A Boost In Profits For This Retailer

Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Staples (NASDAQ: SPLS), the world's leading office products company, made two separate announcements on January 7. First, the company plans to repurchase up to $750 million of its only outstanding bond, a 9.75% senior note due in 2014. The total bond offering was $1.5 billion, so this repurchase would take at most half of those bonds off the market.

Second, the company announced a new bond offering with proceeds going towards the bond repurchase as well as general corporate purposes. There will be two notes offered: $500 million of 2.75% notes due in 2018 and $500 million of 4.375% notes due in 2023. Total proceeds are expected to be $993.8 million after the underwriting discount.

Why Does This Matter?

This is great news for Staples, a company I wrote about in "Staples: Overreaction and Opportunity". Almost all of Staples' current debt is from these 9.75% notes originally sold in 2009; as of the end of October 2012 the balance sheet shows $119 million in short-term debt and $1,542 million in long-term debt. In fiscal 2012 Staples paid $174 million to service this debt.

What this debt deal does is replace this debt with new debt which requires far less in interest payments. Let's assume that Staples buys back the full $750 million aggregate principal amount in bonds. This bond most recently traded at $108.80, meaning the total payment will be $816 million to buy back these bonds. This will eliminate $73.125 million in annual interest payments.

The new debt will add a total of $35.625 million in new interest payments, resulting in an immediate elimination of $37.5 million in annual interest payments. The deal would also add about $177 million in cash to the existing cash balance of $1,020 million.

When January 2014 rolls around the remaining half of the old bonds will mature, resulting in a payout of $750 million. Given Staples' cash balance, this should not be an issue. This will eliminate another $73.125 million in interest payments. At this point annual interest payments will have dropped from the current $174 million to just $63.375 million, a reduction of about $110 million or 63%.

This is extremely significant. Staples TTM free cash flow is just over $1 billion. Adjusting for taxes (since interest payments are tax-deductible) this debt deal should add about $75 million to the free cash flow in 2014, an increase of about 7.5%. That's a pretty nice boost for simply refinancing debt.

Should You Buy Staples?

As I said in my previous article on Staples, I think that the stock is worth between $15-$20 per share. Currently trading at $11.85, the market is offering an enormous discount to my fair value range. I believe that this discount is a result of intense pessimism surrounding Staples as well as much of the traditional brick-and-mortar retail industry. People see Amazon (NASDAQ: AMZN) as a threat to all things retail, but in the case of Staples I think this threat is vastly overdone.

Interestingly enough, Staples is the number two online retailer after Amazon with annual online revenue of about $10 billion. This is almost half of Staples' total annual revenue of about $25 billion. And with Staples ranking as one of the companies with the best delivery speeds according to a national survey it looks like knocking Staples from its position as the dominate office supply company is not going to be an easy task.

Direct competitors Office Max (NYSE: OMX) and Office Depot (NYSE: ODP) are not consistently profitable. Office Max has been cash flow negative for the past two years while Office Depot has much, much smaller margins that Staples, with just $69 million in free cash flow derived from $11.5 billion in revenue in 2011. This compares to about $1 billion in free cash flow from $25 billion in revenue for Staples. Clearly, Staples is king.

The Bottom Line

This debt deal is a positive for Staples, allowing the company to cut interest payments significantly by taking advantage of a low-interest environment. I really think that Staples is being underestimated by the market and that shares will eventually recover. Staples remains a great value, and this debt refinancing only makes the company better.


TheBargainBin owns shares of Staples. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com 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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