Description

CREO ($10) is a pure play on CTP which is driving the move from analog to digital in the offset printing process. Creo is the market share leader (hardware & systems) in an under penetrated and recovering market. Most importantly from here, the company is rolling out a consumables strategy (plates), which could help to double the size of the company over the next several (3-5?) years. With some growth ($750M in revs vs. $578M in ’03) and margin recovery (to 10% from 3% in ’03) eps could exceed $1 within 2 years vs. a reasonable expectation of $0.40-$0.50 this year ($650M revs and 5% ebit). Much of the growth will come from increases in consumables sales, with low double-digit (recovery) growth in hardware products, software and services. With a clean balance sheet ($50M or $1/share net cash), new product categories and strategy, CREO could certainly be worth 15x the $1 eps (1X revs, 10x EBIT) and if they fully execute on their very aggressive growth strategy, $1B at 12-15% ebit drives eps of $1.75-$2. (I did say it was very aggressive and certainly a long road from here!)

I do not think the progression will be straight or smooth but I do believe the odds are quite reasonable that within a few years CREO will have a meaningful share of the plate market and enhanced profits to show for it.

Computer to plate, or CTP, is a process where the plate, or master is created using a laser that burns the image or pages onto a coated plate, which is then put through a chemical curing process and then onto the offset printing press. Historically, plates were created using an analog process; an image or page is photographed, a negative is created and its used to expose a light sensitive plate (the process is analogous to developing photos from a negative, but on a much larger scale). The CTP process is significant in that it enables a printer to cut out the lithography process, which subsequently improves cycle time, cuts labor costs, and ultimately allow the printer put more sales dollars through a fixed cost infrastructure at very high incremental margins.
Market Share:

Creo is by far the market leader (36% share) in CTP system with slightly over 5k systems installed out of an estimated 13k worldwide. The two closest competitors are Agfa and Fuji. Its estimated that there are >300k printers worldwide, although the addressable market for CTP systems is likely around 50K (higher volume printers), with an ASP of about $180k, the total market for hardware is about $9B. Annual hardware shipments may be running about 4k, or a $700-800M mkt (just hardware).


The annual consumables market is currently about as big as the hardware/systems market. Creo's new initiatives are focused on the $1B digital plate market, which is growing at a CAGR of 18%. On average, a CTP machine will use 30-50% of the total hardware cost in consumables on an annual basis. Although Creo has a $45M consumables business (inks papers etc.), they sold no CREO digital printing plates in ‘03. To put this into perspective, Agfa has 95% of their install base on company branded plates; Fuji-DiNipon Screen has ~60%; Creo currently sells only 20% of their CTP systems as bundled packages with non Creo branded plates.

Creo estimates that $400M of the $1B digital plate market is "burned" on their machines of which Kodak supplies 60-70%, or 240-280mm.

About 2-3 years ago, Creo's mgmt realized they were at a competitive disadvantage when selling to the smaller printer (>3 and <50mm in revs) because they were not able to bundle the consumables piece in with the hardware sale like their competition. If you think about this type of customer, it's generally a family or closely held business, with limited liquidity, etc. As is typical with capital equipment sales into small businesses, the competition was able to heavily discount the hardware, as they would make it up on a contracted level of consumable purchases.

Creo approached Kodak in attempts to strike an agreement where Creo/Kodak would share the economics of the consumables. Creo explained to Kodak execs that this would enable them to enter new markets with their products and increase overall volumes for digital plates at EK. Digital plates are a very "sticky" recurring revenue stream, as they are almost insignificant in the total cost of the job, but critical to the printing process. Creo's mgmt would not elaborate on the details, but suggested that EK was not interested in sharing any of the consumable economics. EK is estimated to sell ~240-280mm worth of digital plates to Creo customers.

On September 15th, 2003, Creo announced that it would manufacture, sell and support its own brand of thermal plates using its own technology and IP. In conjunction with that announcement, they also completed the acquisition of First Graphics Limited (FGL) for 11.3mm in cash. FGL is a five-decade-old South African based supplier of equipment, technology and consumables to the printing industry w a 3 yr old plate manufacturing line (South Africa is a good location as it offers cheap labor and puts them in v close proximity to a number of aluminum mfg'ers). Creo stated the acquisition would be accretive to earnings in FQ2'04.

The plates have been commercially available in North America and Europe since that announcement and they have been testing them for close to 18 months prior to launch. Plates come in all different sizes (depending on the printing press/ or run, etc); their first commercially available plate addresses 80% of a printers needs. Mgmt expects over the next 12 months to launch additional plates to round out their offering.

Mgmt admits their biggest risk is execution as it will be somewhat of a challenge to get customers to switch plate manufacturers. As a consequence, mgmt expects to see greater penetration initially at the small to medium printers for the reasons discussed above.

As discussed earlier, Creo does ~45mm of non-plate consumable sales...mainly consisting of ink and paper. Creo expects to double their consumables business in F'04, with the digital plate account for the lion's share of the growth. Mgmt suggested that gross margins on the plates would not be as high as equipment sales (which is >45%), but likely to be in the 35-40% range - similar to service.

Catalyst

-demostrated market acceptance of new CREO printing plates
-recovery of commercial printing markets and thus increased industry capex
-revenue and margin improvement from plates and integrated systems(HW/SW/Plates)