Fitch Ratings has assigned a 'BBB-/RR1' rating to Staples, Inc.'s new credit facilities, composed of a $3 billion five-year asset based lending (ABL) revolver and a $2.75 billion six-year secured term loan. Fitch currently rates Staples' Long-term Issuer Default Rating (IDR) 'BBB-' and its Short-term IDR 'F3'. As of Jan. 31, 2015, Staples had $1.1 billion of debt outstanding. A full list of ratings follows at the end of this release.

Staples' ratings are maintained on Rating Watch Negative following its February 2015 announcement that it has agreed to acquire Office Depot in a transaction that is expected to close by the end of the calendar year, subject to FTC approval. The $6.3 billion transaction values Office Depot at around 9.5x its 2014 EBITDA of $648 million or 7.3x including $210 million in unrealized synergies from the merger between Office Depot and Office Max that closed in Nov. 5, 2013.

The Rating Watch Negative on Staple's IDR and existing bank facility and notes reflects a projected increase in financial leverage as Staples will finance the acquisition with proceeds from the $2.75 billion term loan, a $1.5 billion draw on the $3 billion ABL revolver, and $2.1 billion of Staples' stock. On a pro forma basis as of Jan. 31, 2015, adjusted debt/EBITDAR for the combined company is around 5x, compared with 3.2x for Staples on a stand-alone basis.

Pro forma for the merger with Office Depot, Staples had EBITDA of $2.1 billion in 2014, and Fitch believes EBITDA could approach the $2.5 to $3.0 billion range over the 24 - 36 months following the close of the merger as synergies flow to the bottom line. Fitch expects that leverage could improve to the mid-3x range 24 - 36 months post the closing of the transaction based on growth in EBITDA and debt repayment.

Fitch would expect to downgrade Staples's IDR to the mid to high 'BB' category assuming the merger closes as contemplated following an FTC review. Staples is not required to close the transaction if antitrust authorities require divestiture of assets (retail and/or commercial businesses) that deliver more than $1.25 billion of Office Depot's revenues in the U.S. Staples must pay a $250 million termination fee if the agreement is terminated due to antitrust requirements.

The rating of the bank facilities reflects their senior secured position in the capital structure. The ABL revolver is secured by a first lien on receivables and inventories, and a second lien on the term loan priority collateral. The term loan is secured by property and equipment, intellectual property, and equity interests in restricted subsidiaries, and a second lien on the ABL priority collateral. Both facilities would be expected to receive a full recovery, resulting in an 'RR1' recovery rating, with the ratings capped at 'BBB-' in accordance with Fitch's criteria given our expectation that Staples' IDR would be 'BB' or 'BB+'.

The ratings take into account the benefits and challenges from the combination of Staples and Office Depot. The merger will create a significant competitor in the office supply category, with combined sales of $39 billion, and EBITDA of $2.1 billion. The combined company's sales divide North American Retail 44%, North American Commercial 37%, and international 19%. The challenge will be to stabilize the core office supply business while generating growth from non-office supply categories.

The merger will create significant net synergies, estimated by Staples at $1 billion or more over three years, at a one-time cost of $1 billion. Fitch believes that while a meaningful portion of these synergies will be realized, but that EBITDA will be constrained longer-term by weakness in the underlying business.

Staples' revenues declined 2.7% in 2014, or 0.1% excluding the effect of store closures and changes in foreign exchange rates, while EBITDA for the year declined to $1.5 billion, or 6.6% of sales, from $1.8 billion (7.7% of sales) in 2013. This reflects sales and margin pressure in the company's North American retail business, and some margin contraction in the North American commercial segment.

These trends reflect a secular decline in sales of core office supplies (55% of Staples' 2014 sales, half of which is paper, ink and toner), and weak sales of business technology products, computers and mobility (21% of sales). Declining operating performance also reflects competition from online retailers and persistent weakness in the company's international segment. Fitch believes these trends will persist as the company's investments in its prices, marketing and website to drive sales will likely pressure margins over the near term but could potentially help mitigate top-line pressure longer term.

Key Assumptions:

• Successful completion of the Office Depot acquisition in late 2015.
• Continued top-line weakness in the combined entity's retail business offsetting growth in the commercial business.
• FCF after dividends for the combined entity of $700 million to $1 billion annually will be used for debt reduction.
• Adjusted leverage improves to the mid-3x range 24 - 36 months post the closing of the transaction based on growth in EBITDA and debt repayment.

Rating Sensitivities

Fitch would expect to downgrade Staples's IDR to the mid to high 'BB' category assuming the merger closes as contemplated. If the merger is terminated, future developments that may, individually or collectively, lead to a negative rating action include continued negative sales and margin trends and declines in EBITDA that drive adjusted leverage towards the mid-3x area.

Future developments that may, individually or collectively, lead to a Stable Outlook include a termination of the planned merger with Office Depot, a stabilization of top-line and EBITDA trends, and maintenance of adjusted debt/EBITDAR at or under 3x.

Fitch has assigned the following ratings:

Staples, Inc.

• $3 billion ABL revolving credit facility 'BBB-/RR1';
• $2.75 billion secured term loan 'BBB-/RR1'.

To view Fitch Ratings' entire release, click here.