In the self-congratulatory statement the U.S. Department of Justice released earlier this month when it thought it had killed the 3M Co.'s planned purchase of Avery Dennison Corp.'s office and consumer products business, one thing stands out.
"American customers will continue to receive the benefits of competition," the head of the department's antitrust division said, "including lower prices and greater innovation in these basic office supplies."
The DOJ may have a point on prices, but on innovation it seems backward. Sparking innovation in the fading Avery business was a big part of 3M's motivation for doing the deal in the first place.
Avery's business was not a wreck; it was profitable on 2011 sales of about $760 million. But sales had been on a long slide, shrinking by nearly one-third from 2004 to 2010. Avery's capital spending on the group had declined by about 75 percent over the same period, with Avery putting its capital into more attractive opportunities.
Meanwhile, Maplewood-based 3M had been investing in its office supply business, and its sales had been growing while Avery's were shrinking.
"Initially we were all scratching our heads, and going, 'Why are you buying a dead asset?'" said Nicholas Heymann, the co-head of global industrial research for the investment firm of William Blair & Co. "And [3M's] explanation was that it was really an undermanaged asset. There was a lot of opportunity there, to give 3M a lot more stratification for different price points."
In discussing 3M's opportunities for innovation, Heymann talked about 3M's "pyramid" strategy. It's 3M's way to describe its interest in developing new low-end products -- the bottom of a pyramid -- to protect its market share of premium products at the top.
By acquiring Avery brands, including Avery and Hi-Liter, to put alongside Post-it and Scotch, Heymann said, "there is a lot of opportunity for a double or triple pyramid to work there. They would have the flexibility to offer different products for each customer that are kind of unique but still kind of the same thing. And all of them at different price points."
The whole idea of innovation in a category as bland as office supplies may be counterintuitive. The contents of your office supply cabinet may seem pretty similar to that of William L. McKnight, who stepped down as 3M chairman in 1966.
But look closely. There has been a plenty of innovation. Many of us were adults when we held our first Post-it Note. And loved it.
"At some point it seems like throwing a bunch of innovation at buggy whips," said Mark Henneman, an investment manager with longtime 3M shareholder Mairs and Power Inc., in St. Paul. "But you have got to give the [3M] guys a lot of credit, if they see an opportunity. The people we know in the office supply space were really excited about" the Avery acquisition.
The $550 million all-cash purchase had been announced right at the beginning of this year. The purchase was to include Avery's well-known address labels as well as binders, presentation products, filing and indexing products, writing instruments, and other office and home organization products.
It is routine for companies to submit acquisitions to U.S. authorities for a review of whether the deal will lessen competition and hurt consumers. And clearly there is overlap and competition in this case, so 3M had to know there was a risk of a regulatory hiccup. From the start, the deal had not included Avery's Label Pads and NoteTabs, two product lines that are similar to Post-it Notes. An Avery spokesman said "we are evaluating ways to maximize the value" of those products, which likely means they are even now being shopped to other potential buyers.
"3M has a strong position in the market due to its brand equity," said Ghansham Panjabi, an analyst who follows Avery for Robert W. Baird & Co. "In 2009, 3M entered the [label] market in a big way, and they actually destructed pricing in the market to the point that pricing became more favorable to you and me as consumers. That's the genesis of what DOJ is targeting."
The concerns about label competition were enough to cause the DOJ to threaten to sue to block the deal, and the DOJ release said 3M had abandoned the deal.
Right away after DOJ's statement the two companies released their own, saying that DOJ had it wrong and that they were as committed as ever to closing the transaction.
Rather than abandoning the transaction, as DOJ said, they had simply withdrawn their file to tweak it and then later resubmit it.
3M has declined to discuss the situation further, and analysts acknowledge that they are mostly speculating on the two companies' strategy for retooling their submission to the DOJ.
One common approach is to identify the most sensitive, head-to-head competitive products and carve them out of any acquisition, and then sell them to someone else, as Avery appears to be doing with NoteTabs. Carve out too many assets, of course, and 3M will not see as much strategic value and may abandon the transaction.
A more direct approach for 3M and Avery is winning the argument with DOJ, as analyst John McNulty of Credit Suisse discussed in a short note to his clients. He wrote that they intend to talk directly with large customers to alleviate their concerns about pricing and innovation, and presumably to get them to fully grasp that one of the things at risk in killing this deal is further innovation in the category.
"Maybe this deal isn't dead," said Henneman, in discussing the potential of that pitch to the likes of Staples and OfficeMax. "That would seem to be a pretty easy argument for 3M to make."
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