Description

With free cash flow far in excess of reported net income, a ridiculously low valuation and a near term catalyst that can move the stock higher,  Baldwin Technology Co. (BLD) in many ways is a more liquid version of ticker ADEP which is up 20% since we posted it 2 weeks ago  (ADEP is still cheap btw).   BLD, a misunderstood and growing supplier of process automation equipment for the offset printing markets, is trading at 5.2x LTM free cash flow (EBITDA+ non cash stock comp-cash int-cash tax-maintenance capex).  BLD’s free cash flow should increase next year from increased profitability and improved working capital.  Despite the negative trends in the U.S. publishing marketing, BLD’s business is quite strong due to factors discussed below, including printers needing to upgrade their technology and that only 20% of BLD’s revenue are from the USA and the rest is from growing international markets.  The company has historically done a terrible job highlighting the income statement items that mask the company’s true free cash flow; however, we believe the company is now prepared to better educate the investment community about its $1mm of annual non-cash stock comp expense, its 20% effective cash tax rate which is lower than its 42% book rate and the $0.8mm difference between D&A and maintenance capex.  Anyone who values the company on a p/e or ebitda basis is missing the point.  This write up will be very brief as the company’s website and SEC docs are informative and there is a near term catalyst (Sept 8^th the company will present at the Wall Street Analyst Forum in NYC) so VIC members may wish to quickly look at the stock before this conference.  We have not discussed our estimates for FY 2009 free cash flow (which should be higher than LTM’s) since (i) we are rushing to get this published before BLD’s presentation and (ii) if you don’t think the stock is cheap on LTM numbers, we doubt you will think its cheap on (even higher) 2009 numbers. 

Estimated LTM Free cash flow – The company has not yet published its 10k for FYE June, so the below LTM Estimated FCF is based on some released information and conversations with management.

EBIT                           $10.9

+Restruct charge             1.0

+D&A                             2.8

+non cash stock comp     1.0

-cash interest                 (2.9)  excluding amort expenses      

-cash taxes                   (1.8)

-capex                          (1.9)    

FCF                             $9.2mm

Stock Price                  $3.05

Shares outstanding        15.4

Equity mkt cap            $47.0mm

Debt                            25.2

Cash                            (9.3)

Enterprise Value         $62.9mm

Equity cap/fcf:  5.2x

Note: This FY, total capex will be higher than maintenance capex as the company has some non-recurring special projects, but the normalized  capex and D&A figures are the ones I have used above.  My valuation above does not reflect this higher non-maintenance capex, but nor does it give the company any credit for the improved profitability, working capital and cash flow it expects to generate next year.

Deceiving Cash tax rate - The company’s book tax rate in coming years should be 40-42%.  However, the company has over $55mm of combined domestic and foreign NOLS so its effective cash tax rate for the next few years should be under 20%. 

Non- Cash Stock Comp – Like many companies, BLD incurs a non-cash stock comp expense.  This $1.0mm annual expense is meaningful for such a small company and the company, regrettably, does not highlight this expense in its earnings release.  This expense should continue for several years, but again it is non-cash.  

Additional Gross Margin improvement –Management has committed to increasing its full year gross margin to 32% by the end of this calendar year.  Gross margin improvement is resulting from consolidating operations, outsourcing operations to lower cost countries and increasing the gross margin of OxyDry which was acquired last year.  On its August earnings call, BLD’s conservative CFO stated “there is definitely more room for improvement” in terms of gross margin.  Assuming no sales growth, if management were to increase gross margin to 32%, that would result in an incremental $0.9mm EBIT and $0.7mm aftertax free cash flow, which would increase free cash flow by 8%.  Gross Margin was 31.6% last FYE and 32.1% last quarter.

Strong Backlog – For reasons discussed below, despite weakness in the publishing market, BLD’s business remains strong.   While strong shipments last quarter resulted in June 2008 backlog being down to $48.2mm compared to $52.7mm a year earlier, strong July orders have increased backlog at the end of July to $54mm, virtually unchanged from last year’s figure.

Insider Buying – The company’s CFO bought $45k of stock last week at around $3/share.  I have always thought that since CFOs know their company’s numbers better than the (often overly optimistic) CEOs, insider buying by CFO can be a good tell.  Last year BLD’s CFO received a salary of $80k, so $45k is a fairly sizeable investment for him.  When the insider buying window was open the quarter before last, various insiders also bought stock, admittedly at lower prices. 

Significant Upside Potential – The following table shows the upside potential for the stock using various fcf multiples (note: if formating is screwed up, i will post table as an answer).

Sophisticated Institutional Buyers – Gabelli (11%) is a sophisticated holder of the company’s stock and we believe is in frequent contact with management.  We take comfort that they can help management create shareholder value.

Working Capital Improvement – Over the past year, we estimate management has successfully reduced working capital by $7mm.  We expect they can reduce working capital by another $3mm in the next 12 months.  We have not factored any working capital improvement into our analysis, but remind you that a $3mm working capital improvement is meaningful for a $45mm market cap company.

