Description

We are recommending a long position in PBI’s 7.25% senior unsecured bonds due March 2029.

The Company was last written up on VIC in March 2021 by uncleM.

Executive Summary

The senior unsecured bonds due in 2029 are trading at a $-price of ~68 and related ~16% yield to maturity and we believe a sale and or divestment of the Company’s money-losing Global Ecommerce segment will allow the Company’s bonds to re-rate to non-distressed levels. The initiative to sell the segment is supported by the strengthened corporate governance profile of the Company, following the election of four new Board members proposed by activist investor, Hestia Capital Management.

Hestia’s proxy presentation fully details the issues that have plagued the Company for the past decade. We highly recommend a review of Hestia’s proxy presentation at the following link:

Hestia Capital Investor Presentation - Transform Pitney Bowes (April 2023) (webflow.com)

A sale or divestment of Global Ecommerce may result in a return of ~55% IRR if the bonds re-rate to a $-price of ~90 at the end of the 1H24, which accounts for approximately 10 points of $-price change due to interest rate changes. These bonds have an opportunity to trade closer towards par if the Federal Reserve begins cutting rates in 2024.

The sale of Global Ecommerce is imperative to righting the ship at PBI because of the material drag it has had the Company’s financial performance. The drag of Global Ecommerce completely obfuscates the profitability and cash flow generation of the Company’s other segments: 1) Presort and 2) SendTech Solutions.

The Global Ecommerce segment provides domestic parcel services for shippers, cross-border services for international shippers, and digital delivery services. The Company acquired Borderfree in June 2015 for $395 million and Newgistics in October 2017 for $475 million. These acquisitions in combination created the Global Ecommerce segment. The Newgistics business was EBITDA positive at the time of acquisition. Despite this, the Global Ecommerce segment has never reached profitability on a sustained basis, has cumulatively lost $402 million in EBIT from 2017 thru 2022, and the level of EBIT losses have become more pronounced over time. On a LTM basis, the segment incurred a loss of $129 million, which is the largest EBIT loss relative to any fiscal year between 2017 and 2022.

Since the acquisition, management has continued to miss guidance on profitability and currently estimates 6% to 8% EBIT margins in 2026. We view these assumptions as highly unlikely to occur. The management team has zero experience managing a domestic parcel company and certainly has no business competing with the likes of Fedex, UPS, Amazon, DHL, among others.

It appears that the management is beginning to capitulate and at this point appears to be contemplating a sale of the cross-border portion of the Global Ecommerce segment. The exchange below is from the most recent earnings call for 2Q23.

Q – Kartik Mehta (Northcoast Research): I know we've had a lot of conversation about the cross-border business. And I'm wondering, do you think this is a secular issue for you or is it temporary? So right now, I know it's a drag and I'm wondering if there's a way to reposition the business to make it profitable or is it just you need volume and maybe it's a temporary issue?

A – Marc Lautenbach (CEO of Pitney Bowes): Yeah. Well, I think that's to be determined in all candor. It is a business that's highly concentrated in two customers. Those customer relationships, as I said have evolved. Those dynamics we don't expect to change. The issue around exchange rates has stabilized a touch, so that's a little bit less of a problem. So, I think it's a question mark of how that cross-border business evolves going forward. But again, I think it's easy to kind of over-rotate in cross-border. I would draw your attention back to the domestic parcel business. I mean that's where the biggest chunk of the revenue is. If you look at the long-term plan, that's where all the incremental EBITDA is. And to your question, Cross-border will work itself out one way or another. Either we'll get that business moving forward or if not, I'm confident that it's got somebody in the market place.

The best path forward is to sell the entire segment and use the proceeds to de-lever the balance sheet. The logical buyers of Global Ecommerce include private equity or a strategic buyer, including DHL or smaller regional parcel players, such as LaserShip, OnTrac, or LSO. Assuming a sale of $237.5 million (half of the 2017 purchase price), the Company could effectively retire 10% of the enterprise value of the Company on a book basis. Most of the debt in the capital stack is trading below < 80 $-price.

We ascribe zero value to a sale in our cash flow analysis of pro-forma PBI following the sale or divestment of Global Ecommerce. We use the sale $237.5 million above to illustrate the impact the proceeds could have in reducing the debt burden. Even selling the asset for $0 results in a massive uplift to EBIT and free cash flow generation. While it is not the ideal outcome, we view it as a necessary step in preventing further negative return on capital investments into the segment. Ultimately, PBI should focus on growing the Presort segment, managing the declines in SendTech Solutions, and use free cash to pay down debt.

Presort and SendTech Solutions

PBI’s core Presort and SendTech assets produce significant cash flow despite secular declines in their industries. Under the Presort Services segment, PBI serves as a workshare partner of the United States Postal Service, processing mail through the Company’s own distribution network. SendTech Solutions offers software as a service offering to enable physical and digital mailing and shipping for enterprises. Within this segment, the Company has its own bank, Pitney Bowes Bank, which enables customers to pay for postage, make lease payments for meter rental payments, and finance the acquisition of equipment and working capital for small to medium sized businesses.

