AREX Capital Management, LP, together with its affiliates, a
long-term shareholder of The ODP Corporation (NYSE: ODP) (the
“Company”), today issued an open letter to the Company’s Board of
Directors (the “Board”).
The full text of the letter is set forth
below:
December 18, 2023
Via Electronic Mail
The Board of DirectorsThe ODP Corporation6600 North Military
TrailBoca Raton, FL 33496
Attention: Joseph S. Vassalluzzo, Chairman of the Board
Dear Joseph and Members of the Board:
AREX Capital Management, LP and its affiliates
(together, “AREX” or “we”) have been shareholders of The ODP
Corporation (“ODP” or the “Company”) for several years. During that
time, we have generally been pleased with the Company’s operational
results and share repurchase program, and we were particularly
impressed by its best-in-class supply-chain execution during the
disruptions of 2021 and 2022. Even the decision at the end of 2021
to sell CompuCom at a loss of more than $750 million spoke well of
the Board’s willingness to admit mistakes and act decisively.1
We have also appreciated our open and candid
dialogue with ODP’s Board and management team. As we have privately
communicated to the Board recently, we believe that the results of
the past few years strongly suggest that solid execution and
ongoing share repurchases are insufficient to create meaningful and
sustainable value for ODP shareholders. To that point, since
January 2021, when Sycamore Partners made its unsolicited offer to
acquire the Company, ODP’s shares are roughly flat. Incredibly,
this disappointing performance has come against the backdrop of the
Company reducing its share count by over 25% during this
period.
Unfortunately, our most recent conversations
with the Company have left us concerned that the Board and
management do not feel the appropriate sense of urgency to promptly
take the necessary steps to maximize shareholder value.
Consequently, we find it necessary to publicly share our views and
outline our perspective on the two primary issues adversely
affecting ODP’s stock, along with the obvious remedial actions.
ISSUE 1: ODP IS STILL THOUGHT OF AS A
BRICK-AND-MORTAR RETAILER
We believe that the primary explanation for
ODP’s share price challenges and valuation malaise is that the
omni-channel, but still majority brick-and-mortar, Office Depot
retail business (“Office Depot”) creates a consistent deterrent for
prospective investors who might otherwise provide higher multiples
to ODP’s more attractive businesses. As a result, Office Depot ends
up anchoring the trading value of the overall enterprise. ODP’s
multiple should actually be increasing as ODP Business Solutions
contributes a growing portion of the Company’s EBITDA and as Veyer
rapidly expands its third-party logistics business. Instead, ODP’s
valuation has stubbornly remained below 4x EBITDA, which is
unreasonable for a healthy, unlevered company that should be
growing its EBITDA over the next several years and enjoys strong
free cash flow conversion. Too many investors simply think of ODP
as a challenged brick-and-mortar retailer, and this misperception
will likely persist for as long as Office Depot contributes a
meaningful portion of the Company’s EBITDA, regardless of
management’s efforts to tell its story better. It should be evident
to all that structural changes are necessary for ODP’s share price
and valuation to have a chance to approximate the fair value of its
underlying assets.
Recent history suggests that the Board
understands our thinking and appreciates the need for structural
change. In its May 2021 press release announcing its plan to split
into two independent, publicly traded companies, ODP eloquently
articulated the compelling reasons for separating its
enterprise-focused business from its consumer-focused one: distinct
investment and growth strategies, increased focus on the unique
needs of differing customer bases, attracting talent motivated by
the specific mission of each business, and maximizing valuations
through better alignment with different shareholder bases. During
the separation process, multiple parties expressed interest in
acquiring ODP’s consumer-focused business, and it is our
understanding that a sale announcement was imminent before market
volatility in June 2022 scuttled the deal.
Fortunately for shareholders, the work that was
completed prior to the aborted divestiture was not in vain. As the
Company stated in the June 2022 press release announcing the
termination of the sale process, “The completion of our internal
reorganization will make such a potential separation substantially
simpler should the Company determine to resume the separation
process following a change of market conditions in the future.”2 By
almost any conceivable definition, market conditions today are
dramatically improved, and the separation benefits that the Company
itself previously enumerated are as relevant today as they have
ever been. In fact, there is no compelling reason to maintain the
existing corporate structure, and the process of executing on a
tax-free Office Depot spin-off should begin immediately. Of note,
while the spin-off process is progressing, the Company could also
explore whether any of the prior bidders for Office Depot remain
interested, or if additional prospective buyers may have emerged in
the improved M&A environment.
