AREX Capital urges ODP board to relaunch Office Depot separation, sale of Varis

AREX Capital Management, LP, together with its affiliates, a long-term shareholder of The ODP Corporation issued an open letter to the Company’s Board of Directors which read in part, “As we have privately communicated to the Board recently, we believe that the results of the past few years strongly suggest that solid execution and ongoing share repurchases are insufficient to create meaningful and sustainable value for ODP shareholders. To that point, since January 2021, when Sycamore Partners made its unsolicited offer to acquire the Company, ODP’s shares are roughly flat. Incredibly, this disappointing performance has come against the backdrop of the Company reducing its share count by over 25% during this period. Unfortunately, our most recent conversations with the Company have left us concerned that the Board and management do not feel the appropriate sense of urgency to promptly take the necessary steps to maximize shareholder value. Consequently, we find it necessary to publicly share our views and outline our perspective on the two primary issues adversely affecting ODP’s stock, along with the obvious remedial actions. We believe that the primary explanation for ODP’s share price challenges and valuation malaise is that the omni-channel, but still majority brick-and-mortar, Office Depot retail business (“Office Depot”) creates a consistent deterrent for prospective investors who might otherwise provide higher multiples to ODP’s more attractive businesses. As a result, Office Depot ends up anchoring the trading value of the overall enterprise. ODP’s multiple should actually be increasing as ODP Business Solutions contributes a growing portion of the Company’s EBITDA and as Veyer rapidly expands its third-party logistics business. Instead, ODP’s valuation has stubbornly remained below 4x EBITDA, which is unreasonable for a healthy, unlevered company that should be growing its EBITDA over the next several years and enjoys strong free cash flow conversion. Too many investors simply think of ODP as a challenged brick-and-mortar retailer, and this misperception will likely persist for as long as Office Depot contributes a meaningful portion of the Company’s EBITDA, regardless of management’s efforts to tell its story better. It should be evident to all that structural changes are necessary for ODP’s share price and valuation to have a chance to approximate the fair value of its underlying assets. Recent history suggests that the Board understands our thinking and appreciates the need for structural change. In its May 2021 press release announcing its plan to split into two independent, publicly traded companies, ODP eloquently articulated the compelling reasons for separating its enterprise-focused business from its consumer-focused one: distinct investment and growth strategies, increased focus on the unique needs of differing customer bases, attracting talent motivated by the specific mission of each business, and maximizing valuations through better alignment with different shareholder bases. During the separation process, multiple parties expressed interest in acquiring ODP’s consumer-focused business, and it is our understanding that a sale announcement was imminent before market volatility in June 2022 scuttled the deal. Fortunately for shareholders, the work that was completed prior to the aborted divestiture was not in vain. As the Company stated in the June 2022 press release announcing the termination of the sale process, “The completion of our internal reorganization will make such a potential separation substantially simpler should the Company determine to resume the separation process following a change of market conditions in the future.”2 By almost any conceivable definition, market conditions today are dramatically improved, and the separation benefits that the Company itself previously enumerated are as relevant today as they have ever been. In fact, there is no compelling reason to maintain the existing corporate structure, and the process of executing on a tax-free Office Depot spin-off should begin immediately. Of note, while the spin-off process is progressing, the Company could also explore whether any of the prior bidders for Office Depot remain interested, or if additional prospective buyers may have emerged in the improved M&A environment. Another issue that plagues ODP’s shares is Varis. While the Company’s initial investment thesis may have been reasonable, Varis’ results to date have been unambiguously disappointing, as evidence of commercial progress has been sorely lacking and milestones have continuously been pushed out. Meanwhile, the Company continues to pump shareholders’ cash into the venture, and we estimate that between operating losses, capital expenditures, and the acquisition of BuyerQuest, ODP will have invested more than $300 million into Varis by the end of 2023. Varis is currently expected to generate less than $10 million in revenue this year, most of which is subscription revenue that was acquired through BuyerQuest as opposed to new platform revenue. We suspect the 2025 Varis revenue objective of $120 million that was presented little more than a year ago at the Company’s Investor Day is now internally acknowledged to be wildly unachievable. It is time to change course. The core of ODP’s investment proposition is modest growth and prodigious free cash flow generation. Investors who find that type of opportunity appealing are a very poor audience for a highly speculative, cash-consuming venture capital project-which remains an accurate description of Varis despite three full years of investment and business-building efforts. Nothing in ODP’s history or present remotely suggests it is the appropriate home for such a concept. Furthermore, ODP has zero credibility with investors in making large allocations of capital into tangential business areas given its disastrous acquisition of CompuCom…The Company should immediately explore the divestiture of at least a majority stake in Varis. If Varis’ prospects are as exciting as ODP has previously articulated, there should be no shortage of third parties eager to invest in or acquire what has already been built. Divesting a majority stake would establish a real-world valuation mark for Varis and should provide the capital needed to bridge it to profitability, while also potentially allowing ODP to recoup some of its historical investment. Alternatively, a full sale of Varis would provide ODP with additional capital for share repurchases, further focus the enterprise, and vastly improve the ODP investment story by completely eliminating an overhang.”