Office Depot's Dutch Tender Offer (ODP)
One more update in the Office Depot restructuring saga with a massive share repurchase and FY22 earnings guidance.
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ODP Share Buyback
51 mm shares outstanding
900 mm long term debt
500 mm in cash and cash equivalents
1.7 market cap
Welcome to episode 33 of the podcast today we will cover one more twist in Office Depots restructuring journey.
On 18 July Office Depot announced a Dutch Tender auction for $300 mm of their common stock priced between $31.50 and $36.00. The auction represents between 17% and 19% of shares outstanding as of the announcement date. The stock gaped up from the low $30s to mid $30s on the news.
In conjunction with the Dutch Tender news the company stated their intention to repurchase an additional $600 mm in common stock and released FY22 earnings guidance of greater than $4 per-share. The $4.00 per share earnings estimate does not take into effect the announced share repurchase.
The Dutch Auction began on 18 July and will expire at midnight New York City time on August 12th 2022 unless extended.
At this point a quick review of ODPs finances is warranted. Currently, the company has 51 mm shares outstanding, 900 mm in long term debt, 500 mm in cash and cash equivalents, and a 1.7 billion market cap. Breaking the above numbers down on a per-share basis might provide more clarity in terms of what’s actually going on.
Each $35 share equates to $10 cash, $4.00 in earnings and $18.00 of long term debt. Of course common shareholders aren’t on the hook for long term debt but to the extend that debt helps or hurts the companies performance a shareholder is impacted by it.
Now, assuming the company buys back all of the 300 mm tender offer and the 600 mm share repurchase at the current share price they will have repurchased 25 mm shares leaving about 26 mm of the original 51 mm shares outstanding. Now apply FY22s low end operating earnings guidance of $280 mm to the new 26 mm share base and you get earning per share of around $10 per share. At $10 per share in earnings you could see a significant rise in the stocks price even using at half of the current P/E ratio of 9.
As I ran through the numbers for this share repurchase I asked myself why Office Depot elected to announce a $300 mm Dutch Tender offer and a $600 mm share repurchase. Why not simply announce a $900 mm share repurchase and be done with it. Ultimately, I can’t know what the CEO and board were thinking but I do have a theory.
Announcing the Dutch tender with a cap of about $36 per-share effectively puts s ceiling on the stock price. Arbitrageurs looking to make a spread between the stocks market price and the price they might realize in the Dutch Tender won’t pay more than the $36 announced cap on the stock. This ceiling on the stock price could allow Office Depot to buy in shares via their normal stock repurchase without the share buyback pressure driving the stock price too high. Basically, they get more shares for the money if the share price stays below a set price when the company itself is the main buyer.
In the end this botched spin-off could still pay off for investors. The key factor working in support of investors is that a stocks earnings command a multiple of their value in a stocks price. Buffett covered this phenomenon in some of his later shareholder letters buy comparing retained earnings to dividends and their value to the shareholder.
If a company earns and retains a dollar that dollar might sell for the stocks P/E multiple of $10 so that $1 in earnings is worth $10 dollars to the stockholder. If a company dividends out the earned dollar, however, that multiple of the earned dollar isn’t applied. In fact the dividend is taxed at something like 15% percent so that the retained dollar is worth $10 and the dividend is worth .85 cents to the investor.
Of course other factors are relevant in the above over simplified example. Can the company effectively use the retained capital, what other opportunities are available to investor, and what is that investors actual tax rate are all questions that must be considered but the idea that retained earnings command a premium for investors is still a useful construct to understand.
That fact that retained earnings command a premium for the investor due to the P/E multiplier means that retained earnings against a reduced share base may have much more impact on the share price than would the sale of a business division and cash distribution to shareholders would. This is because the cash distribution would effectively be a dividend and the same issue that I just mentioned would reduce the upside to investors of that cash distribution. Perhaps this is what ODPs CEO was thinking when they structured and announced this share repurchase program. That the retained earnings, divided by half the share base, and multiplied by the stocks P/E ratio would have a greater impact on the share price than would the sale of the retail division and retention of or dividending out of that cash.
With that summary we wrap up episode 33 of the podcast. I hope you learned something along the way and are more prepared to profit from ODPs failed spin-off and share repurchase pivot. We will be back again soon with another investment summary.