Crunching the Office Depot, OfficeMax Merger Numbers (SPLS, ODP, OMX)

Unless you've just returned to planet Earth from your mission to Mars in the last five minutes, you've undoubtedly heard that office supply chain stores Office Depot Inc. (NYSE:ODP) and OfficeMax Incorporated (NYSE:OMX) are merging. The market celebrated with some buying - a lot of buying - and that buying effort is still going strong. It is, after all, the biggest step either company has been willing to make to halt the sprint toward the edge of the cliff.

Yet, just because it's perceived as good for OfficeMax or Office Depot doesn't inherently make it bad for competitors like Staples, Inc. (NASDAQ:SPLS). Indeed, given how the union of OMX and ODP will almost certainly mean some of their stores are closing, Staples stands to win some new business that the other two players are willing to sacrifice in the name cutting costs.

Somehow though, there's something about the math that leaves me with an uneasy feeling about the whole thing.

Crunching the Numbers

The end-goal of a merger between OfficeMax Incorporated and Office Depot Inc. is clear enough... sharing costs. Though both retailers have slashed expenses since 2007 (give or take), dwindling sales have made the cost-cutting efforts futile. Indeed, the spending cuts may well have fueled the dip in sales, exacerbating the problem rather than solving it. With no other cost-cutting measures left to utilize on their own, the next-best step is to share what corporate expenses they can by teaming up.

The estimates of cost-savings vary anywhere from $300 million to $600 million per year. A KeyBanc Capital Markets analyst suggested in 2011 that combining the two companies could save almost $500 million per year, though Tuesday's story from the Wall Street Journal implies the range could be somewhere between $400 million to $700 million.

For perspective, ODP will be generating about $10.9 billion in sales for 2012, while OMX will do $7.1 billion in business for last year. So, $500 million in saving is significant. It's even more significant, however, knowing that both companies have struggled just to break even, and neither company has booked an annual operating profit of more than $100 million in years. That level of cost cutting could mean triple-digit increases in the bottom line, if things go as planned.

That's a big "if" though. In fact, it's a huge "if". The market has heard tall tales of expense-slashing before, with many - even most - of those hopes never panning out nearly as well as hoped.

Moreover, while OfficeMax and Office Depot will be sharing some costs as part of the deal, they'll also be incurring some new ones as a result. Nomura analyst Aram Rubinson  opined yesterday that a merger between OMX and ODP could mean as many as 25% of the combined company's stores get closed. That's not a cheap undertaking. Jefferies; Daniel Binder says it can cost between $1 million and $2 million just to close a store down. Office Depot owns 1500 stores globally (1100 of which are in North America), while OfficeMax owns about 900. A 25% reduction in the store count could mean more than 500 stores are shuttered, at an extra - though non-operating - cost of $500 million to $1 billion.

That's not the worst part of all, though. Aside from the expense of store-closings, the merged retailers will also be cutting up to 25% of their combined revenue by closing stores. That's more than $4 billion in sales. The benefit of the savings may be offset (or more than offset) by the fact that the shrinking organization is also going to be forced to digest a shrinking economy (benefit) of scale or size. The whole point of expansion is to spread costs out among more and more stires. Now those costs are going to be shouldered by fewer stores again, each of which has fixed costs that don't scale up or down.

Staples Isn't Being Ushered to the Head of the Line Either

Regardless of whether or not the math of an OfficeMax/Office Depot merger makes sense, Staples has been named as the primary beneficiary here. After all, there's $4 billion worth of office supply business up for grabs if ODP and OMX close a few hundred stores. That's an optimistic assumption though.

While it is true that Staples is the dominant player in the office supply retailing space, it' not true that Staples is the reason Office Depot and OfficeMax are struggling to survive. Stores like Wal-Mart and Target as well as online shopping centers like Amazon have been chipping away at ODP and OMX for years as well. Though SPLS certainly stands to win some new business, alternative suppliers in the office space also stand to gain.