Why OfficeMax looks like a takeover candidate

Benj Gallander and Ben Stadelmann
Saturday, December 9, 2000

There is one primary reason why the Contra Guys’ annualized returns over the past 10 years have been more than 20 percent and that is our ability to buy companies that eventually are taken over. In a portfolio that normally averages about 30 stocks, we have been involved in four takeovers this year. Last year it was six, two in 1998, and four in 1997. Because this event normally means receiving a substantial premium to the pretakeover price, returns get a turbo-boost. And that is what this game is all about.

It is virtually impossible to know when a takeover will occur. Rumours abound about various companies being in play and, more often than not, they are false. But there are signs to look for — and we found many in last month’s purchase of OfficeMax.

We purchased OfficeMax (OMX-NYSE) for $2.81 (US), less than a third of book value. With impending writedowns as the organization closes about 50 stores, we estimate we bought in at about half of future book value. This value includes losses that we suspect will continue until the middle of next year as the firm contends with major competitors Office Depot and Staples, along with a slower sales environment. The third-quarter number was red to the tune of about $10 million. Excess inventory still must be dumped, which will squeeze future margins. And severance pay to employees also will tarnish the bottom line for the next couple of quarters.

As often happens when growth stocks fail to meet forecasts, a pack of yappy lawyers is organizing disgruntled shareholders into class-action suits. This does not concern us unduly, as these lawsuits seem to come out of a cookie cutter and have more to do with lawyers’ ambulance chasing and investor frustration than with management’s incompetence. Having been there many times ourselves, we understand the disappointment of a zapped stock price, but the sign on the door clearly says, “Enter At Your Own Risk.” But this represents another reason for this firm to be trading at a steep discount.

Given all the bad news, what makes this major office supplier such a likely takeover candidate? A recent deal with Gateway should help turn the firm’s computer business around. Trying to go on their own, OfficeMax’s computer business was about as exciting as — well, as setting up a computer. But Gateway has now set up kiosks throughout the retail chain, and has invested $50 million in return for two kinds of preferred shares. The deal offers synergies to both corporations, including cross-promotional opportunities.

Clinching the takeover possibility for us was the fact that Slim Helu, one of Mexico’s richest men, has been purchasing scads of the company. After a major buying spree this fall, he is nearing the 15 percent limit where OfficeMax’s poison pill kicks in. Our belief is that if Slim puts the right offer on the table, chief executive officer Michael Feuer will jump at the deal. A price of $5.50 a share or so would certainly make this an interesting proposition.

Slim and the Contra Guys have had prior dealings. Last December, we purchased a piece of CompUSA, the largest computer superstore chain in the United States. Our buy-in value of $5.56 a share was quickly dwarfed when Mr. Helu decided to add to his 15 percent position by pitching to buy the whole firm at $10.10 a share. He appears to be acting in the same manner this time — performing a gradual creeping takeover before launching a bid for the entire organization. The CompUSA deal closed swiftly in March for an 80 percent gain in three months.

What happens if Slim does not buy in? We will have purchased a well-managed organization that is one of the big three in the United States. Their new initiatives should start paying off next year. And given a price of almost $20 two years ago, this one has plenty of upside. OfficeMax trades at about $1.62.

We never count on a takeover when buying a firm. That would be like counting our chickens before they hatch. But this one does have scribble marks on the wall and could prove to be a good one to deposit in a Christmas stocking.