Shares of both Office Depot Inc. and Staples Inc. are up in early trading Tuesday on a report that the two office supply chains — under pressure from activist fund Starboard Value LLP — are in advanced talks to combine. The possibility of a merger comes as Starboard's chief, Jeffrey Smith, has been eying a March 4 deadline to nominate director candidates to Staple's board, according to people familiar with the situation. A merger would need to be announced before the deadline to avoid a possible proxy fight with Starboard that could involve the activist fund running a change-of-control slate of directors. Office Depot was up 16.6% at $8.94 per share and Staples was up almost 11% at $18.97 in early morning trading Tuesday after The Wall Street Journal reported that the two companies were in advanced talks to combine. Staples has a market cap of about $12.2 billion, while Office Depot has about a $4.9 billion market cap. Must Read: One Big Risk in a Potential Merger Between Staples and Office Depot The reported talks come shortly after Starboard opened its activist campaign with a regulatory filing in December, followed by a Jan. 20 letter from Smith to Staples chairman and CEO Ronald Sargent raising concerns about governance changes the company implemented on Jan. 14 and pushing for a combination of the two chains. The activist urged Staples to hire an investment bank and antitrust lawyers to help it evaluate a transaction with Office Depot. Starboard, Staples and Office Depot officials did not return calls. Steve Wolosky, a partner at Olshan Frome Wolosky LLP who represents Starboard, also did not return calls. If Starboard succeeds at driving Staples and Office Depot to combine he may want to give some credit to John Chevedden, a gadfly investor who is known for making nonbinding shareholder proposals at companies in which he has small stakes. Chevedden's proposal at Staples' June annual meeting to create an independent board chairman received more than 51% of the vote, a significant vote of non-confidence by the office supply chain's investor base. That's the kind of indicator that institutional investors aren't happy with top management that the Starboards of the world like to see before going full tilt with a public campaign. Smith acknowledged Chevedden's proposal in his January letter, noting that a majority of participating shareholders at the company's 2014, annual meeting voted to separate the roles of chairman and CEO and that Starboard was "disappointed" that it took the company more than seven months to respond to "this clear mandate from shareholders." Staples had said on Jan. 14 that the board plans to appoint an independent chairman upon the succession of the current chairman. However, people familiar with the activist argued that Staples' succession announcement left it unclear whether Sargent would step down from his job anytime soon. And proxy advisory firm Institutional Shareholder Services governance Quickscore Report for Staples, obtained by The Deal Tuesday, appeared unmoved by the company's governance changes. Both before and after the latest change, ISS had given the company a seven out of 10 (with 10 being the worst score). Notably, the ISS report issued a red flag that said the role of chairman and CEO have not been separated. That suggests that disgruntled institutional investors that voted for an independent in June are unlikely to be appeased by the company's moves and could be amenable to backing Starboard's efforts if it came to a proxy fight. Staples on Jan. 14 also announced that it had added a Google Inc. executive, Paul-Henri Ferrand. In addition, Staples said Sargent had elected to accept a 2.5% base salary raise and to eliminate a tax gross-up provision in his pay plan. Tax gross-ups are typically payments to an executive that are equal to their tax liability. The possibility of a merger comes about a year after a $1.2 billion combination between Office Depot and OfficeMax Inc. — one that received extension attention from antitrust authorities but ultimately was approved in November 2013 without divestitures. Starboard was heavily involved with that merger — the fund pushed to put its candidates on the board at Office Depot after a deal was announced, eventually settling for three board seats, including one for Smith who had a hand in recruiting Office Depot CEO Roland Smith, a former supermarket executive. An Office Depot-Staples combination also brings up the specter of 1997 when the two companies tried to merge, but were blocked by the Federal Trade Commission. Still, as the Office Depot-OfficeMax deal illustrated, the competitive landscape has been greatly altered, especially now that brick-and-mortar office supply stores face stiff competition from online retailers such as Amazon.com Inc. as well as big box stores including Costco Wholesale Corp. , Target Corp. and Wal-Mart Stores Inc. . Nevertheless, such a deal would likely be looked at thoroughly by antitrust authorities in Washington. Read more from:
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