HARD LINE RETAILERS

Bear, Stearns & Co. Inc. U.S. Equity Research

May 31, 2007
Sector

Rating

Hard Line Retailers

Market Weight

An Insider's View of the Office Products Market

We hosted a conference call featuring Steven Jacober, President of the School, Home, & Office
Products Association (SHOPA).

Companies Covered
Company

Cl. Price Rtg

Office Depot, Inc.

OfficeMax, Inc.

$35.02
$44.06

O
P

O=Outperform; P=Peer Perform; U=Underperform

Securities in this report priced as of:

May 30, 2007 16:00ET

A BEARISH VIEW. Growth in the office products mkt decelerated to a 2.8% gain in 2006 and
Mr. Jacober expects less than 2.0% growth in 2007 based on a deceleration in the economy. While
industry participants had anticipated a strong back-to-school season, there has been a reversal of
sentiment (and orders). A similar (but less severe) change in sentiment also occurred in the
delivery business. Mr. Jacober believes that the slowdown could be a precursor of a slowdown in
the national economy.
WE ARE MORE BULLISH ON THE SPACE; MACRO DATA SUGGESTS A
REACCELERATION. While trends did slow recently, given the well-documented macro
correlations to topline, we believe retail comps are in-line with the GDP slowdown that has
occurred over in 1H07 and that this is a backwards looking view. Macro indicators suggest the
business environment is reaccelerating and we believe the data points indicate more of a soft spot
in demand. Finally, consumer spending is holding up ok, May has improved over April, and the
pricing environment has not become aggressive.
RETAILERS ARE NOW GETTING ALLOWANCES ON PRIVATE LABEL
MERCHANDISE. In a noteworthy change, retailers are now asking for (and getting) vendor
allowances on private label merchandise produced by the national brand manufacturer (who also
produces the own brand goods). This is good news for the superstores and worse news for their
big vendors.
AMPLE STORE GROWTH OPPORTUNITIES.
opportunities for the office superstores.

Mr. Jacober sees ample store growth

NO CHANGE IN THE ANTITRUST PERCEPTION. Mr. Jacober testified as a witness when

the FTC blocked the proposed acquisition of ODP by SPLS in 1997. Although there seem to be
expectations of a merger in the office superstore industry, Mr. Jacober does not see a changed
situation where the government would allow a merger.
Equity Research Analyst(s)
Christopher Horvers, CFA
212-272-4007
chorvers@bear.com

Shane Miller

212-272-6906
smiller1@bear.com

Aaron Goldstein

212-272-0247
agoldstein@bear.com

All numbers are after stock-based compensation expense, normalized consistent with BSC option expense policy.

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PLEASE REFER TO PAGE 3 OF THIS REPORT FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION
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On Wednesday, May 31st, we hosted the third of our Hardlines Retailing 2007 Summer Conference Call Series entitled An Insiders View of
the Office Products Market featuring Steven Jacober, President of the School, Home, & Office Products Association (SHOPA). For
background, SHOPA was created in 1991 in New York City by a group of industry executives to produce a strong trade show in tune with the
industry needs and to provide a forum in which other industry needs could be addressed. The association includes 700 manufacturers,
manufacturer representatives, retailers, wholesalers, distributors, commercial/contract stationers, and service companies involved in the
production, distribution, and sale of school supplies and office products. SHOPA segments the industry into 64% retail and 36% contract
according to 2005 figures, and for commercial products in 2007.
A BEARISH VIEW. Growth in the U.S. School and Office Products Market decelerated to a 2.8% increase ($332B) in 2006 from a 3.5%
expansion in 2005 and 3.3% rise in 2004. However, Mr. Jacober expects less than 2.0% growth in 2007 based largely on a deceleration in the
national and global economy. While industry participants had anticipated a strong selling back-to-school season for 2007, there has been a
reversal of sentiment, which has resulted in a pullback in vendor orders. A similar (but less severe) change in sentiment from the vendors also
occurred in the commercial (or delivery) side of the business as optimism in January and February transitioned to slackening demand and order
in March and April. Mr. Jacober believes that the slowdown could be a precursor of a slowdown in the national economy, where there is a
traditional four to six month lag with office supply sales. Other factors contributing to his concern are consumer gas prices, the related
increasing cost of fuel in the distribution system, and accelerating cost of raw material expenses (paper, plastics, and steel, for example).
School and Office Products Market
2002
Industry Total
294
% Growth Y-O-Y

2003
302
2.7%

2004
312
3.3%

2005
323
3.5%

2006
332
2.8%

Source: SHOPA

Retail Distribution

Commercial Distribution

($ billions)

2004
Specialty Stores
66.4
33%
Office Supply Superstores
18.2
9%
Mass Retailers
55.6
28%
Food/Drug Stores
5.1
3%
College/Bookstores
11.2
6%
Copy/Printing Stores
10.7
5%
Stationary/Gift Stores
3.2
2%
Institutional/School Firms
6.7
3%
Internet/Direct Sales
9.2
5%
Other
12.7
6%
Total
199 100%
Source: SHOPA, Bear, Stearns & Co., Inc.

