Description

We believe Cimpress is a great long at the current price.

In a nutshell:

• The company is a powerful disrupter with an already dominant market position in a large fragmented industry where eventually only few competitors should remain.
• Compared to traditional business models the company's business model provides great value to customers at a fraction of the traditional costs in the industry.
• Importantly the economies of the business and industry allow the company to keep a fair share of the created value to itself, which leads to high returns on capital that should persist for a long time.
• The true earnings power of the business is currently masked by aggressive investments that lower current earnings, but should ultimately drive intrinsic value much higher.
• The business is managed like a private company with a very long term focus and the founder and his team often implement changes that create near term earnings volatility.
• Every now and then, the market hates some of the changes and the stock tanks. Recent changes and events led to a 15% sell off after the last earnings release. We believe the company was already undervalued before the sell off and is even more so now.
• The company currently trades at what we believe to be roughly a 10% earnings yield of its true earnings power, while growing its true earnings power at rate greater than 10% a year.

Business description:

Cimpress is in the boring and slightly but surely declining printing business. However, its business model has completely changed the economics of printing small individually customized products. Historically you clearly had a very pronounced classic cost curve in the printing industry, where a low number of units results in a very high unit cost and increasing unit numbers progressively lead to lower unit costs. Cimpress has broken the classic cost curve in the printing business and has comfortably positioned itself at a point where it is able to produce small order sizes of uniquely customized products with the quality, reliability and importantly the cost structure of mass production.

This is possible because the company takes in a huge volume of small individually designed orders that are solely acquired through the web, are then clustered and routed by smart software systems to more homogenous batches and then fulfilled by a highly automated manufacturing platform. The business started out with business cards under the Vistaprint brand and that is the area where Cimpress so far has certainly achieved the highest level of automation. Today, Cimpress produces around 6 billion business cards a year at a fraction of most competitors’ costs. An order of 250 business cards needs less than 15 seconds of human labour for pre-press, printing, cutting and packaging. Compare this to the collectively biggest competitor group of small local printing shops. They don’t stand the slightest chance to be cost competitive and automation is not even the only advantage Cimpress has over them.

Cimpress is a very determined company with ambitious goals. So the same mass customization principles are not only applied to business cards, but to a variety of other printing products like, flyers, leaflets, brochures, banners, signs, trade show displays, packaging products like folded cartons, bags and labels, promotional products and gifts like decorated apparel, bags, textiles and some hard goods, you get the idea. Over time the company will try to dominate every market where the principles of mass customization create great value for costumers.

In FY 2016 the company produced over 46 Million uniquely designed products and is currently at a revenue run rate around $2b. Revenues are roughly split between Europe and North America and a bit in the rest of the world. The core customers of Cimpress are micro and small businesses that benefit greatly from the company’s low prices. One might think this is a small market, but taken together it is quite large and Cimpress should have a long runway ahead of it.

Revenues are up over 10 times since the company went public in 2006. GAAP earnings are clearly up but show a different picture, they started to depart in FY 2012. Since then earnings are burdened with aggressive marketing investments, loss making start-up units in regions other than the established markets North America and Europe, aggressive software builds, intangible non-cash amortisations and integration costs from acquisitions and large investments in quality and service to improve customer experience and loyalty to drive customer life time value higher.

In our opinion, taken together the investments make great sense and will continue to achieve decent returns. Some investments were and are certainly needed to keep a decent organic growth rate. Some investments are for profitable growth 5+ years down the road; some smartly widen the company’s competitive advantages; some are for long term brand building and other investments continue to increase the company’s TAM. We think there will come a day when the company will stop to be as aggressive as today and the margins will gap up. However we hope that this day will be quite far in the future.

Just a look at the headline numbers of cash flow, free cash flow and share count during the period of 10x revenue growth shows the quality of the business. The period after FY 2011 looks messy and seems like the business has lost some of its quality, but we don’t think this is the case. The transcripts and slides of the last 5 years of investor days and the letters from CEO Robert Keane hold a great amount of information about the evolution of the business and put the historic and current numbers in the right context.  

