The ODP Corporation: Potential 40% Upside (NASDAQ:ODP)

The ODP Corporation (ODP) sold its CompuCom Subsidiary in a transaction consideration of up to $305 million which consisted of a mix of cash, an interest-bearing promissory note, and a contingent future earn-out. The company originally purchased the business for $1 billion, and therefore effectively lost $695 million in the span of four years. Through the Q3 2021, CompuCom earned approximately $14 million excluding its goodwill impairment charge. For Q3, the business had net earnings of $28 million, or $112 million at a run rate. Despite the seemingly low price, management justified the transaction given the business was a non-core asset, which often indicates that it proves difficult to operate effectively and is more of a distraction than a benefit:

This action represents an important step in continuing to align our business model and resources towards our core strategy.”

With that deal now in the past, management can focus on two things, working through the potential divestiture of its consumer/retail side of the business and then exclusively focusing on organically growing the digital B2B side of the house.

Retail Sale

Management originally had planned to work through a public company split, spinning off the retail/consumer side of the business, to maximize shareholder value. The plan was to have ODP, the retail products and services (flat sales), and the NewCo, representing the B2B solutions division (growth-orientated), would receive their appropriate market valuations rather than trying to assign a blended valuation to two unique businesses. However, after receiving two separate proposals from USR Parent Inc. (the parent of Staples and portfolio company of PE-firm Sycamore Partners) in November 2021 for $1 billion in cash and another confidential bid in December. Unable to find similar retailers that would be interested in purchasing the consumer business, the other bid may have come from another PE firm.

Given that ODP management delayed their decision to split the company due to two offers tells me that the second offer was competitive, if not slightly higher. If we assume a slight premium of $1.1 billion, that’s a pretty attractive deal for shareholders. I think what’s interesting here is that previously ODP may not have been able to sell its consumer business to Staples over anticompetitive concerns. Remember when the FTC blocked the merger back in 2016? Well, here we are once again, and it’s unclear whether either company has made enough changes to their respective business models to achieve clearance. This point becomes even more relevant today as antitrust regulators are reviewing merger guidelines and planning to create stricter rules.

However, this hidden third-party could be ODP’s ticket to maximizing shareholder value by obtaining a cash deal free and clear rather than working through a slower, potentially less valuable split transaction. If we assume ODP will receive $1 billion, that’s about ~$19 in cash per share.

For context, ODP already has $13 in net cash per share after factoring in their total debt of $353 million and $753 in cash as of Q3 plus the $305 million equates to $705 million. Putting both of those together would bring net cash per share to $32, which leaves us with a relatively small enterprise value of $583 million!

The B2B Remainder

According to ODP’s Q3 2021 filing, the Business Solutions Division generated approximately $3.45 billion in YTD revenue, or $4.6 billion annualized, down by 3% against the 2020 comparable period. Most of this decline was due to lower PPE, cleaning supplies, and eCommerce sales, partially work-from-home trends, and some inventory supply chain constraints affecting high selling products such as ink and technology products. For Q3 2021 YTD results, operating income was $89 million, down from $98 million in the prior year, where $3 million of the decline was sales related and the remaining $6 from slight margin compression.

UBS analyst, Michael Lasser, questioned in the Q3 2021 conference call about how margins might be impacted heading into Q4. Management responded by saying that while they do have pricing power on certain products, margin pressure would be expected to continue:

So as we looked at the quarter and we as we looked at inventory levels, we were not probably as heavily discounted as in years past, which obviously improved our margin profile and we expect, given all the challenges on supply chain, the challenges on products that will continue that trend throughout this year.”

With that being said, I think ODP is only facing very minor year-over-year weakness in their B2B segment on sales and margins. So if we take the $89 million, about $111 million in operating income for the full year doesn’t sound unreasonable.

Putting it together, looking at ODP’s business exclusively through the lens of its B2B division would produce an enterprise value of $583 million versus a potential operating income of $111 gives us an EV/EBIT of 5.3x and after-tax 6.6x earnings. In other words, shares are trading pretty inexpensively here at $43/share.

Michael Lasser also fired away with another critical question regarding the future of the B2B landscape going forward in light of the new mix of back-to-office, hybrid environments, and permanent work-from-home conditions. Management gave a constructive response indicating that they want to tap into all three markets and return back to their historical performance:

So early indications, clearly, we’re able to serve customers in a variety of ways and we’re building towards the area that Gerry mentioned from a technology standpoint, ensure that we’re capturing that spend for corporations, no matter where the individual sits in the office or at home. But it’s too early to tell whether the trends back to 2019 occur in 2022 or we start to see that that pace begin in 2022 and continue on in years there after.”

Naturally, office settings are most beneficial for ODP, but I can also see the validity for the latter two bringing in sales, albeit at a lower level. Fortunately for ODP, many firms are returning to the office starting next month. I think once COVID calms down, more companies will follow suit.

We already know that the Q4 print will be difficult, I think it’s important to recognize that investors are now effectively buying into a stable or potentially even a growth business at mid-single-digit valuation multiples that reflect a company that’s in terminal decline. In other words, this $43 price tag looks like a pretty interesting opportunity.

If we assign a 9x net earnings multiple to ODP’s B2B solutions, then the stock would rerate and be fairly valued 40% higher at $60 per share. How does it get there? Well, management has already been approved for a $650 million buyback program, which represents nearly 30% of shares outstanding at current prices. Additionally, about 13% of shares have been sold short, so eventually those shares will need to be covered and if the stock continues repricing to the upside, short sellers would need to cover their positions and simply add fuel to the fire.

Relevant Risks

Despite the apparent valuation discount, there are also risks involved with ODP, including but not limited to the following:

• The FTC could once again block staples and the third-party buyer could back away from their offer, forcing ODP to return to the split company transaction, which could potentially result in less than a $1 billion valuation.
• B2B revenue and margins could continue to weaken, in part due to the ongoing office work environment.
• The economy could weaken materially in 2022, leading to further performance declines in the retail and B2B segments.

Bottom Line

ODP appears to be a bargain in plain sight, in part contingent on the outcome for the consumer business. The company is still generating continuing operations EPS of about $3.50, which places the valuation at 8.5x ex-cash earnings today. So factoring these two scenarios together gives us some decent downside protection and a solid, perhaps even probable, event-driven catalyst. With that, I’m likely going to initiate with a starter position at current levels. What do you think? Let me know in the comments section below. As always, thank you for reading.