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Valuing Office Depot—Comparing Buyout Transactions In Retail

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PETM’s leveraged buyout

PetSmart (PETM) is a specialty pet goods retailer. On December 14, PETM announced its leveraged buyout, or LBO, by an investor group. The investor group is led by BC Partners. The group includes Caisse de Dépôt et Placement du Québec and StepStone.

The transaction is similar to a potential Staples (SPLS)-Office Depot (ODP) deal. Like SPLS and ODP, PETM is also facing competitive threats from big-box retailers and online retailers—like Amazon (AMZN). PETM’s same-store sales have been declining.

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Jana Partners gets activist

PETM’s LBO is also due to another activist investor—Jana Partners. In July, Jana Partners urged a sale to maximize shareholder value. With Starboard Value acquiring a substantial stake in SPLS and ODP, it could also push the companies to merge. A merger would allow the companies to realize cost synergies and unlock shareholder value in an industry that’s struggling. The industry is underperforming the broader retail sector.

PETM and SPLS are part of the SPDR S&P 500 ETF (SPY) and the SPDR S&P Retail ETF (XRT).

PETM valuation

The transaction announced this month, values PETM at $8.3 billion—excluding debt. Including debt, it values the company at $8.7 billion. This translates to 8.5x forward EBITDA (earnings before interest, tax, depreciation, and amortization). It’s 9.1x PETM’s trailing 12 months, or TTM, adjusted EBITDA.

The $8.3 billion equity component will be paid in cash. Shareholders will receive $83. This is a premium of 39%—compared to the company’s share price as of July 2, before Jana’s interest in pushing for a sale was known.

ODP valuation

However, PETM’s margins and returns are much higher than SPLS and ODP. Office supply retailers have some of the lowest margins among all of the retail segments. PETM’s market cap and enterprise value are also almost double ODP’s market cap and enterprise value. Also, PETM has positive earnings and free cash flow. It has a dividend yield of 1%. ODP doesn’t pay a dividend.

As a result, a potential buyout of ODP by SPLS would be at a discount to PETM’s EBITDA multiple. Assuming a premium of 20%–25% over ODP’s share price as of December 9, ODP’s equity valuation would be $4.3–$4.5 billion. Including ODP’s debt of ~$0.7 billion, the estimated purchase price comes to $5–$5.2 billion. It’s a forward EBITDA multiple of 6.9x–7.2x.

That’s at the lower end of the valuation range. Including the potential impact of synergies from a merger between the first and second office supply retailers, the valuation increases. We’ll discuss this more in the next part of this series.

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