Why we think this business is a winner:

·        Cimpress has a disruptive business model:

We think of a business model as disruptive, if it happens to dramatically change at least one of the defining competitive factors like functionality, reliability, convenience, quality or price of a product or service in an industry. Cimpress clearly step changed the price equation with its mass customization approach. Its growing size continues to increase this advantage over traditional competitors. Initially price was the only way Cimpress, or more appropriately Vistaprint back then, could attract customers. The beginnings where humble, improvements followed and so did customers with higher expectations who want more than just cheap prices.     

Given enough time and scale, the business model should be able to not only deliver the lowest prices but also an unmatchable variety of products, higher quality and greater convenience than local competitors can provide. Scale brings great power to the mass customization business model, whereas historically there were little economies of scale at play in this industry (not talking about the high unit volume part of the printing industry). This is also why the industry is still so fragmented.  

Another nice feature is, even though we are still relatively early in the transformation of the industry, we are already well past the point where it is easy to start a new company with a matching business model and compete with Cimpress. So we think there is relatively muted interest to newly enter the business with a similar business model, the small existing ones will have a tough time and the small traditional incumbents are unable to scale and become competitive. 

·        A dominant market leading position:

Cimpress is the largest and at the same time most determined company in its industry. Taken as a group, the local printing shops are the biggest competitors, but they are poorly positioned strategically. We think of them as destined to loose and welcome market share donators going forward.

The companies Office Depot including Office Max, Staples, Fedex Office and UPS Store also compete with Cimpress. All of them have a physical presence with over 1000 stores across the US, but none of these companies primarily focuses on customized printing; it is more something that they sell on the side. They generally rely on instore printing where they can’t get the advantages of mass production. Cimpress has/used to purse some partnerships with them (we are not aware of partnerships with other companies). Cimpress has an ongoing partnership with Fedex Office had one with Office Max and until very recently also had a partnership with Staples.  

We don’t see the group of companies with large physical presence as well position either. They are not building large scale mass customization printing footprints and without that, a company won’t be cost competitive. They also lack and are not aggressively building a successful web presence to cheaply acquire orders based on templates/easy to self-build designs. 

Real long-term competition comes from companies that are able to both scale and connect a mass customization printing platform and a web front that is drawing in customer orders in large numbers. Besides Cimpress there are a couple of other companies trying to do that, but we think Cimpress is by far the most successful of them and best positioned as well.

Direct competitors with a focus on printing material for micro, small and medium sized businesses are generally quite small. A list would include (ranked by US traffic based on Alexa data): Moo.com, uprinting.com, gotprint.com, overnightprints.com, psprint.com, nextdayflyers.com, printrunner.com, printplace.com, jukeboxprint.com, 4over4.com, primoprint.com and 48hourprint.com. We don’t really have revenue and profit numbers because they are all private, but by looking at estimated traffic, page views, time spent on side etc. it is quite obvious that Vistaprint which only generates 60% of Cimpress’ revenue is the 800-pound gorilla. In fact we think most of them are tiny. Moo is likely the biggest but still generates less revenue than Cimpress generates FCF. However, Moo currently seems to be able to successfully scale at least in premium business cards.  

Another group of direct competitors are the ones that focus on consumer products like photo books, holiday & birthday cards, posters and calendars, customized clothing, and promotional goods. The biggest and most successfully scaled company in this area is Shutterfly.com in the US (public with roughly $1b in revenue and $100m FCF) followed by CEWE (public with roughly $650m revenue and $40m FCF) in Europe. They are quite large, but both of them make most of their money with photo printing which is not the most attractive market in our opinion. Other competitors, again ranked by size based on US traffic include Zazzle.com (private, likely around $350m revenue), cafepress.com (public, $100m revenue, shrinking, slightly negative OCF), avery.com (primary focus labels), customink.com (private, likely around $400m revenue), 4imprint.com (public $400m revenue $10m FCF), snapfish.com, discountmugs.com and qualitylogoproducts.com.     

