Description

Growth investors have sent MPAC down 40% in the last week, presenting value investors with the opportunity to own a high quality (targeted 10% OM 20% ROE), at a 20% discount replacement cost, and trading at potentially 3.8x ‘06E ev/ebitda. I think there is $1.00 downside (adjusted slight discount to tangible book, comps trade at substantial 3-5x book) and potentially $12-15 upside (10x ev/ebitda) over the next 12-18 months (-9% downside/131% upside). Mod-Pac is going through a transition now, which we think will be a key inflection point to gaining a substantially higher valuation. At the current valuation even with -0- from VistaPrint and new initiative printlizard.com (estimated 25% ebit margin), we think MPAC is trading at around 3.8x ev/ebitda on 2006 numbers. While the business is in transition over the next year or so we expect to see revenues go from $53mn to $56mn in 2006, despite losing 35% of revenues. Management has solid track record of reliability and thinks they can replace this business in 6-12 months. If this happens the stock should trade in the low to mid $20’s range.

What caused the stock to drop:
1: VistaPrint transition: In July 2004, MPAC/Vista Print agreed to break their deal, which called for MPAC to print Vista Print’s North American business through 2011 with 25% GM plus cost. MPAC received $22mn in cash for agreeing to break the agreement and a 13 month transition period until August 2005. In April 2005, they announced a deal that goes into effect after August 2005, which are 18% GM and additional surcharges for less than $750K a month in business. However, MPAC in preparation for Vista Print growth trajectory aggressively ramped up capacity and equipment by spending $7.30 a share from ’02 through 1H05 in Capex 77% of EV. The company should be able to generate high returns on this capital investment with their compelling POD solution.

2:Mod-Pac received the $22mn cash upfront, and recognizes $1.8mn a quarter of this payment over 30 months from deferred revenue. This is .30 a quarter in non-cash net earnings per share, which is offset with $.34 a share in depreciation from a cash generating perspective.

3:Guidance (although this had been known since July 2004)

“We expect that VistaPrint revenue is likely to fall off at a greater rate than revenue growth resulting from of our new marketing activities. This could result in a reduction in year-over-year comparatives lasting from 6 months to a year.”



Valuation and Comps
Replacement
500K sq ft HQ w/ annual rents of $2mn and 10% cap rate $10-20mn
50-60K in other office space $1.5mn
7 Heidelberg presses at $2mn $14mn
5 Die cutters at $1mn $5mn
15 gluing lines @ $150K $2.25mn
Choppers and staplers $1mn
2 HP presses at $500k $1mn
Cogeneration facility $4mn
Wedding Invitation print company $1mn
Software/servers for Print on Demand $1.5mn
Working capital $10mn
Total $62.75mn = $13.50-16.20 a share
MPAC’s PP&E at cost is $17 a share, most Heidelberg press can last up to 20 years useful life but are depreciated over 10 years.

The company should trade at significant premium to replacement value given industry premium and earnings power of assets: especially Mod-Pac with its much higher margin print on demand business.

This obviously does not include intangibles such as: high customer satisfaction (most customers are very long term), significant expertise in print on demand (estimated POD retail revenue for VistaPrint $150,000,000 where Mod-Pac was the back end), and established customers in core business like Hershey and Tyco.

2006 estimate $9 to 11mn + in Ebitda = $2.44-2.97 a share on $9.00+/- EV
2006E: D&A $6.5mn
Understated Real Estate is .60 a share +/-
Operating EBIT $4mn 2006E $56mn @ 7% or after tax net $.70 a share
Non-cash EPS from VistaPrint EPS $4.68mn or $1.26 a share
Stated EPS $1.96 ‘06E
D&A $1.76 ‘06E
OCF = $2.46 a share
CAPEX= $1.15 a share
FCF= $1.31 a share


Comps
Ev/revs Ev/Ebitda p/tbk top line growth OM d/tc
SGK 1.75 10.8 33 8.4% 11.2% 25%
LABL 1.34 10.3 5 10.3% 10% 18%
CDMS .8 8 3.6 2% 7% 74%Avg 1.3x 9.7x median: 5 6.9% 9.4% 39%

MPAC .75 3.7x ‘06E 1.1x target 10%+ 5%

ev/revs ev/ebitda p/tbk
Mpac comp $18.70 $28.30 $50



What gives me confidence the transition will succeed:
1: Mod Pac has gained significant Print On Demand experience, having printed over $150,000,000 in retail value for VistaPrint over the last 4 years from getting started in 2001.
2: Cost savings are compelling Mod-Pac can print for 2/3 less than what your local printer charges for the same thing. (see example below)
3: Mod Pac will be able to partner with everyone from graphic artists, to potentially a Staples.com in addition to their own front end printlizard.com (opened in June 05)
4: VistaPrint’s business grew from $16mn in 2002 to $90mn in 2005 (June year end) 75% CAGR.

