By Nadia Damouni and Dhanya Skariachan
NEW YORK (Reuters) - Office Depot Inc
Both companies, which trail industry leader Staples Inc
The deal is expected to be structured as a stock-for-stock transaction, the person said, but the source also warned that the talks could still fall apart.
Office Depot has a market capitalization of $1.1 billion while OfficeMax has a market value of $932 million.
Analysts have long called for consolidation in what they see as a cluttered sector, in which sales crumbled during the global financial crisis. Office supply stores are also fighting a battle for relevance, with shoppers increasingly buying their paper, toner and technology online or at mass merchants.
Office Depot declined to comment on the news of a potential deal. Representatives for OfficeMax were not immediately available for comment. The news was first reported by the Wall Street Journal.
Neuberger Berman LLC, one of OfficeMax's top investors and which has pressured the company to do more for shareholders, said it would support a merger with Office Depot Inc
Benjamin Nahum, a portfolio manager at the investment firm, told Reuters in an interview on Monday that his preference would be for OfficeMax to declare a special dividend before merging with Office Depot.
"In our view this would facilitate a fair deal," Nahum said, adding that OfficeMax shareholders should be compensated for "the balance-sheet strength that we bring to this combined entity".
Neuberger Berman had called on the company last June to return money to shareholders in the form of a dividend or share repurchases and raised the specter of a proxy fight.
According to Thomson Reuters data, Neuberger Berman owns 4.76 percent of OfficeMax, making it the third-largest shareholder of the Naperville, Illinois company.
Office Depot has also come under pressure, with activist hedge fund Starboard Value LP urging it last September to make some drastic cost cuts and take other steps to improve performance.
In 2011, Office Depot CEO Neil Austrian told Reuters that while the office supply retail sector was ripe for consolidation, antitrust regulators were sticking to an antiquated view of the sector and not letting key players merge.
The Federal Trade Commission rejected a $4 billion merger of Office Depot and Staples in 1997, saying it would lead to less competition and higher prices for customers.
Analysts now play down those concerns as mass merchants such as Target Corp
On Friday, shares of OfficeMax closed down 1.29 percent to $10.75 while Office Depot was up 2 percent to $4.59. U.S. financial markets were closed on Monday for a national holiday.
(Editing by Bernard Orr, Dale Hudson and Edwina Gibbs)