    In response, Bakhtiari said that wholesale isn’t Staples’ go-to-market strategy, and Essendant is built to provide wholesale support. “These resellers are going to have much greater mindshare with us than with Staples and Office Depot.”

    “The end customer will, of course, have a choice,” he said. “They can chose to use Essendant or go to another office products supplier.”

    If you're an affected customer, obviously you’re likely to fight re-assignment and have Staples chose a contract other than yours. If Staples says no, then you’ll have to find another supplier. But that’s the problem. There won’t actually be another supplier to choose from, as we’ve argued, especially if this deal gets approved by the FTC. That’s the problem with monopolies.

    But can’t Essendant in turn re-assign these contracts out to smaller retail players?
    My view: Yes, it can, and we hope this would be the case. Of course, I’d bet the contracts are for localized customers who can be served by small competitors that are hopefully local to the customers and serviceable by them yet far below the radar of Staples’ competitive intelligence and sales and marketing teams. If you were a conspiracy theorist and wanted to look at this more nefariously, you could view it as Staples washing its contracts through Essendant, which could then again re-assign these contracts to these players. Regardless, it’s terribly clever.

    These small office product dealers are ones that might belong to co-ops or GPOs like Independent Stationers and TriMega, but most importantly, they will almost certainly be Essendant customers. So, in our hypothesized scenario, Essendant not only loses no business but also may get something more. Although Essendant is paying $22.5 million — the number is actually a bit meaningless, because trading parties can agree to any number behind the scenes that can get settled up later.  Really, you could sort of view this as Staples doing Essendant a favor. What might Essendant get in return for helping Staples avoid paying a $250 million breakup fee? Well, if the deal goes through, what might happen to any business that, say, Office Max does with S.P. Richards? Might it be at risk and get reallocated to Essendant? Maybe not, but maybe yes.

    How will this move “help minority and women-owned businesses compete for national commercial customers,” as stated?

    My view: It’s at best unclear, and at worst, could potentially fly in the face of such goals.

    At best, Essendant could work with enterprise customers whose contracts were sold off to it and work with them to compete the business to minority and women-owned businesses (if those customers even want that). And again, these are businesses that buy from Essendant, of course. It could even outsource the effort and give the contract portfolio to someone like OfficeZilla or maybe EPIC Business Essentials, which is a combination of Independent Stationers and Point Nationwide.

    At worst though, the business could be redirected to a diverse (e.g., woman-owned or minority-owned) office products dealer that many would consider a “pass through” diversity business. In the case of Staples, you can read about such a potential scenario described here. The firm mentioned, Guy Brown, was also mentioned in this industry press release as part of the proposed FTC remedy involving Essendant. This firm, and the use of pass throughs, is worthy of an entirely separate blog post. But, just to give you a flavor of this situation, if you go to the Guy Brown Products website, you see a picture of an African American woman, but, the firm was actually started by two Indian entrepreneurs, “self-proclaimed brown guys from Vanderbilt”.  

    I kid you not. And if you track an order on the firm’s website, you are actually directed to an Office Max web site. The irony of this is telling. I couldn't even make this stuff up!
    There’s a twisty back story to this, but let’s press on.

    Lessons Learned
    At the end of the day, at least to me, the latest Staples proposal doesn’t seem materially different from its previous ones in the sense that there still won’t be a remedy in terms of providing for a viable national competitor to it for large commercial accounts.

    I’ve shared quite a lot of information here, as well as a lot of my own ideas, so let’s wrap up with some additional general takeaways and lessons learned from my perspective:
    Don’t launch an acquisition unless you are willing to pay the breakup fee.
    Over-regulation is bad, but sometimes regulators do get it right.

    Bringing in what amounts to a supplier to pose as a real competitor to help you clear a regulatory hurdle is a clever ploy, but more generally, it illustrates the concept of “supply chain versus supply chain” and tapping your supply base creatively. Procurement organizations can and should learn from this.
    C-level executives and activist investors who portray their intentions and activities (and press releases) in a certain way to the market must also be prepared to deal with the ramifications of when those statements are held to the light of closer scrutiny and analysis.

    A failed acquisition is not necessarily a bad thing.  Office Depot needs the money, especially since it would exit this process weaker (in my opinion), and maybe Office Max could be spun back out — it supposedly had a pretty good technology platform — if there was a white knight to help it.  And of course, procurement organizations would win with at least some modicum of competition.

    Supply markets will always surprise you. New, creative suppliers, alternatives and models will eventually emerge…

    … But, in the meantime: absolute supply-side power has the potential to corrupt absolutely. Many industry insiders, analysts, and even general observers might agree that this attempted “remedy” supports this point.  

    And finally: The house always wins, and so do the attorneys. Manage your legal spend well.

    Before I close this out, let me state that Spend Matters, nor its parent company, Azul Partners, has any vested stake in this merger. None of the companies mentioned in this article has a commercial relationship with us — unless it has bought access to our online premium research with a credit card — nor do we have any financial interests or incentives of any sort tied to the outcome. We are only sharing our opinion on something that we feel is bad for competition. And if it’s bad for competition, it’s bad for procurement.

    You’ll have to forgive all the major media outlets out there who don’t understand the deeper workings of the supply chain. They’re not from procurement, nor are (most) experienced analysts. It’ll actually be interesting to see whether they’ll even cover this story.