ISSUE 2: VARIS IS SEEN AS A CASH-BURNING
SCIENCE PROJECT
Another issue that plagues ODP’s shares is
Varis. While the Company’s initial investment thesis may have been
reasonable, Varis’ results to date have been unambiguously
disappointing, as evidence of commercial progress has been sorely
lacking and milestones have continuously been pushed out.
Meanwhile, the Company continues to pump shareholders’ cash into
the venture, and we estimate that between operating losses, capital
expenditures, and the acquisition of BuyerQuest, ODP will have
invested more than $300 million into Varis by the end of 2023.
Varis is currently expected to generate less than $10 million in
revenue this year, most of which is subscription revenue that was
acquired through BuyerQuest as opposed to new platform revenue. We
suspect the 2025 Varis revenue objective of $120 million that was
presented little more than a year ago at the Company’s Investor Day
is now internally acknowledged to be wildly unachievable.
It is time to change course. The core of ODP’s
investment proposition is modest growth and prodigious free cash
flow generation. Investors who find that type of opportunity
appealing are a very poor audience for a highly speculative,
cash-consuming venture capital project—which remains an accurate
description of Varis despite three full years of investment and
business-building efforts. Nothing in ODP’s history or present
remotely suggests it is the appropriate home for such a concept.
Furthermore, ODP has zero credibility with investors in making
large allocations of capital into tangential business areas given
its disastrous acquisition of CompuCom.
To be clear, this is not a personal critique of
the highly qualified team attempting to build Varis, and we readily
acknowledge that Varis may eventually achieve commercial success.
We are simply stating that we do not want more of our money
invested into this project given the enormous uncertainty
surrounding it and the highly attractive alternative that exists
for that capital—namely, the repurchase of ODP’s significantly
undervalued shares. We suspect that other shareholders feel
similarly.
The Company should immediately explore the
divestiture of at least a majority stake in Varis. If Varis’
prospects are as exciting as ODP has previously articulated, there
should be no shortage of third parties eager to invest in or
acquire what has already been built. Divesting a majority stake
would establish a real-world valuation mark for Varis and should
provide the capital needed to bridge it to profitability, while
also potentially allowing ODP to recoup some of its historical
investment. Alternatively, a full sale of Varis would provide ODP
with additional capital for share repurchases, further focus the
enterprise, and vastly improve the ODP investment story by
completely eliminating an overhang. The Company should not be
concerned with whether the valuation achieved in either scenario
even approximates its basis—the simple reality is that the highest
price that a third party is willing to pay for Varis today is, in
fact, the value of the asset. And if no third parties are willing
to invest capital into or acquire Varis at any price, that too
speaks volumes about the project’s prospects and would provide
clear evidence of the need to immediately shutter it. In short,
simply continuing the status quo at Varis is unacceptable.
THE DAY AFTER
After taking the steps that we outline above—for
simplicity, we will call it the “AREX Plan”— existing ODP
shareholders would own shares in two new companies: “RemainCo,”
consisting of ODP Business Solutions and Veyer, and “NewCo,”
consisting of Office Depot. As part of the separation, we
anticipate NewCo signing a long-term contract with Veyer under
which Veyer will continue providing the services that it currently
provides at market rates. Further, we anticipate NewCo being spun
out on a net-debt-free basis.
We believe that the market will have a
dramatically more favorable view of RemainCo once it no longer
operates a primarily brick-and-mortar retailer. And a RemainCo with
two attractive businesses—a modestly growing, highly cash
generative B2B distribution business and a logistics business with
strong growth driven by expanding third-party activity—should enjoy
a vastly improved valuation relative to ODP’s current reality.
In our analysis of RemainCo’s prospective
trading value, we use a multiple of 6.5x EBITDA for ODP Business
Solutions and 7.0x EBITDA for Veyer (see Appendix for a discussion
of our segment valuation rationales). Further, we assume that Varis
is sold in its entirety for $150 million, or roughly half of
invested capital.
For NewCo, we use a multiple of 3.0x EBITDA, a
discount to where similarly situated omni-channel retailers trade.
In fact, none of the retailers in the Russell 2000 with positive
EBITDA trade below ~3.5x EBITDA. We use this extreme multiple to
illustrate the point that if the separation produces a re-rating of
RemainCo, NewCo’s valuation is, in fact, fairly irrelevant. While
the Company has at times expressed concerns that Office Depot’s
standalone valuation would be a material risk in a separation, the
analysis presented here clearly refutes this notion. Further, if
ODP shareholders do not feel that NewCo is trading at an
appropriate level upon separation, they could continue to own the
standalone business, only now in a far more focused structure. Of
note, the valuation we present for NewCo equates to a ~25% free
cash flow yield on this year’s estimates, and if NewCo initially
traded at that level, it could quickly repurchase a substantial
portion of its shares, which would likely lead to an improvement in
its valuation.
