OREANDA-NEWS. Fitch Ratings has placed its ratings on Staples, Inc. on Rating Watch Negative following Staples' announcement that it has agreed to acquire Office Depot, Inc. in a transaction valued at \$6.3 billion. This values Office Depot at 10.5x its projected 2014 EBITDA of approximately \$600 million or 8.5x including \$140 million in unrealized synergies from the merger between Office Depot and Office Max that closed in Nov. 5, 2013.

Fitch currently rates Staples' long-term Issuer Default Rating (IDR) 'BBB-' and its short-term IDR 'F3'. As of Nov. 1, 2014, Staples had \$1.1 billion of debt outstanding. A full list of ratings is shown below.

KEY RATING DRIVERS

The Rating Watch Negative reflects a projected increase in financial leverage as Staples will finance the acquisition with \$4.25 billion of debt and \$2.1 billion of Staples' stock. On a pro forma basis for the LTM period ending Nov. 1, 2014, adjusted debt/EBITDAR for the combined company is around 5x, compared with 3.2x for Staples on a stand-alone basis. The acquisition debt is composed of \$1.5 billion drawn on a new \$3 billion asset based lending (ABL) revolver and a new \$2.75 billion secured term loan.

Based on preliminary projections, Fitch expects that leverage could improve to the low-4x range 24-36 months post the closing of the transaction based on both growth in EBITDA and debt repayment. Fitch would expect to downgrade Staples's IDR to the low to mid 'BB' category assuming the merger closes as contemplated following an FTC review, expected by the end of calendar 2015. Staples is not required to close the transaction if antitrust authorities require divestiture of assets (retail and/or commercial businesses) that deliver more than \$1.25 billion of Office Depot's revenues in the U.S. Staples must pay a \$250 million termination fee if the agreement is terminated due to antitrust requirements.

The ratings take into account the benefits and challenges from the combination of Staples and Office Depot. The merger will create a significant competitor in the office supply category, with combined sales of \$39 billion, and EBITDA of \$2.1 billion. The combined company's sales divide North American Retail 44%, North American Commercial 37%, and international 19%. The challenge will be to stabilize the core office supply business while generating growth from non-office supply categories.

The merger will create significant synergies, estimated by Staples at \$1 billion or more over three years, at a one-time cost of \$1 billion. Fitch believes that a significant portion of these synergies will be reinvested in the business, including marketing, e-commerce and prices to drive top-line growth.

Staples has experienced weak sales and margin trends caused by a secular decline in sales of core office supplies (57% of Staples' 2013 sales, half of which is paper, ink and toner), and weak sales of business technology products (15% of sales). Declining operating performance also reflects competition from online retailers, persistent weakness in the company's international segment, and the challenging macroeconomic environment.

Fitch believes these trends will persist over the medium term. Staples has accelerated its restructuring efforts, closing up to 225 stores in North America and reducing costs by \$500 million by the end of 2015. At the same time, the company's investments in its prices, marketing and website to drive sales will likely to pressure margins over the near term but could potentially help mitigate top-line pressure longer term. Fitch expects that the planned store closings and downsizings could stabilize or modestly improve store productivity trends. Together with expected store closings at Office Depot, these closings will help to rationalize the sector's retail footprint.

RATING SENSITIVITIES

Fitch would expect to downgrade Staples's IDR to the low to mid 'BB' category assuming the merger closes as contemplated. If the merger is terminated, future developments that may, individually or collectively, lead to a negative rating action include continued negative sales and margin trends and declines in EBITDA that drive adjusted leverage towards the mid-3x area.

Future developments that may, individually or collectively, lead to a Stable Outlook include a termination of the planned merger with Office Depot, a stabilization of top-line and EBITDA trends, and maintenance of adjusted debt/EBITDAR at or under 3x.

Fitch has placed the following ratings for Staples on Rating Watch Negative:

Staples, Inc.
--Long-term IDR 'BBB-';
--Bank credit facility 'BBB-';
--Senior unsecured notes 'BBB-';
--Short-term IDR 'F3';
--Commercial paper 'F3'.