 Overall, Cimpress is the dominate player in its core market, large in other areas and we think by far the best positioned company of all.

·        Large addressable market opportunity:

The company estimates that its addressable market in North America and Europe alone is $100b. In addition, other geographic regions (which the company correctly terms as most of world) and the consumer print market would increase the figure by at least 50%. This estimate leaves Cimpress with current market share of just below 2% in North America and Europe and even lower on a global scale.

Most of the printing orders happen to still go through an offline channel, but like in many industries the online channel rapidly takes share due to its advantages. The transition from offline to online will provide a nice and long tailwind for Cimpress and open up more and more of the large market opportunity.  

·       Defined group of future market share donators:

There are still a vast number of small print shops out there that compete with Cimpress in its core market. We think a significant number of them will have to close shop over time and the ones that survive will likely need to outsource the printing to companies like Cimpress and only focus on the client service and design part of the business. Due to its dominant position, Cimpress is positioned as the natural winner and likely to continue capture the highest share from the donators.

It is estimated that there are still around 30’000 print service provider in North America with 70% of them having less than 10 employees. The landscape in Europe doesn’t seem to be materially different. In Germany alone, there are roughly 6’000 print shops with less than 10 employees, which also equates to roughly 70% of all the print shops in the country (Link).

·      Cimpress heavily invests in its competitive advantages:

In our opinion the company’s 2 biggest advantages are its relative/absolute scale and its mass customization platform (MCP) including the needed manufacturing and software technology capabilities. The company is well aware of its advantages and aggressively invests in both.

The MCP is a result of over 200 filed patents and an investment of over $1,4b in technology and manufacturing. To replicate this platform it would take a competitor years and the learning curve is likely quite flat.

Scale is very important in this business. Scale lowers per unit costs in many areas and brings additional benefits on top: lower costumer acquisition costs, lower software development costs, greater cross selling possibilities, lower procurement costs, more efficient logistic systems, better shipping terms, economies of scale in manufacturing, better customer service, budgets for long term brand building, G&A leverage etc.

The company currently spends close to $550m in marketing and selling (roughly 30% of revenue and ca. 2 times the FY 2011 amount), over $220m in technology & development (roughly 12% of FY 2016 revenue and more than 2 times FY 2011 number) and close to $150m in general and administrative costs (roughly 8% of revenue and 2 times FY 2011 amount). We think there is untapped operating leverage in each of the 3 areas and Cimpress aggressively invests/spends gain scale.

In FY2016 roughly $300m was spent for advertising, over $30m to scale Most of World units, over $30m to scale promotional and apparel. Cimpress also aggressively spent money in M&A to scale and consolidate its position. Since 2014 the company spent $520m to acquire 7 European companies in the Upload and Print segment (focused on professional designers). The segment already roughly generates $600m in revenue and $70m in NOPAT and is growing nicely so IRRs also seem to be decent.

None of the competitors has the budget to invest as aggressively in its MCP capabilities or advertising and SKU expansion to acquire as much additional revenue as Cimpress. We think the gap between Cimpress and competitors could actually widen in the future, but Shutterfly could become a formidable long term competitor, especially if they expand into business printing material market.  

·        Best talent in its industry:

We think Cimpress has the best talent in its industry. It is almost a given simply due to the company’s relative size but we also think the company has a great culture that attracts talent. The CEO Robert Keane and the board have put a lot of effort into building a right culture. The company’s 8000 people employee base includes great talent to build its needed software systems, great talent to build first class lean manufacturing, great talent in direct marketing and great talent in capital allocation and strategy.

·        Very good strategic logic:

Cimpress is currently in the early stages of opening up its mass customization capabilities to bring other companies on to its platform.

