Description

At about 5x 2006E Cash EPS, M&F Worldwide is once again too cheap. While the Company has been written up several times at VIC and the stock has move up significantly, the company is as cheap as it has ever been. While Ron Perelman and his cronies continue to control the Company, the discount to fair value of 50% is excessive.

M&F Worldwide recently acquired Clarke American from Honeywell in an all-cash transaction that leveraged the balance sheet and was significantly accretive to earnings. The company now has two operating divisions, Mafco Licorice and Clarke American. In addition to its operating divisions, M&F Worldwide also has significant non-core assets in the form of excess licorice inventory, a tax shield from intangibles generated in the Clarke American acquisition, stock in Principal Financial Group, and Corporate deferred tax assets. As a result of the separate financing of the two businesses and the non-core assets, I believe that the current valuation of the stock can be justified by either of the divisions on a standalone business. There is a significant margin of safety because of the low-valuation, diverse operating businesses, and non-recourse financing of the two separate businesses.

Mafco Licorice is the world’s largest refiner and processor of licorice. Licorice is produced by boiling shredded licorice root to extract the sap. Licorice root comes from the licorice shrub, which is indigenous to the middle-east and several of the former soviet states. The Company has long-standing relationships with a large number of licorice suppliers, which provides it with a substantial sourcing advantage. The refined product is sold to tobacco companies as a flavoring agent (70% of total sales). In total, licorice flavoring accounts for about $0.02 of the cost per pack of cigarettes. This end-market also provides a substantial level of stability to the business because (1) Cigarette companies are reluctant to mess with the taste of their product and (2) licorice is a small part of the total cost to make cigarettes. The remaining 30% of sales goes to food manufacturers, confectioners, and pharmaceutical companies. According to management, they have managed to get mid-single digit price increases every year and the revenue declines in 2002-2004 were due to problems in the mulch business and a lowering of inventories by the tobacco manufacturers. Revenue has begun to grow again and the company expects mid-single digit revenue growth going forward.

Clarke American is the second largest check printer in the United States with a 30% market share. It operates in a shrinking overall market but it is highly cash generative. Clarke American is being bought from Honeywell, which acquired it as part of the acquisition of Novar. The purchase price is $800 million, all of which will be paid in cash. Clarke American has successfully taken market share while increasing its average revenue per order. Thus, it has been growing revenues despite the shrinking market share. Despite the declining number of checks written per year, the overall market for check orders is declining more slowly because many people order checks for structural reasons (i.e. new bank account, changed name, etc.) rather than for replenishment reasons. While 80% of Clarke American’s revenue comes from check printing, the remaining 20% comes from cross-selling bank products out of call centers managed by Clarke American. According to M&F Management, these activities are more profitable for the bank because Clarke does a better job of serving the needs of these customers and Clarke American should double the number of accounts it serves in this way over the next five years. If these projections are met, the division should actually be able to grow revenue at a CAGR of about 2.5-3.0% over the next five years.

2006 Projected Financials ($ in millions):

Reported P/E:

Adjusted EBITDA: $170.8
Depreciation & Amortization: 65.5
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Reported Operating Income: 105.3
Net Interest Expense: (51.4)
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Pre-Tax Profit 53.9
Taxes (19.7)
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Net Income 34.1
Diluted shares outstanding: 20.4
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Reported EPS: $1.67
Reported P/E: 10.0x

Cash P/E:

Net Income: 34.1
Plus Non-Cash Amortization: 34.7
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Cash Net Income 68.8
Diluted shares outstanding: 20.4
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Cash EPS: $3.37
Cash P/E: 5.0x

FCF Yield:

Adjusted EBITDA: $170.8
Capex & Capital Leases: (28.5)
Difference btn Amortization & Prepayments: (3.8)
Change in Working Capital: (0.6)
Restructuring Expenses: (4.0)
Other: (3.0)
Interest: (51.4)
Taxes: (19.7)
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Free Cash Flow: 60.0
Diluted shares outstanding: 20.4
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FCF per Share: $2.94
FCF Yield: 17.6%

