The evening of the day after....

Today was a very quiet day with respect to CE, compared to the launch of the offer from Staples to buy the company just a couple of days ago, which was rapidly followed by a trick of CE themselves, namely the proposed merger with the French company Lyreco. After the announcement yesterday, shares of CE initially dropped about 8% to EUR 7.44, but recovered during the day to a level of EUR 7.99, just 1.5% below the previous day close with a volume of more than 25 million shares traded. Today was a remarkable day with the share price ending at a level of EUR 8.21, which is well above the offer from Staples. Volume with 9 million shares was also again strong. Like many others, I am very curious to see where this will eventually lead to, and it sure is interesting to speculate about it.

I believe very strongly that today's price moves were not caused by investors who think the Lyreco merger is a great deal. I rather think that it is caused by speculators betting on a last increase of the offer price by Staples to convince CE shareholders that an increased offer is superior to the merger with Lyreco, which may be only mildly superior to the execution of the stand alone strategy of CE.

Staples must surely be very surprised, like most of us, that CE was able to bring this deal to the table. Staples should however take part of the blame for allowing this to happen. The company smelled a bargain, when CE was really brought to extremely low share price levels, and took those low levels as the base line for their offer. It is no wonder this left many long term CE investors, who would have bought at levels of at least EUR 10 per share and more, insulted and reluctant to accept an offer that would lock in a substantial loss position for them.

CE must have surely been desperate to accept the deal with Lyreco at these conditions. I am willing to accept that CE and Lyreco were already talking for many months about a possible merger. But come on, you are paying 19 times 2007 net income and giving away the top job, and you call that a great deal? The deal was put together this way, because management of CE wants to block an acquisition by Staples. At a valuation well below the EUR 1,731 million price tag, I could have accepted this as a sensible deal for CE shareholders, but now I believe they would just go from one promise for the future to the next promise for the future.

In a nutshell, CE may get into a situation where they will incur initially additional finance costs of EUR 70 million a year, and get net synergies of negative EUR 12 million in the first year, EUR 48 million in the second year, and EUR 80 million in the third year. Only in year 4, which is 2012, the full annual benefits of EUR 100 million are expected. The additional profits still have to come from EBITDA margin increases and sales growth, just like in the strategic plan. The higher profitability of Lyreco may bring an instant higher margin and net income, but unfortunately this higher net result also has to be shared with 102.5 million new shares.

I am not able to see that a merger at these conditions is a master stroke by Mr. Ventress, although it could end up unintentionally creating more value for CE shareholders through an increased offer by Staples. If Mr. Ventress wants to take credit for that later, that's fine with me.

Lyreco is surely the smart party, until now, in this story. The situation with Staples allowed them to leverage their negotiation position, and get a lot more value and power out of this deal than would have otherwise been possible. Just imagine a possible alternative, where Lyreco would have had to speak with Mr. Buffett on his European tour. He would have been impressed with the company and may have offered them maybe 12 times 2007 net income in cash on the spot. No, this situation is much better for Lyreco, and the story may not even have ended yet for them, having shown that they are willing to be acquired.

While market participants will be pondering the merits of the merger with Lyreco, Staples must also be considering what their next move should be. It seems clear that the EUR 8.00 offer is dead. Even if it would be superior value for CE shareholders, they now have an alternative, that may be good enough reason for them to decline the offer from Staples. This can not be a pleasant outcome for Staples, unless they believe CE and Lyreco will screw up the merger and future years ambitions. In my opinion, Staples could and should consider raising the offer to a level where CE shareholders feel it is the safer bet, and gives them a better feeling about sharing the potential synergies of the acquisition by Staples. A raise to a level of EUR 8.50 may not do the trick anymore. Just consider if Staples would offer EUR 9.00 per share, which would be an increase of about $290 million, or about $ 0.40 per Staples share. Surely this will not be the biggest obstacle. Even a higher price would not be such a big deal, but I will not speculate further about the wisdom of Staples in setting an increased offer price.

If Staples can still acquire CE, and effectively block the merger with Lyreco, there may be another added advantage, being the fact that apparently Lyreco is willing to be purchased (in case Staples didn't know this already). This does not have to happen immediately, but at least the purchase price can be brought to more sensible levels, and given some time, Staples could probably pay in cash as well, or could consider issuing shares to finance a deal.

Staples could also be really bold, and block the merger with Lyreco by acquiring CE, and immediately renegotiate the terms of the merger with Lyreco, and make it a Staples/CE/Lyreco combination. That sounds like a perfect end game, but I am probably getting carried away now......