Why Office-Supply Stores Popped and Then Dropped

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Office Depot (NYSE: ODP  ) and Office Max (NYSE: OMX  ) opened higher today on word that their merger was official, and the stocks moved up 10% and 15% higher, respectively. However, once details of the companies' plan emerged, both stocks plummeted, with Office Max falling as much as 9% and Office Depot taking it on the chin with a 19% loss.

So what: According to the terms of the deal, Office Depot agreed to buy Office Max in an all-stock deal valued at $1.2 billion. Office Max shareholders will receive 2.69 Office Depot shares for every one Office Max share. Based on the current prices, Office Max shares appear overvalued. Investors seemed to grow sour on the deal when the announcement revealed that the two companies had not agreed on a new headquarters or a CEO and took the odd step of splitting the board evenly. Insiders expect the deal to close by 2013. Both stocks had made strong gains yesterday when rumors broke, but Office Depot gave back all those gains and then some, while Office Max lost about half of yesterday's share-price appreciation.

Now what: The market seemed overly optimistic on this deal to begin with, and Staples' (NASDAQ: SPLS  ) tandem response is even more bizarre. Investors seem to think the merger will create a stronger Office Depot yet also benefit Staples, but strangely, when Office Depot and Office Max shares tanked, Staples followed, down as much as 8%. A disastrous merger would seem to favor the current industry leader more so than a successful combination. Either way, I'd avoid this industry entirely, as bricks-and-mortar office retail seems destined for the dustbin. Walk into one of these stores and you're more likely than not to be greeted with empty real estate and only the sound of the ventilation whirring. For a better choice in the broader sector, pick up a copy of our newest special free report: "3 Companies Ready To Rule Retail". Just click right here to get access now.