Value Creation from the AREX Plan |
|
|
|
|
|
|
($ in millions, except per share amounts) |
|
EBITDA |
|
Value |
|
2024E |
2025E |
Multiple |
2024E |
2025E |
ODP Business Solutions |
$ |
199 |
$ |
227 |
6.5x |
$ |
1,293 |
|
$ |
1,475 |
|
Veyer |
|
77 |
|
89 |
7.0x |
|
540 |
|
|
626 |
|
Total RemainCo Enterprise Value |
$ |
276 |
$ |
316 |
|
$ |
1,833 |
|
$ |
2,102 |
|
Net Cash(1) |
|
|
|
|
211 |
|
|
211 |
|
Other Assets(2) |
|
|
|
|
208 |
|
|
208 |
|
Varis Sale |
|
|
|
|
150 |
|
|
150 |
|
RemainCo Equity Value |
|
|
|
$ |
2,402 |
|
$ |
2,671 |
|
per share |
|
|
|
$ |
60 |
|
$ |
67 |
|
NewCo Equity Value |
$ |
197 |
$ |
182 |
3.0x |
$ |
591 |
|
$ |
547 |
|
per share |
|
|
|
$ |
15 |
|
$ |
14 |
|
Total ODP Equity Value |
$ |
473 |
$ |
499 |
|
$ |
2,993 |
|
$ |
3,218 |
|
per share |
|
|
|
$ |
75 |
|
$ |
81 |
|
% upside to current |
|
|
|
|
46 |
% |
|
62 |
% |
Note: AREX segment-level estimates of ODP 2024E and 2025E EBITDA
include corporate allocations. Share count based upon expected
year-end 2023 level of ~40 million fully diluted
shares.(1) AREX estimates for cash balance on
December 31, 2023. (2) Includes cash surrender
value of company-owned life insurance, CompuCom promissory note,
and held for sale assets. |
As shown above, based on our forecasts for 2024
EBITDA and valuation assumptions, the AREX Plan should deliver
value to ODP shareholders of ~$75 per share, or nearly 50% above
current levels. Applying the same framework using 2025 estimates
suggests the delivery of ~$81 per share of value to ODP
shareholders, or more than 60% above current levels. Of note, our
upside values and return estimates do not incorporate the more than
$6 per share in cash that we expect ODP to generate over the course
of 2024.
ADDITIONAL VALUE CREATION
OPPORTUNITY
While we believe the steps outlined above will
create substantial shareholder value, there is material additional
upside potential if the Company were prepared to modestly increase
its leverage to support larger share repurchases ahead of a
prospective separation. And while we appreciate the Company’s
desire to maintain a conservative balance sheet, its current net
cash position seems unnecessary, particularly considering its
significant free cash flow generation.
As illustrated below, a modestly leveraging
buyback could drive meaningful value creation through the
acquisition of undervalued shares. Specifically, we estimate that
if the Company were willing to migrate its balance sheet to a net
leverage position of 1.0x 2023 EBITDA, it would immediately have an
incremental ~$875 million of capital available for share
repurchases.3 This would represent more than 40% of the Company’s
current market capitalization! While we recognize that Office Depot
is less “leverageable” than other parts of the business, this
scenario would still leave the Company with an appropriately
conservative balance sheet—specifically, the resulting
post-repurchase capital structure would result in a very reasonable
leverage ratio for RemainCo of ~1.7x following the implementation
of the AREX Plan.
In an admittedly abstract analysis, if ODP were
to use the aforementioned ~$875 million to repurchase its shares at
$55 per share, our sum-of-the-parts estimate for ODP’s shares based
on 2024 estimates would increase from ~$75 per share to ~$88 per
share, or more than 70% above current levels. The same analysis on
our 2025-based approach increases our fair value estimate from ~$81
per share to ~$98 per share, or ~90% above current levels.
