Cenveo Inc. CVO
December 13, 2005 - 10:30pm EST by
2005 2006
Price: 13.30 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 665 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Cenveo is a compelling opportunity to invest alongside one of the best management teams in the printing industry, who have a strong track record of creating significant shareholder value through turning around companies. Upon achieving the $100 million of cost savings that management has identified, EPS and FCFPS should grow to $1.37 and $1.75, respectively, in 2007 from a loss of $1.88 and cash burn per share of 68c in 2005. As this occurs, shares of Cenveo could eventually trade to over $18 based on a 9% FCF Yield in 2007.

Cenveo is one of North America’s leading providers of visual communication solutions delivered through print and electronic media. Cenveo’s products include offset and digital printing, custom and stock envelopes, and business documents and labels. The company also provides communications consulting, end-to-end project management and eServices.

The printing, envelopes, and business documents market is estimated to be $175 billion. Cenveo participates in a $60 billion portion of the total print, envelope, and printed office products market, including; closely held, customized broad, and limited offerings. The industry is highly fragmented with 32,000 commercial printers in the US, though current competitive pressures are forcing 4-5% of capacity to become rationalized annually.

Throughout the 1980’s and early 1990’s the printing industry grew at a similar rate to GDP, but since 1997 it has lagged GDP growth. As a result, commercial printing operators are supplementing their core ink-on-paper services with a broad range of communications services that add value for clients. Conditions have improved for the industry over the past two years, due to these additional service offerings, as well as an improvement in the broader economic recovery, but the competitive landscape remains challenging. Specifically, industry overcapacity, commoditization of services, lower customer switching costs, and price erosion remain secular headwinds. Higher raw material costs from rising paper, ink (derived from natural gas and crude oil) and energy prices have also put more pressure on industry participant’s margins.

Business Segments:
Envelope, Forms and Labels
In this segment the company manufactures customized envelopes & packaging products, stock envelopes, traditional & specialty business forms, and labels used for mailing, messaging & bar coding. The company operates 35 envelope plants, six business forms’ plants and three business labels’ plants. For the first three quarters of 2005, this segment generated $696 million of revenues, up 7% year-over-year versus a three year CAGR of 1%. The rise in sales through the first three quarters of 2005 was the result of favorable foreign exchange rates. Operating profit in the first three quarters of 2005 was $54 million compared to $62 million through the same period last year. The decline in the segment’s operating profit and margin was the result of higher paper costs and other raw materials. Management’s long-term objective is for this business to grow in-line with GDP, rather than the 1% CAGR it has produced over the past few years. This segment could eventually generate operating margins in the low-teens, versus 8% reported through the first three quarters of 2005, as management shutters printing facilities and improves capacity utilization.

Commercial Printing
This segment designs, manufactures, and distributes printed products that include advertising literature, corporate identity materials, financial printing, calendars, greeting cards, brand marketing materials, catalogs, maps, CD packaging and direct mailers. The segment operates 33 printing facilities and five distribution and fulfillment centers. From 2002 to the present this segment has grown at a CAGR of 2%. For the first three quarters of 2005, Cenveo’s commercial printing operations generated $606 million of revenues, or 47% of total revenues, compared to $611 million of revenues, or 48% of total revenues, through the same period last year. The decline in revenues was the result of the closure of the company’s plant in Atlanta.

The company’s commercial printing operations had an operating loss of $9 million compared to an operating profit of $9 million through the same period last year. The segment’s drastic decline in profitability is primarily the result of restructuring charges and the losses related to the disposition of non-strategic businesses. Management sees the most opportunity in this segment of Cenveo’s business from a revenue and margin enhancement perspective.

Commercial printing is a highly fragmented $50 billion industry, which means there are significant opportunities to take share from competitors, grow organically, and make acquisitions. When Mr. Burton was at the helm of Moore Corp. the company’s commercial printing operating margin was in the mid-teens and in recent conversations with management they stated that there were no structural issues at Cenveo that would inhibit the segment from eventually achieving similar margins.

Proxy Fight:
In September 2005, Burton Capital Management and Goodwood Inc., led by Robert Burton, Sr, won the proxy contest for control of Cenveo. Mr. Burton, the former CEO of Moore Corp. and KKR’s World Color Press, initiated the proxy contest after acquiring 10% of Cenveo’s equity with Goodwood Inc. With over thirty years of experience in the printing industry Mr. Burton was familiar with the operations of Cenveo and identified its poor operating results were the product of mismanagement, rather than industry weakness. In his presentations to shareholder’s Mr. Burton highlighted that shares of Cenveo had declined 53% over the last five years and that operating metrics were abysmal. Specifically, Cenveo’s operating margins had declined from 8.9% in 1999 to 4.5% in 2004 and sales had declined by over $100 million during the same time period despite a $10 million commensurate increase in SG&A. On the company’s third quarter conference call, Mr. Burton’s first as CEO, management discussed their strategy for a turnaround Cenveo, which included selling the Canadian envelope operations, paying down debt, and targeting $100 million of cost savings.

Management's Background:
From December 2000 through December 2002, Mr. Burton was the Chairman, President and CEO of Moore, a leading printing company with over $2.0 billion in revenues for fiscal year 2002. During his tenure at Moore, Mr. Burton led Moore to a turnaround by significantly reducing costs, recruiting top-tier executive talent and growing revenue through acquisitions and a "one-stop shopping" customer focus. Moore's share price increased from $2.38 on December 12, 2000, the first date of Mr. Burton's employment, to $10.16 on December 6, 2002, the date of his resignation. This was not the first time Mr. Burton delivered results to shareholders.

