Fundamental AnalysisOfficeMax Company Background OfficeMax is the largest operator of high-volume, deep-discount office product superstores in the United States in terms ofthe number of stores and breadth of geographic coverage. It was incorporated in 1988 by Michael Feuer & Robert Hurwitz. In addition to office prodiuets and equipment, OfficeMax stores sell furniture through its FurnitureMax division and provides a copy services through its CopyMax division. OfficeMax was also one of the frst movers to provide on-line office product sales through OfficeMax Com. ‘The company grew rapidly through the late 80s and 90s and it currently has 995 stores in locations throughout the United States, Japan, Mexico, Brazil, Puerto Rico, and the U-S. Virgin Islands. In 1991 K-Mart acquired 92.7% equity interest in OfficeMax with Feuer & Hurwitz ‘maintaining the remaining 7.3%. In 1994 O1 issuing an inital public offering (IPO) at which time 73% of K-Mart’s shates were sold, reducing K-Mart’s owners eeMax went publi the company to approximately 25%, However, in response to growing public concer relating to K-Man’s 25% ownership inthe company, in 1995 OfficeMax successfully negotiated with K- Mart to sell its remaining 25% interest in Office Max. After breaking away from K-Mart, OlficeMax grew more rapidly both in terms of sales and number of store locations becoming the third largest player in the industry. In 1999 the ‘company initiated a restructuring program in order to create a more focused, customer-driven ‘merchandise seletion; to improve its product sourcing: to optimize its product assortment; 1 re- engineer its supply-chain and merchandising processes; and to upgrade its computer support systems and distribution networks. ‘The expense of these initiatives coupled with a settlement of, the Ryder lawsuit and a decline in sales due to the economic slowdown inthe later half of 2000 — ‘whieh is typically when the company receives 50% of its annual sales ~all led to a net loss for OfficeMax in 2000. Economic Analysis ‘According to the Conference Boar, in March 2001 leading evonomic indicators decreased 0.3%, coincident indicators increased 0.1%, and lagging indicators decreased 0.4%. ‘Taken together, these three indices suggest slow growth in the second quarter of 2001. The ‘changes in the economy that are relevant to stores such as OfficeMax, which are in the office product segment of the specialty retail industry, inelude changes in the consumption componentof the real GDP, disposable personal income, consumer confidence, interest rates, unemployment rates, and the consumer price index. Te economie indicators that will impact OfficeMax’s growth in the near future are somewhat mixed. The growth inthe real GDP has slowed to 2%; nevertheless the consumption ‘component of the real GDP has increased by 3.1%. This sa positive indication that consumer financial health i still strong. Real disposable personal income was up by 2% through the first {quarter of 2001. This grovth in disposable personal income is another positive sign indicating that consumers would be willing to spend on nonessential items. Interest rates have decreased to 3.87% on three-month T-Bills. This deerease in interest rates should also stimulate increased ‘consumer spending. However, three economic indicators are negative and could have an adverse impact on OfficeMax. The consumer confidence index was down 8 points in April 2001 and the consumer price index was up 2% in March and for the year ending Mareh 2001 it was up 2.99%. These indices would both indicate a slow down in consumer spending, Finally, the unemployment rate hhas continued to increase since December 2000 and reached « high of 4.5% in April 2001. The ‘unemployment rate is significant to OfficeMax because its main customer base includes small business owners and selfemployed home office workers. In times of rising unemployment and \weak economic conditions fewer people are willing to risk opening their own business or leaving secure jobs to work out of a home offi, Because these two consumer seyments represent a Jarge portion of OfficeMax’s customer base, a steady rise in the unemployment rate could negatively impact OfficeMax’s growth. Industry Analysis “The office products industry is $28 bilion industry, whieh has been through a sionifieant evolution in the past 15 years, Iniially this industry was highly fragmented consisting of many small morand-pop stores or small regional chains. However, because the office products industry is a high-volume, low-margin industry, is biased in favor of retailers thot are bigger and more efficient than ther competitors. This trend led to the birth ofthe “category killers” inthe mid-1980s. Inthe offic prodets industry category killers are superstores that dominate the office products merchandise category and can offer larger variety of products at lower prices. Today the office products industry consists of three main‘competitors, OfficeMas, Office Depot, and Staples. Office Depot is the industry leader with a 42% market share, followed by Staples with 39%, and OfficeMax with 19%. Growth in te office products industry was very rapid through the late 80s and the 905, ranging from 15% to 40%, however, firms in this industry have entered the mature stage and ‘grow is leveling off at a slower pace. Conservative growth estimates for firms in the industry range from 8% to 15%. ‘The office products industry is cyclical the stale ofthe economy. The continued decline in the leading economic indicators together with nature; thus it is very responsive to changes in the mixed indicators that pertain specifically to the office products industry would also suggest slow growth, Using Michael Porter's five competitive forces model to analyze competition within the office products industry reveals: 1. Rivalry Among Competing Sellers: Rivalry among competing sellers in the office produets industy is intense, Firms compete primarily onthe basis of very low discount prices therefore profit margins are very slim. High-volume isthe key to increased profits this industry therefor, firms inthe industry benefit from economies of scale. 2, ‘Threat of Potential Entry: The threat of potential of entry of new competitors is weak because of significant barriers to entry due to economies of seale in purchasing and istibution. This is also why the industry has consolidated into three dominant firms. 3. Competitive Pressures from Substitute Products: Competition from substitutes is ‘weak as there are no substitutes for office produets in general, however, firms such as K= Mart, Wal-Mart, and various drug stores offer office products on a very small limited seale, These firms do not pose significant increase in competition for firms in the office products industry because the category killers in the industry have lower cost structures, ‘which allow them to charge lower prices.4. Power of Suppliers: The power of sup} is fairly weak because the sheer size of firms within this industry allows them to exer significant bargaining power over their suppliers. 5. Power of Customers: The power of customers inthis industry is ily strong because the produets sold are similar from store to store and there is no cost for customers to switeh to the lowest priced store. As.awhole, the office products industy is a competitive industry where prices are set at ‘marginal cost, profit margins are low, and zero economic profit is likely. The industry has reached the mature tage of growths; therefore growth in the industry has slowed. The industry is also subject to business eycles thus, it is very responsive to changes in the state of the economy. ‘The current indications of economic slowdown would suggest slower growth for firms in the office product industry, Company Analysis, Discussion of Screening Ratios: Office ax’s preliminary sereening ratios ate as follows: Ratio Caleulation’ Results per share BV per share IMVIBV = 37577-66 047. eet share to MV per share [BVI = 7.86/3.73 2At [cash Per Share (Total Cash Shares [CIS = 127,397 00024060255 $1.02 lout) jet-Nel Per Share (CA-TLM Shares Out) |NetNel Per Share = (150201300- $208 '1242437000)"124969255 bins Q= (Stock Price X¥ of [Tobins Q = (2.73x124960255) 1037257000 0.24 [shares\/(TA Intangibles) All indications suggest that OfficeMax stock is mispriced and may be undervalued. OF cours, in evaluating these screening ratios one must consider whether the amounts given forthe ‘book value and the value of total assets less intangibles are accurately accounted for. book value. This would indieate that OfficeMax might