CONCLUSION
We are firm believers in ODP’s long-term
prospects, and particularly in the valuable ODP Business Solutions
and Veyer businesses. However, we are also sober about the enormous
challenge that ODP’s current business mix presents for public
market investors as the Company attempts to argue its way to a fair
valuation. The steps that we have outlined should generate
significant value for shareholders, far greater than what the
Company is likely to deliver in any version of the status quo. No
more time should be wasted exploring whether the 4-BU framework
might ultimately resonate with investors or continuing a very
expensive hope-based strategy with Varis. We feel that the Board
must act decisively to unlock this value for shareholders, and if
it does not, we will consider taking additional steps to hold the
Board accountable and ensure that shareholder value is
maximized.
We hope to discuss these matters with the Board
soon. We eagerly await your response.
Best regards,
|
|
Andrew RechtschaffenManaging
Partner |
James T. CorcoranPartner |
APPENDIX: SEGMENT VALUATIONS
ODP Business Solutions:
Determining the correct multiple for ODP Business Solutions is
complicated by the lack of an appropriate, pure-play public comp.
Veritiv Corporation, a B2B distributor that was recently taken
private and has more than 40% of its business in markets that
overlap with ODP Business Solutions, offers one relevant data
point. Over the past five years, when public, Veritiv traded at an
average EV/EBITDA multiple of ~6x, and it was recently acquired by
private equity firm Clayton, Dubilier & Rice at an EV/EBITDA
multiple of ~5.5x. However, the majority of Veritiv’s business is
focused on packaging products, its overlap with ODP Business
Solutions is generally in lower-growth core office categories (and
in challenged customer segments, such as commercial printers and
publishers, within those categories), and it has a worse
medium-term organic growth outlook than ODP Business Solutions (its
merger proxy filing forecast annual revenue growth of ~1%).
There are other publicly traded B2B distributors
with large market shares, including W.W. Grainger, Inc. and
Fastenal Company. However, while these companies have historically
traded at much higher EBITDA multiples, they are generally focused
on the industrial segment and have superior growth prospects. As
such, we value ODP Business Solutions at 6.5x EBITDA, which
represents a modest premium to the historical and take-private
valuation of what we believe to be an inferior comparable company.
We would also note that, setting aside relative valuation, on an
absolute basis, 6.5x EBITDA feels inexpensive for a growing
distribution business with limited capital needs (capital
expenditures are ~2% of EBITDA for ODP Business Solutions).
Veyer: In valuing Veyer, we
employ a weighted average approach to balance the fact that, on the
one hand, more than 60% of Veyer’s 2025 EBITDA will still be coming
from ODP’s two primary businesses that collectively offer very
modest growth prospects (and create significant customer
concentration), while on the other hand, Veyer’s fast-growing
third-party EBITDA stream merits a higher valuation.
We arrive at a multiple of 5x EBITDA for the
“legacy ODP portion” of Veyer’s business based on ODP Business
Solutions’ and Office Depot’s relative contributions to Veyer and
the multiples we use to value those segments. Given the rapid
near-term projected growth for Veyer’s third-party EBITDA, we
consider the higher end of the range for publicly traded
non-brokerage focused 3PLs like GXO, Inc. and asset-based
transportation companies like Saia, Inc., and conclude that a
multiple of 11x EBITDA is appropriate. The resulting blended
multiple for Veyer is 7x EBITDA—though as the higher growth
third-party EBITDA becomes a larger part of the mix over time, the
segment’s “fair” multiple should increase.
Office Depot: While there is a
range of valuations for omni-channel retailers with end markets
about which investors have medium-term concerns, a multiple of 3.0x
EBITDA is an outlier, and we use it only for the sake of
conservatism. It is also worth noting that our valuations for
Office Depot are well below the levels that were being discussed
during the 2021-2022 sale process.
About AREX
AREX Capital Management, LP is a value-oriented
investment firm based in New York City. AREX takes a long-term,
opportunistic approach to investing and focuses primarily on
publicly traded companies with significant, unrealized
potential.
Media Contact
Valerie Toomey, Chief Operating OfficerAREX Capital Management,
LP(646) 679-4000info@arexcapital.com
1 CompuCom was acquired in 2017 for $937
million. ODP ultimately received sales proceeds consisting of $100
million in cash, a promissory note of $59 million, and a potential
earnout with a maximum theoretical value of $125 million that the
Company valued at $9 million as of September 30, 2023.2 “The ODP
Corporation Completes Realignment of Operating Business Entities to
Better Serve Customers,” June 21, 2022.3 Inclusive of the cash
surrender value of Company-owned life insurance policies and
CompuCom promissory note.
A photo accompanying this announcement is available at
https://www.globenewswire.com/NewsRoom/AttachmentNg/f5d55236-69b5-4d41-8262-fc4c1eb405a4
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