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For Investors, Truth Often Lies Beneath the Surface

February 24, 2017

This past Wednesday, I spent part of my day reading a 75-page memorandum opinion outlining a federal district court’s decision last May to block the merger of two office supply companies: Staples, Inc. and Office Depot, Inc.

 

Prior to reading the opinion, I had loosely followed the case in newspapers such as the Wall Street Journal. I had not given much thought to the matter, and my knowledge was very limited. Nonetheless, I admit to lifting my eyebrows when I read that Federal Trade Commission’s opposition to the merger had prevailed in court. I did not see how such a merger could possibly be expected to harm consumers, given the ultra-competitive retail environment and emerging presence of online competitors such as Amazon.com.

 

Reading Judge Sullivan’s explanation of the case was eye-opening and educational. It did not take me long to realize that I had been analyzing the case all wrong. On the surface, it seemed that the proposed merger was between two retailers serving a market of individuals and small businesses. But in reality, this was only part of the story. Little did I know that a substantial portion of revenue for these companies flowed from contractual arrangements with very large enterprises (think Fortune 100 companies). These contracts often involved complex IT integrations, desktop delivery, and nationwide service networks, with revenues of some contracts topping $1 million per year. Staples and Office Depot together controlled around 80% of this market. A combination of the two would have eliminated nearly all competition for such large accounts. As for Amazon, Judge Sullivan explained that Amazon is not yet a substantial threat in the market for large enterprise contracts, and may never be due to its perceived inability to contractually guarantee discounted pricing for many products that are sold by third-party merchants (third-party merchants set their own prices).

 

While the above may seem to have little to do with investing, the story was a reminder to me that truth often lies beneath the surface. The only way to get at the truth is to dig up the facts. And only after important facts are brought to light, and properly interpreted, can one obtain insight and make rational, informed decisions. Proper due diligence on the part of investors requires more than casual glances at the newspaper and stock charts – these are just starting points. Finding real gems requires time and effort.

 

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