UPDATE:Office Depot Shuns Contract Potentially Worth Over $500 Million

Office Depot Inc. (ODP) walked away from a contract potentially worth over $500 million in annual revenue, but might be better off without it and could actually have bought itself one more year of the revenue.

Friday, Office Depot said it wouldn't submit a bid in Los Angeles County related to the U.S. Communities Government Purchasing Alliance, a cooperative that aims to secure good terms for supplies that local and state governmental agencies need. Office Depot has had the contract since 1996, and it represented roughly $600 million, or 5%, of its 2009 sales. By backing out of the bidding process, and with a dearth of large bidders, the cooperative has the option to cancel the bid and renew the existing contract for the 2011 year.

Office Depot, the No. 2 office-supply chain by market capitalization, said the "onerous" terms of the contract could have hurt profitability. While shares of the company dipped in after-hours trading Friday on the news, they moved higher Monday afternoon following notes from at least three analysts downplaying the news and highlighting ways the loss of business might be an overall positive for Office Depot.

Joe Sandoval, general manager for purchasing and contract services for Los Angeles County, who runs the bidding process, said he has "no intention" of cancelling the bid at this time, citing other "valid" bidders. He confirmed that OfficeMax Inc. (OMX), the third-largest office supply retailer, didn't attend the preliminary bid hearing and therefore isn't allowed to bid on the contract.

Sandoval noted that he is permitted to extend the current contract for one year should he decide that's the best option. L.A. County makes the bid on behalf of other agencies across the U.S., he said, and aims to use the size of the contract to exercise pricing power, "looking out for the taxpayer."

Analysts at both Janney Capital Markets and J.P. Morgan said Office Depot's decision demonstrated "discipline," and J.P. Morgan called it the "right decision for the long term."

Office Depot shares have slumped since posting first-quarter results that missed Wall Street views and warning its business remained weak in California, where some 13% of its U.S. stores are located.

Further, it recently lost its accreditation with the Florida Better Business Bureau, according to Office Depot, because of its recent, roughly $5 million settlement with "the Florida Attorney General concerning contract pricing to certain customers in Florida." Office Depot said it is "optimistic" the appeal process will result in restored accreditation.

Plus, Chairman and Chief Executive Steve Odland and two former employees have received Wells notices from the Securities and Exchange Commission's Miami office notifying the three the office made a "preliminary decision to recommend that the SEC bring civil enforcement actions against them related to possible violations" of disclosure rules.

FBR Capital Markets, which had expected Office Depot to retain the majority of the contract, believes the decision to abandon the bid could even yield a "strategically positive" outcome. FBR now believes Office Depot's move will, in fact, cause Los Angeles County to cancel the current bidding and renew the current contract, under the same terms, for one year. This would mean Office Depot wouldn't have to take on the new, less-palatable terms, while keeping the revenue stream and giving the company "another year to regain traction and credibility."

Office Depot, in a federal filing, said the low operating profit on the contract mean it "could manage [its] infrastructure costs as needed in the short term to mitigate the potential financial impact of the current business not retained." A company spokesman declined to be more specific.

Industry behemoth Staples Inc. (SPLS), meanwhile, has called the contract terms onerous in the past, and FBR said another contract it has appears to have a conflict that could discourage it from making a competitive bid. A Staples spokesman declined comment on its contract bids.

Office Depot shares, off 48% in the past three months, were recently up 6 cents, or 1.5%, at $4.12.

-By Maxwell Murphy, Dow Jones Newswires; 212-416-2171; maxwell.murphy@dowjones.com

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