2005
66.5
32%
18.5
9%
57.7
28%
5.3
3%
11.5
6%
10.9
5%
3.2
2%
6.8
3%
9.7
5%
15.9
8%
206 100%

Office Supply Superstores

Independent Dealers
Contract Specialists
Contract Stationers
Other
Total

2004
11.7
10%
19.8
18%
65.5
58%
4
4%
12
11%
113 100%

2005
12.9
11%
19.9
17%
67.8
58%
4.1
4%
12.3
11%
117 100%

WE ARE MORE BULLISH ON THE SPACE; MACRO DATA SUGGESTS A REACCELERATION. While trends did slow recently,
given the well-documented macro correlations to topline, we believe retail comps are in-line with the GDP slowdown that has occurred in
1H07 and that this is a backwards looking view. Macro indicators (e.g., ISMs, industrial production, payroll, surveys, etc.) suggest the
business environment is reaccelerating and we believe the data points indicate more of a soft spot in demand vs. an overall industry slowdown.
Indeed, as one example, below we put the generally optimistic view (as described by our economist) included in the FOMC comments released
earlier this week:
The growth of business fixed investment seemed most likely to move higher in coming quarters, supported by strong corporate balance sheets
and profits, favorable financial conditions, and a gradual strengthening in business output. The downside risks to business capital spending
appeared to have diminished somewhat since the previous meeting...the correction of inventories to more comfortable levels appeared well
advanced, thus reducing the possibility that going forward this adjustment process could trigger shortfalls in business spending and output"
Finally, consumer spending is holding up ok, May has improved over April, the pricing environment has not become aggressive, and PC sales
were organically strong at SPLS (who has generally a smaller assortment in the category).
NO DRAMATIC CHANGES IN THE PRICING ENVIRONMENT. According to Mr. Jacober, there has not been any change in the
pricing environment for office supplies, which supports the view put forth by ODP, OMX, and SPLS on their 1Q conference calls. Moreover,
if demand slows, he suggested that retailers will be more selective in choosing what to promote (vs. more dramatic price changes in past
economic slowdowns). Besides our view of profitable-growth focused new management teams at ODP and OMX, in this current
environment, retailers are not able to exert as much downward pricing pressure on the manufacturers due to the rising cost of raw materials.
BEAR, STEARNS & CO. INC. 383 MADISON AVENUE NEW YORK, NY 10179 (212) 272-2000 WWW.BEARSTEARNS.COM

Moreover, recent increases in tariffs for paper shipped from China, India, and Indonesia mitigate potential promotional pricing in this category.
Bottom line: keeping the reality of the category in mind it is pen and paper, so price cuts are a fact of life when demand slows; maybe not as
much in the current environment.
PRIVATE LABEL PENETRATION UP TO 40%; RETAILERS ARE NOW GETTING ALLOWANCES ON PRIVATE LABEL
MERCHANDISE. In a noteworthy change, retailers are now asking for (and getting) vendor allowances on private label merchandise
produced by the national brand manufacturer. This provides a gross margin help to the big three office superstores and is another way that they
are flexing their muscles over the vendor base (a familiar ongoing trend). This is good news for the ODP, OMX, and SPLS and worse news for
their big vendors.
More broadly, the office supply retailers continue to increase greater share of private label, with current estimates at 16%-21% of total products
across the industry. SHOPA estimates that private label penetration could reach 30%-40%. Direct sourcing continues to increase as well, with
increased sourcing out of secondary and tertiary markets outside of China including Vietnam, Malaysia, India, and other Pacific rim countries.
AMPLE STORE GROWTH OPPORTUNITIES. Mr. Jacober sees ample store growth opportunities for the office superstores given the
fragmentation, the potential for market share gains, and the formation of small businesses and home offices. We believe there is about 3 or so
years left of ample store growth at the current pace (so long as there isnt an overpaying on the real estate side).
NO CHANGE IN THE ANTITRUST PERCEPTION. Mr. Jacober testified as a witness when the Federal Trade Commission blocked the
proposed acquisition of Office Depot by Staples on antitrust grounds in 1997. Although there seem to be expectations of a merger in the office
superstore industry, Mr. Jacober does not see a changed situation in this sector where the government would allow a merger. The proposed
acquisition of Office Depot included a sale of 63 stores from Staples to OfficeMax to assuage antitrust concerns, but was blocked due to
concerns that prices were raised in areas where only one store was offered. The FTC released this statement following the ruling, "Staples and
Office Depot are the two largest operators of office supply superstores in the country," said William J. Baer, Director of the FTC's Bureau of
Competition. "The fact is that in those communities where Staples faces competition from Office Depot, prices are significantly lower than
where it does not. Therefore, if this merger is allowed to proceed, in those areas, competition will be reduced or eliminated and consumers will
pay higher prices." In the 1997 decision, the government was clear about its decision not to allow the Staples/Office Depot merger, due to the
overlap of stores and potential for prices increases for the consumer. Although highly competitive, the Office Supply industry has room for
growth for all three retailers, and they will continue with their store opening programs.

