Given slower store traffic and an uncertain global economic environment, did Staples pick the wrong time to spend approximately $4.4 billion in connection with the June 30 acquisition of Dutch peer Corporate Express? Borrowings and debt service requirements have increased substantially at the world’s largest office products retailer, according to its third-quarter 2008 regulatory 10-Q filing:
- Our consolidated outstanding debt as of November 1, 2008 was $4.08 billion, with a major portion of it due next year. If we are unable to satisfy our debt service requirements, we may default under one or more of our credit facilities. If we default or breach our obligations, we could be required to pay a higher rate of interest or lenders could require us to accelerate our repayment obligations, and such a default could materially harm our business and financial condition.
For the nine-months ended November 1, Staples generated year-to-date free cash flow of $690 million (after $244 million in capital expenditures and $231 million in dividends), compared to free cash flow of $309 million for the same period last year. Ergo, the company is throwing off more than enough cash to cover net interest expense of $60 million to $70 million anticipated for the fourth-quarter of 2008. In addition, the ratio of earnings to fixed charges ratio of 4.45 times was well above the debt service requirement of 1.5 times.
Despite a slowdown in global corporate spending, the Corporate Express purchase is looking net positive for Staples, as the Dutch office supply company contributed $2 billion, or almost 29 percent, to total net sales of $7 billion in the third-quarter. Although European retail same-store comparables declined six percent, hurt by softening demand for computers, furniture and business machines, operating margin improved year-on-year 21 basis points to 3.55 percent.
Chairman and Chief Executive Officer Ron Sargent told analysts on the third-quarter earnings call that the company is pleased with the steady progress underway in the integration of Corporate Express, and management remains confident that a tight focus on expense controls and synergies (such as consolidation of purchasing and supply chain operations) would result in $300 million of cost savings over three years from the merger.
In my opinion, the current level of indebtedness (75 percent of shareholder equity), combined with maturing debt obligations and vulnerability to a prolonged downturn in consumer and business spending, will limit Staples’ ability to borrow additional amounts (for working capital, future acquisitions, and capital spending initiatives) needed to resuscitate growth. Management, however, spins a more optimistic tone, opining that cash flow from operations, existing liquidity of $1.6 billion (cash on hand and untapped credit lines), and proceeds from new debt offerings will generate enough liquidity — in addition to daily working capital needs — to repay debt (inclusive of a bridge loan) of approximately $2.94 billion maturing in less than one year, rebuild its credit profile (currently a BBB rating), pay common stock dividends, and fund anticipated $400 million in 2009 CAPEX. In this weakened economy that is one ambitious office order to fill.