I think Mr. Market is allowing investors to buy a good business with the upside of becoming a great business for less than replacement cost of the assets that should trade at a significant premium to book given the returns on invested capital. Mr. Market is very fearful of the VistaPrint transition which we think is a gross exaggeration to reality, even assuming worst case scenarios.

Access to capital
Company has $6mn untapped revolver and $5mn of net cash on $35mn EV.

Competitive advantages:

Cost: MPAC can print through Printlizard.com (just launched in June) for on average -60% less than what your local printer can print for. While targeting 50-60% gross margin and a 25-30% operating margin. There are 25,000 small printers with less than 20 employees with revenue of $28bn a year. The small printers are declining at about 6% a year. Mod-Pac we estimate has already printed over $150,000,000 in retail sales for VistaPrint over the last 5 years

Expertise: Mod Pac print on demand business has printed we estimate $154,000,000 for VistaPrint since 2001. So we are confident that they have significant expertise in print on demand execution on the back end.


Company has opportunity to take significant share from offline printers that are geographically constrained combined with the above cost advantages.

Goldman Sachs and Bear Sterns are taking VistaPrint public very shortly (i think Sept/Oct). We think this could be a catalyst for getting Mod-Pac a higher valuation due 100% pure play on Print on Demand.


The 2004 annual letter to shareholders has some good industry insights and long term objectives in it.

In May, Mod-Pac hired Marie Smith who was CIO at Bausch and Lomb and previous was at Kellogg in a similar role.

We have ordered thank you cards through Printlizard.com and 250 cards cost $75, our local printer down the street was going to charge us $206 for the exact same order and specs.

Risks
Class A& B, Class B automatically converts to A if it is ever sold. Class B cannot receive dividends unless less than or equal to Cl A shareholders. Class b has 10 for 1 voting rights.

Father/son and brother: Dan/Kevin Keane run Mod-Pac, Robert (Dan’s brother) is CEO of VistaPrint. Kevin Keane bought Mod-Pac in 1970, and brothers grew up in the print industry. Robert went off and launched VistaPrint (VPRT) about 8 years ago, which will come public in September 2005. In our research and discussions we are very impressed with Dan Keane from the stand point of strategy, execution, being shareholder friendly, and where we think company will be in 2-3 years.

Transition away from VistaPrint is not successful: At this price it does not really make that much of a difference. With $6.5mn in D&A in 2006E and core business (no printlizard or vistaprint) $36mn with 7% EBIT you get $9mn in ebitda on $37mn current EV or about 4.2x.

Disclaimer: We currently own shares in MPAC and may buy or sell more stock without updating VIC.

Catalysts:
20% discount to replacement cost (assets should be able to generate 20% ROE)
Possible increased buy back (company bought back 4% of company in 4Q04 @ higher $12.09)
Free call options on: Printlizard.com (estimated 25% EBIT) and potential additional vistaprint like customers.
1.1x adjust tangible book 3.8x Ev/EBITDA on our 2006 estimates (peers 3-5+ tbk/10x ev/ebitda)
Fastest organic growth rates in industry
60% capacity, high incremental margins from additional revenue
Limited downside: buyback and hard book
VistaPrint (pure play Print on Demand) IPO Goldman/Bear led deal

Catalyst

Catalysts:
20% discount to replacement cost (assets should be able to generate 20% ROE)
Possible increased buy back (company bought back 4% of company in 4Q04 @ higher $12.09)
Free call options on: Printlizard.com (estimated 25% EBIT) and potential additional vistaprint like customers.
1.1x adjust tangible book 3.8x Ev/EBITDA on our 2006 estimates (peers 3-5+ tbk/10x ev/ebitda)
Fastest organic growth rates in industry
60% capacity, high incremental margins from additional revenue
Limited downside: buyback and hard book
VistaPrint (pure play Print on Demand) IPO Goldman/Bear led deal