Gathering of the Office Supply Stores

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So Office Depot (NYSE: ODP) is buying out Office Max (NYSE: OMX). The larger firm will take over the smaller one in a $976 million all-stock swap and the two will be combined. Simple enough. The real news here is that this is one more sign of consolidation in the retail industry.

A major reason for this is the spread of low cost alternatives and big box stores. Both Wal-Mart (NYSE: WMT) and Costco (NASDAQ: COST) sell a lot of the same things as both Office Depot and Office Max. That's got to be disquieting for two retailers who look like pretty big boxes themselves. But that's the way it is and no two ways about it.

Still, it's possible that the larger firm can better compete with its more generalized rivals. By specializing in office supplies and hardware there's space for them to become a stronger presence in the industry, provided the sales team can lock up some long-term discounted contracts with bigger buyers. I wish them luck.

Office Depot

It's interesting that the newsies are considering Office Depot to be the dominant partner in this merger. While the firm is bigger than Office Max the fact is that it's hardly a bastion of profitability. November's earnings last year weren't exactly lighting up the boards in a positive way. Still, the news is good for the firm as it now has an easy way to expand. As recently as last September the stock was below $2, and during its recent run it's been as high as $5. Be cautiously optimistic about how it's going to go.

Office Max

Everyone keeps saying that this will be a merger of equals. But not all equals are, well, equal. Office Max is the smaller of the two firms, and it wouldn't surprise me if it's the one going away after the dust has settled. Still, Max has a better margin than Depot even if its overall sales are smaller. Maybe that's what it's bringing to the table. Watch to see if the CEO for the combined firm comes from the Max side. That'll tell a lot of the 'merger of equals' tale. The stock, like its soon-to-be partner, has been on a good run, likely caused by the merger rumors. Still, it's worth watching, though the likely gain in value is already factored in.

Staples (NASDAQ: SPLS)

Staples is well thought of right now, and it got a lot of name checks during last year's election season with Mitt Romney being involved with it at one time. Still, overall it had a good 2012 with an operating margin at 6.51% (even if Q4 was rough). It seems to be far overbought with a P/E of 543.13, and I can't imagine that's any form of irrational exuberance. The stock has been in a trough most of the last year. Last March it was at $16.84 before dropping to $10.66 in August and now sitting at $13.60. It's yet to be seen how Staples will react to a merger of two of its rivals. It had best lock in some of those long-term supply contracts before the merger gets approved.

Wal-Mart

While it doesn't specialize in office supplies and therefore isn't a direct competitor to either Office Depot or Office Max, Wal-Mart does supply a lot of office supplies on an ad hoc basis. I know a great many firms that use the giant retailer for their paper, ink and small business equipment without ever hitting an office supply store. There's less hassle in doing it that way for the smaller ones. What Wal-Mart won't get is the monstrous large contracts from major buyers. I don't think it worries them, though. The firm's profits are up for Q4, after all. The firm's stock is up 20% since last April, and it pays a 2.30% dividend. I think it'll get by.

Costco

The same argument applies to Costco as applies to Wal-Mart. While they don't specialize in office supplies they do siphon off some of the retail business away from the big specialty stores. The issue becomes just how much of it they get. Still, there's money to be made with Costco. January year-over-year numbers are up, and the stock has grown 22% since last May. I actually have more faith in Costco as a general retailer than I do Wal-Mart. The 1% dividend isn't great, but at least it's an indication that the firm acknowledges it needs a dividend.

Look, the whole merger thing is still going to have to jump through the regulatory hoops. Various people will complain that it's non-competitive. It's not, of course, but they'll complain that it is. Don't let them influence your investment decisions. The merger will go through. The real thing you, as an investor, have to decide is whether you think the combined store will do well in the environment. Can a big box specialty office supply retailer continue to thrive? Once you have an answer to that, make your investments and see where it goes.

Good luck!

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Nate Wooley has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale and Staples. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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