From April 1991 through October 1999, Mr. Burton was the Chairman, President and CEO of World Color, a Kohlberg Kravis & Roberts portfolio company and a leading commercial printing company with revenues in excess of $2.3 billion in fiscal year 1998. During his nine-year tenure as the senior executive of World Color, Mr. Burton led its turnaround, which culminated in a sale to Quebecor Printing, Inc. in 1999. The sale created Quebecor World, one of the world's largest commercial printers. World Color completed its IPO on January 25, 1996 at a price of $19.00 per share and was sold to Quebecor at $38.00 per share.

From 1981 to 1991, Mr. Burton held a series of senior executive positions at Capital Cities/ABC, including President of ABC Publishing. At Capital Cities/ABC, Mr. Burton was instrumental in turning around the operations he ran from a loss position to a major profit contributor for the company. Mr. Burton has also held senior executive media positions at CBS and IBM and Walter Industries, Inc.

Since the commencement of the proxy fight, Mr. Burton and his family have acquired 3 million shares of Cenveo, or 6% of the total shares outstanding. Mr. Burton publicly stated on the last conference call that he will continue to buy shares in the open market.

Cost Cutting:
Currently, Cenveo’s operating margins are trending below the rest of the industry. Management points to Cenveo’s bloated cost structure as the cause and will pursue over $100 million of cost cutting initiatives to realign the company’s margins with the industry. For starters, management plans to eliminate over 15% of the current workforce, or 1,400 employees. Along with a rationalization of the workforce, management also plans to shutter unprofitable commercial printing and envelope plants throughout the US. New management’s philosophy is that the commercial printing and envelope businesses do not need a national footprint because printing is a commodity business that does not require geographical convenience to better serve customers. Currently the company’s printing facilities are operating at 50% capacity utilization on an abbreviated five day work schedule compared to the rest of the industry that operates on a 7 day work schedule and capacity utilization of 70-80%. Management’s plan is to shutter at least 10 to 15 unprofitable plants next year starting in Q1’06. The combination of lay-offs and plant closing should generate $50 million of annual savings. Other fixed costs that the company expects to eliminate are $19 million from reducing HR, benefits, and lower G&A and rent. Along with fixed cost-savings, the company expects to save on cost of goods. Specifically, Mr. Burton has completely eliminated discretionary spending at the company because prior management was not taking advantage of the company’s purchasing power in the procurement process. As the company becomes more selective with vendors and receives better pricing and rebates on paper and other raw materials, the company should realize additional savings $7.5 million. In 2007, new management expects to achieve an additional $25 million of cost savings related to productivity maximization and waste reduction.

Canadian Business:
The new management at Cenveo has publicly stated that it is pursuing ways to monetize the company’s Canadian envelope business, which in 2004 generated approximately $200 million of revenues and $40 million of EBITDA. Despite poor operating results in the US, Cenveo’s Canadian business has always performed strongly because it was never integrated with the US business and thus never adopted any of its irrational operating policies.

Mr. Burton stated on Cenveo’s Q3 earnings call that he expects to sell or spin-off the Canadian operations for at least 7.0x EBITDA, or $280 million, and will apply the proceeds to pay down the company’s debt load. Management is confident that they will be able to receive such a price based on the high level of interest the Canadian operations garnered when prior management was evaluating strategic alternatives.

Management will likely apply some its $300 million of NOLs, which will offset some of the tax burden related to this transaction. Therefore, assuming $280 million of net proceeds from the sale, the company’s total debt burden could be reduced to $512 million from its current $792 million.

Refinancing Opportunity:
Cenveo currently has some very expensive debt on its balance sheet that management would like to refinance, specifically the $350 million of 9 5/8% senior notes due 2012. Assuming interest rates don’t rise significantly over the next year, management expects to call this debt in March 2007 and fund it with cheaper debt. I assume the company will achieve a lower rate, considering that it will likely have sold its Canadian operations by March 2007 and its credit statistics should be drastically improved as a result.

Valuation and Price Target:
When valuing shares of Cenveo, investors must look to the future earnings power of the company once management has successfully achieved its cost-cutting goals. Given Mr. Burton’s track record of successful turnarounds, I believe it is prudent to assume that he will realize his operational targets of $100 million of cost savings. Additionally, I believe he will also be able to sell the Canadian envelope business for an estimated $280 million and I have reflected this in my estimates. After incorporating these assumptions into my estimates, shares of Cenveo are attractively valued versus its peers. As EPS and FCFPS grow from today’s depressed levels of ($1.88) and ($0.68), respectively, to $1.37 and $2.37, respectively, in 2007, I believe the valuation gap between Cenveo and its peers will diminish. Applying a 9% FCF yield to Cenveo’s FCFPS of $1.75 in 2007, I arrive at price target of $19.43 per share.


1- sale or spin-off of the Canadian Envelopes business in Q1
2- Achievement of $75mm of run-rate cost savings in 2006
3- Additional $25mm of cost savings in 2007
4- Refinancing of 9 5/8% notes in March 2007
5- Sell-side coverage
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