Increasing Investor Relations – A relatively unknown company, BLD is seeking to increase its i.r. efforts.  On September 8th they will be presenting at a conference in NYC and management is eager to speak or meet with investors.  They are located in CT and the CFO is very accessible.

Favorable Business Dynamics – (copied from latest earnings call transcript)

Baldwin performed stronger during the past several months than one might expects based on the current economic conditions. Several initiatives and dynamics contributed to this development; firstly for Baldwin there are two favorable trends in the newspaper industry.

(a) Due to the competition for advertising dollars from alternative media, such as the internet. Newspaper publishers are aggressively targeting to lower their production cost and improve the color and quality of their print advertising. They do that by either outsourcing the production to a third party or by internal pooling of production volumes. Both cases drives the demand for new printing centers including investments in new printing equipment and state-of-the-art process automation equipment

(b) To improve plant utilization, newspaper printing plants are also increasing their production of semi-commercial product such as colorful newspaper insert. That again creates additional demand for Baldwin equipment as we offer beautifully technologies for those newly emerging production processes. Those dynamics combined with our close relationships with OEM press manufacturer and our diligent focus to identify, track and successfully close on project in these segments, enables us to expand our position in the newspaper segment.

Secondly, the company benefits from an increasing demand for it’s consumables and parts, driven by growing installed base and trends in prints towards shorter-runs and more colors as a result of the competition with alternative expediting media to print, that I’ve just discussed. We are constantly engaged in further development of our consumable product offering to insure the best value to our customers on a global basis.

Thirdly, the company’s unmatched global present in all major markets for print, particularly in our growing presence in emerging countries enables us to take advantage of dynamics in emerging regions. Printers and publishers in those fast growing areas, now also tend to invest more into automation of the printing process. We expect those dynamics to continue and to generate further opportunities for our products offering. Our strategically important presence in Japan for 40 years, our initiatives in China and our operations in India provide us with a strong plus point to take advantage of opportunities appearing in Asia.

Fourthly, as a result of increasing awareness of the effects of printing on the environment and the desire to make the process more environmentally friendly, we are also experiencing growing demand for our filtration technology. Those investments upgrade not only contribute to the cleaning of print, but they also provide short payback periods in many cases less than a year. Additionally, Baldwin’s cleaning consumables are well-suited for the new environmental requirements. As a consequence the demand for our pre-impregnated washcloths that contain solvents with very low levels of volatile organic compounds content is growing.

Let me now give you some feedback from Drupa 2008. From May 29, through June 11, Dusseldorf was host of the worlds leading exhibition for the print media industry. The feedback from press manufactures throughout the show was very positive. They reported strong demand during the two weeks at Drupa 2008. Customers from emerging countries such as China, Eastern Europe and Latin America especially contributed to that success.

Drupa 2008 provided us with a great platform to show our range of innovative process automation technologies. As reported during our last call, we also celebrated Baldwin’s 90th anniversary during the show. The traffic at our booth throughout the 14 days, both from OEM press manufacturers as well as from printers and publishers was very impressive.

Our booth was strategically very well positioned and our open stand concept attracted many visitors. During the show we also introduced our new cleaning platform for newspaper applications, Impact Fusion F and ProTect 2, setting new standards in blanket cleaning for newspaper print. These products have been designed for straight newspaper or semi-commercial print applications where gas dryers or UV Curing Systems are installed.

Finally, I’m to report you on our progress to expand Baldwin’s presence in China. We successfully started the production of our first product in Shanghai this past year and we are now implementing the transfer of sourcing and manufacturing of a second product line to China.

As previously mentioned, China and its surrounding Asian market is a very promising print market and it will play an increasingly important role in our activities in the future.

Stock buyback program – The company has $2.8mm of availability under its buyback program.  The company has not been an aggressive buyer of its stock.  In the March quarter they bought 150k shares at $2.73 per share and we do not believe they bought back much stock last quarter.  Last FY the company paid down $11mm of debt and now that they have a much healthier balance sheet we hope they will use their free cash flow to buyback stock.   The company does intend to opportunistically grow through acquisitions.

Potential Lawsuit Windfall – The company has sued Technotrans, a German company, over patent infringement.  BLD is suing the company for approximately $40mm.  BLD will not need to incur major legal expenses for this case and expects a ruling during the first half of calendar 2009.  We have not investigated this case extensively and would be buying the stock even without the potential benefit of this legal victory.  Technotrans is a microcap, publicly traded in Germany.  A settlement of $40mm (or even a partial settlement) is very meaningful considering BLD’s market cap is currently only $45mm.  However, we do not know how much (if any) Technotrns will be ordered to pay or if they will have the financial ability to make such payment.

Dual Class of Stock – One negative is that the company has 2 classes of a stock.  Although the supermajority class is no longer able to control the Board, the optics of a dual class of stock rubs people the wrong way.  Holders of the supermajority shares are also significant holders of the “regular” shares.

Catalyst