Sycamore Partners had better be ready to roll up its sleeves. The private equity firm is buying Staples for $6.9 billion. Handing over a near-20 percent premium for the struggling office supplies retailer looks foolhardy.
As at many other chains, the top line at Staples has been declining. The company's revenue has fallen more than 7 percent over its last two fiscal years, and those declines are continuing. Staples posted an operating loss in its most recent year. According to Eikon, analysts are expecting revenue to fall for the next three years.
Sycamore's deal requires a fancy calculator to add up. Assume the buyers write a check for 30 percent of the deal's value, which would be lower than the average. If the company can then match analysts' estimates for next year's EBITDA of $1.3 billion and maintain that performance over five years, it could afford dividends of roughly $300 million a year.
Selling the company at the same 5.3 times EBITDA as the purchase price, and assuming no debt is paid down in the meantime, Sycamore would post a f15 percent annual return. That hardly gives the private equity firm much cushion if it can't lure customers into buying more printers and post-it notes.
But paying those dividends will be a stretch. The company currently has nine banks listed as financiers, suggesting that no single bank is willing to take on a lot of the deal risk. They will want the company to use free cash flow to pay down debt. If not, firms like Staples enter dangerous territory. The retail, restaurants, and consumer products sectors have accounted for a quarter of all defaults this year, according to S&P Global Ratings. They comprised only a tenth at this point last year.
Most turnarounds require some investment. If Staples finds it must use most of its cash to pay off debt, it will struggle to nurse itself back to health. Sycamore can prod the company to pay dividends or invest in propping up EBITDA – but probably not both. The private equity firm is already elbows deep in trying to revive retail businesses. The paper shredders Staples sells may come in handy.
Commentary by Lauren Silva Laughlin , a columnist at Breakingviews.
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