Important Disclosures
The costs and expenses of Equity Research, including the compensation of the analyst(s) that prepared this report, are paid
out of the Firm's total revenues, a portion of which is generated through investment banking activities.
This report has been prepared in accordance with the Firm's conflict management policies. Bear Stearns is unconditionally
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This publication and any recommendation contained herein speak only as of the date hereof and are subject to change
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Analyst Certification
The research analyst(s) primarily responsible for the preparation this research report hereby certify that all of the views
expressed in this research report accurately reflect their personal views about any and all of the subject securities or issuers.
The research analyst(s) also certify that no part of their compensation was, is, or will be, directly or indirectly, related to the
specific recommendations or views expressed in this research report.
Christopher Horvers
Companies Analyzed
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* Office Depot, Inc. (ODP) - $35.02 (as of May 30, 2007 16:00 ET) - Outperform
Price Target ('07): $43.00
Risk(s) to Price Target - Macro economic growth, small business spending, labor markets, company execution, and stock
market volatility
Valuation Methodology - PE and PEG
* OfficeMax, Inc. (OMX) - $44.06 (as of May 30, 2007 16:00 ET) - Peer Perform
* Staples Inc. (SPLS) - $25.06 (as of May 31, 2007 16:00 ET) - Outperform
Price Target ('07): $30.00
Risk(s) to Price Target - Macroeconomic changes, company execution, stock market volatility
Valuation Methodology - PE
Office Depot, Inc. (ODP): The subject company is or during the past twelve (12) months has been a non-investment banking
client (securities related services) of Bear Stearns & Co. Inc.
OfficeMax, Inc. (OMX): The subject company is or during the past twelve (12) months has been a non-investment banking
client (securities related services) of Bear Stearns & Co. Inc.
OfficeMax, Inc. (OMX): Within the past twelve (12) months, Bear, Stearns & Co. Inc. or one of its affiliates has received noninvestment banking compensation from this company.
OfficeMax, Inc. (OMX): Bear Stearns is affiliated with the specialist that makes a market in the common stock of this issuer,
and such specialist may have a position (long or short) and may be on the opposite side of public orders in such common
stock.
Staples Inc. (SPLS): The subject company is or during the past twelve (12) months has been a non-investment banking client
(securities related services) of Bear Stearns & Co. Inc.
Staples Inc. (SPLS): Bear, Stearns & Co. Inc. is a market maker in this company's equity securities.

Bear, Stearns & Co. Inc. Equity Research Rating System:

Ratings for Stocks (vs. analyst coverage universe):
Outperform (O) - Stock is projected to outperform analyst's industry coverage universe over the next 12 months.
Peer Perform (P) - Stock is projected to perform approximately in line with analyst's industry coverage universe over the next
12 months.
BEAR, STEARNS & CO. INC. 383 MADISON AVENUE NEW YORK, NY 10179 (212) 272-2000 WWW.BEARSTEARNS.COM

Underperform (U) - Stock is projected to underperform analyst's industry coverage universe over the next 12 months.
Ratings for Sectors (vs. regional broader market index):
Market Overweight (MO) - Expect the industry to perform better than the primary market index for the region (S&P 500 in the
US) over the next 12 months.
Market Weight (MW) - Expect the industry to perform approximately in line with the primary market index for the region (S&P
500 in the US) over the next 12 months.
Market Underweight (MU) - Expect the industry to underperform the primary market index for the region (S&P 500 in the US)
over the next 12 months.
Bear, Stearns & Co. Inc. Ratings Distribution as of March 31, 2007:
Percentage of BSC universe with this rating / Percentage of these companies which were BSC investment banking clients in
the last 12 months.
Outperform (Buy): 41.7 / 16.6
Peer Perform (Neutral): 49.4 / 11.8
Underperform (Sell): 9.0 / 7.2
Securities covered by the author(s) of this report include:
Christopher Horvers (Hard Line Retailers): Bed, Bath & Beyond, Best Buy Co., Circuit City Group, Lowe's Companies, Inc.,
Office Depot, Inc., OfficeMax, Inc., Radioshack Corporation, Rent-A-Center, Staples Inc., The Home Depot, WilliamsSonoma, Inc., Tuesday Morning Corporation, PetSmart Inc.

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