Front end (customer acquisition), back end (manufacturing) and the software applications that efficiently and successfully connect the front to the back end are each very different activities. Cimpress has disconnected its own front and back end in the last 2 years and is now able easily link the complete set front end brands to the complete set of manufacturing plants. This has led to an explosion in SKUs each brand can offer and should also drive increased asset utilisation.

The Idea to open it up further makes great strategic sense. Once MCP is build it can be sold at no additional cost (and excess economic returns can be earned) to different companies that have advantages in only one area. It makes sense for the different partners and it makes even more sense for Cimpress. First, over time it should decrease competition through co-opetition, because the ones that move to the platform won’t build it themselves and second, it should enable Cimpress to maximize the excess economic returns this activity can generate.

We think the company’s MCP vision can be a great source of value, but we have to wait and see how successful it will be. If it doesn’t bear fruit it will at least be helpful to drive industry consolidation because it makes the integration of acquired companies easier.  

Cimpress has also applied great strategic logic by acquiring a host of Upload and Print (U&P) businesses in Europe. The U&P businesses are set of companies that also operate via e-commerce channel but address a completely different costumer type than Vistaprint. U&P customers are more professional customers like independent graphic designers, local print shops, agencies, graphically-trained employees in corporate departments that create their own prof. designs and upload finished design to Cimpress.

The acquisitions opened up a whole new market opportunity for Vistaprint and due to the different customer types the renaming to Cimpress and go to market strategy with multiple brands made the most sense.     

·        Great customer focus:

We all know how well the costumer focus equation has worked for the small little book store start up Amazon.com… Cimpress is aware of the equation and increasingly embraces the importance of customer focus/satisfaction. Over the recent years, Cimpress has implemented many, many changes to improve the customer experience. In the early years the company primarily focused on customers how primarily price focused. Important metrics like net promotor scores, LTV of costumers and other KPIs are going up across the board.

The customer cohorts increasingly show higher customer LTVs and are a show that the company is acquiring a higher value and more loyal customer base.

Cimpress is determined to ongoing improvements in this area. Greater scale will continue to enable the company to offer greater selection, higher quality, better service, faster shipping etc. and push customer satisfaction higher.

·        Outstanding management:

Robert Keane is a wonderful leader and in our opinion perfectly suited to continue to lead Cimpress. We are impressed by his achievements with the company. He is very entrepreneurial, not afraid to try new things and to fail on small scales. He embraces the importance of a decentralised culture, is a keen learner and we think also humble and down to earth. He even seems to have figured out what great capital allocation means, though probably with help from Prescott General Partners who own roughly 15% of Cimpress.

Prescott also pushed for board member Scott Vassalluzzo, who chairs the compensation board and has recently lead the implementation of a wonderful long-term employee incentive plan. We strongly recommend his two recent letters.  

·        High returns on capital:

The business is asset light and able to generate decent returns on invested capital. The following ROIC numbers include all the investments that currently go as expense through the P&L but initially don’t bring any positive returns. Take for example the multiyear investments in brand building (TV Ads, etc.), the $30m in most of world investments or the MCP platform and Columbus build outs. By deciphering the numbers a bit, one can quickly get above a 25% ROIC without the long term investments.

·      Great capital allocation:

The company has done a wonderful job at repurchasing its own shares. The capital spent on share repurchase has so far achieved very nice IRRs. Over the past 8 years Cimpress allocated $672m of capital to repurchase 18.8m at an average price per share of $35.68, including $153m of capital spent in fiscal year 2016 to repurchase 2.2m shares at an average price of $71.06. The 18.8m shares that were bought for $672m would currently be worth over $1.5b.

Another area of significant investment in recent years was M&A. Early investments like the Webs acquisition 2012 achieved poor returns, but the whole Upload and Print Segment acquisitions since early 2014 not only made great strategic sense but also seem to drive home decent returns. Cimpress already gets around $70m NOPAT, on the $520m that they spent and the segment grows at rates >10%.  