EV Multiples:

EV / 2006 Pro Forma EBITDA: 6.0x
EV / 2006 Pro Forma EBITA: 7.4x

Sum of the Parts / DCF Model:

DCF of Check Printing Business: $816.9
Less Debt of Check Printing: (623.1)
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Equity value in check printing: 193.8
Diluted shares outstanding: 20.4
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Check Printing Value per Share: $9.50
Plus DCF of Amortization Tax Shield: 6.60
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Total value in check business $16.10

DCF of Licorice Business: $328.5
Less Debt of Check Printing: (65.8)
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Equity value in check printing: 262.7
Diluted shares outstanding: 20.4
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Check Printing Value per Share: $12.88
Plus Excess Licorice Inventory: 1.80
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Total value in check business $14.68

Corporate Value Items:

Preferred Financial Group Shares: $0.15
Deferred Tax Assets: 1.30
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Total value at corporate level: $1.45

The licorice business and the check printing business are separately financed on a non-recourse basis. Therefore, if either subsidiary encounters financial problems, it can go bankrupt without bankrupting the entire company. On a sum of the parts basis, I believe that the Company is worth $32.23 per share, or 92% above the recent $16.75 close. Looking at the downside scenario of one of the divisions going bankrupt, the licorice business plus the corporate assets is worth about $16.13 and the check business plus the corporate assets is worth $17.55 per share. In other words, from a fundamental basis there is not significant downside from the recent trading prices, even if one of the two operating subsidiaries goes bankrupt.

Comparable Company Multiples:

John H Harland:

2006 Cash P/E: 13.5x
2006 EV / EBITA: 9.6x
2006 EV / EBITDA: 5.8x

Deluxe:

2006 Cash P/E: 8.8x
2006 EV / EBITA: 8.3x
2006 EV / EBITDA: 6.2x

Implied M&F Price at avg multiple: $27.23

M&F currently trades at a substantial discount to both Deluxe and John H Harland despite having a better mix of businesses. With 48% of its non-corporate equity value in the licorice business, which is growing, more cash generative, and less competitive, M&F deserves to trade at a substantial premium to John H Harland and Deluxe. The only metric on which M&F does not look substantially less expensive is EV / EBITDA, but that metric obscures the difference in capital intensity between the two companies. I therefore prefer to look at EV / EBITA or EV / EBITDA – Capex, both of which show substantial upside.

Risk:

The major risk to investing in M&F Worldwide remains Ron Perelman, the controlling shareholder. Historically, he has been unfriendly to minority shareholders and has attempted an especially egregious abuse at M&F Worldwide when he attempted to sell his controlling stake in Panavision to M&F Worldwide at about 400% of its market price. In order to block the transaction, minority shareholders needed to sue. Despite the overhang from Perelman, I believe that the approximate 50% discount to fair value is excessive. First, given the added emphasis on corporate governance and his previous failure to hurt minorities, I believe that it is unlikely he would attempt to hurt minority shareholders again. Likewise, Perelman seems to be trying to clean up his image through showing a nicer side of himself, such as through the recent forbes article on him. Lastly, even for companies with more substantial corporate governance problems, a 50% discount to NAV seems excessive. For instance, IFI and IFIL in Italy have among the worst corporate governance standards given the abuse actually inflicted on minority shareholders (rather than attempted and defeated) through unfair capital increases and related party transactions. Despite these problems, they trade at about 40% discounts to their NAV – or about 20% more than most European holding companies. Looking at a range of a 20-40% discount to NAV for M&F Worldwide would suggest a value per share for M&F of $19.34 - $25.78 or upside of 15%-54% from today’s price.

Catalyst:

2006 EPS shows substantial accretion from Clarke American acquisition
Continued fair treatment of minorities narrows discount further

Catalyst

2006 EPS shows substantial accretion from Clarke American acquisition
Continued fair treatment of minorities narrows discount further