·      A Superb long-term oriented incentive program:

Cimpress has recently implemented a very thoroughly thought through and powerful performance based long term equity incentive plan. The plan is extensively discussed in the recent Proxy Materials and a great & required read.

In brief and crude terms the system works the following way. LTI payout is based on two criteria (vesting and performance requirements) and earliest payed out is 6 years after grand and latest 10 years after grant. If the performance criterion is not met at any year in the time period from year 6 to 10 nothing is payed out.

The Vesting criterion is simple. Once LTI is granted in the form of PSUs, each year 25% of the PSUs vest, so it takes 4 years for the grand to fully vest. If an employee leaves he can keep the already vested PSUs but the performance based criterion still needs to be reached for him to receive any shares.

The performance based requirement is based on the performance of Cimpress share price performance. To account only for the real value created and cancel out the back ground noise from volatility the criterion is based on the 3-year moving average share price of Cimpress. 6 years after the initial grant the performance based criteria kicks in the first time. The hurdle to receive any shares is a CAGR of 11% (for the 3-year moving average share price) from the grant date to any anniversary year 6 through 9. CAGRs above 11% increase the number of shares per PSU up to 250% for >20% CAGR. If the 11% CAGR is not met in any year through year 9, the minimum CAGR requirement in year 10 drops to 7% for all employees except for Robert Keane, his hurdle stays at 11% for all years.

Robert Keane has committed himself to always take 100% of his LTI in PSUs, which means strongly believes the company can do better than achieve a compound annual growth rate of 11% over many years to come. We strongly believe in the power of incentives and think this incentive system will be strong force to create an owner mentality and performance based culture throughout the whole company. 

Current valuation is attractive:

Cimpress goal is to maximize steady-state FCFF per share. We couldn't be any happier with the metric the company choose to maximize and hold itself accountable against. A year ago the company started to provide quite a detailed analysis how they calculate steady-state FCFF per share (see below the summary of the 2016 calculation). The method and calculation is included in the yearly shareholder letter and will be updated going forward. For FY2016 the company came up with a range of $270m-$350m. We tend to agree with their thinking and believe the company should be able to do at least around $250m in FCF if it chooses to maximize near-term earnings.

We further believe the company is currently growing FCFF per share @ greater than 10% p.a. and should be able to do so for quite some time. The core Vistaprint brand recently had a period of years with single digit growth rates but the growth started to re-accelerate recently. Certain rebranding measures were a drag on revenue (for example: discontinuing email heavy coupon campaigns, lower shipping prices etc.) but were needed to drive long term revenue growth. We think the readjusting is behind the company and especially Canada with 20% growth rates even though Vistaprint has the highest penetration there shows the potential for continuing >10% organic earnings growth is there.

Recent Events (that lead to sell-off):

Q1 GAAP operating income declined significantly year over year to a loss position with some anticipated headwinds from an amendment to the WIRmachenDRUCK earn-out arrangement, the loss of certain partner revenue and profits (discontinued partnership with Staples and a pratnership in Albumprinter Segment), increased organic investment spend, including the reduction of Vistaprint shipping pricing, and the implementation of our new long-term incentive program. Additionally, operating loss was negatively impacted by both an increase in the earn-out liability for the WIRmachenDRUCK acquisition resulting from strong performance and increased backlog at the end of the quarter due to extreme weather causing flooding at our production facility in North America (timing only) at the end of the quarter.

The effects of the events are all well covered and discussed in the recent earnings material and CC. In our opinion the underling business performed quite well.

Risks:

• Faster and pronounced decline in the customized small sized printing materials
• Aggressive market entry by big well funded company
• Successful scaling of many smaller competitors in certain niches (like Moo.com in high quality business cards). 
• Aggressive entry (uneconomic behavior) by companies like Shutterfly or CEWE into the micro, small & medium business market

Catalyst

No specifc catalysts, ongoing growth...