Total net sales at PBI are forecasted to decline due to industry headwinds. Management has guided that presort services market growth is expected to decline -6% to -2%, SendTech market growth to decline  -7.5% to -5.5% and domestic shipping to grow +6% to +8%. These figures accumulate to consolidated growth of mid-single digits. Interestingly, over the last three fiscal years presort services revenue grew 4.4% and 3.9% over the last five years. SendTech Solutions declined -3.7% over the last three years and declined -4.7% over the last five years. For the Presort and SendTech Solutions segments, these declines were not nearly as pronounced as the predicted long-term market trends due to the Company’s market position in presort and recurring revenue stream in SendTech solutions. PBI has 23% market share in mail sorting with the next closest peer at ~2% market share. We believe they have the opportunity to continue growing share with bolt-on acquisitions, layering in incremental mail volumes on the existing network base and rationalizing costs. This was most recently highlighted by their acquisitions of Pittsburgh Mailing in September 2022 and Skymail International in October 2022. SendTech Solutions is the dominant postage meter business with ~70% market share in the U.S. and globally. The segment has 65% to 70% recurring revenue with a large installed base of over 800K units. PBI has lost share in this market from stamps.com as the existing management team has neglected the asset. Under current leadership, the salesforce was reduced by approximately 90%, from 1,000+ to 150. Eliminating Global Ecommerce will allow for re-investment in the Presort and SendTech assets to optimize free cash generation.

Proforma PBI (Ex Global Ecommerce)

We believe these core assets have solid free cash flow profiles and much more longevity than what market participants are expecting. In an effort of conservatism, we forecast the following assumptions, for Presort Services, we assume revenue declines of -3.0% and EBIT margins averaging 12.3% through fiscal year 2029. For SendTech Solutions, we forecast revenue declines of -5.0% and EBIT margins averaging 25.5% through fiscal year 2029. We assume an EBIT uplift of $120 million from the sale of Global Ecommerce and a reduction of corporate costs of $60 million. The Company is a $685 million small cap with a substantial amount of unallocated corporate costs. In the last twelve months, the Company had $210 million of corporate costs, representing ~30% of the market capitalization of the Company.

Based on these assumptions, we estimate the Company can generate $2.3 billion in unlevered free cash flow thru 2029. Furthermore, PBI can buy back the current enterprise value of the Company in ~6.5 years, which is roughly equivalent to the 2029 bonds.

Activist Involvement

The presence of activist investor, Hestia Capital Management, makes the sale or divestiture of Global Ecommerce increasingly likely. Hestia recently ran a proxy contest against the Company and successfully won four of the five seats that it nominated during the proxy fight. The only candidate from their slate not selected was Hestia’s potential CEO replacement candidate. Notably, one of these Board members, Todd Everett, formerly was the CEO of Newgistics, where he led the Company through a period of significant growth and profitability. Katie May was also nominated to the Board, who was formerly the CEO of ShippingEasy.com, which was sold to Stamps.com. She served as a Director at Stamps.com until its sale to Thoma Bravo. Hestia has a history of unearthing deep value opportunities, including Hestia’s recent involvement with Gamestop. Hestia CEO, Kurt Wolf, was nominated to the Board of Directors in June 2019 preceding the infamous short squeeze saga. 

The Hestia Directors now take on the role of the much-needed adults in the Board room at the Company. We have a high degree of confidence that they are asking the difficult questions about the future trajectory of PBI.

Why the debt and not the equity?

The capital structure has gotten less risky following a private placement offering and there are no near-term maturities until 2026. The Term Loan A matures in March 2026. PBI completed a $275 million private placement with Oaktree to eliminate the senior unsecured notes due in March 2024 and reduce the principal by ~$50 million on the Company’s Term Loan A. The offering increased the amount of secured debt in the capital structure and increased the annual interest burden however, we view this transaction positively with an anchor investor showing up in the capital structure.

We believe the action items presented above will benefit bond and equity holders alike, however, the senior unsecured bonds due in 2029 presents an opportunity to earn equity-like upside with a higher position in the capital structure. A sale or divestiture of Global Ecommerce is the catalyzing event to get the bonds to re-rate to non-distressed levels and bondholders clip 7.25% until then.

We also are constructive on the 6.875% senior unsecured bonds due in 2027 and think this is a good option if there are challenges acquiring the 2029 bonds. The 2027 and 2029 issues are small in size at $380 million and $350 million, respectively. There is less $-price appreciation opportunity in the 2027 maturity and the 2027’s trade at a $-price of ~75 and related ~16% yield to maturity. Concurrently with the private placement transaction with Oaktree, PBI amended its credit agreement and provided a pathway to retiring the 2027s with secured debt or a future convert issuance.

Risks

-          Secular declines in the Presort and SendTech segments accelerate faster than what is contemplated in the analysis above

-          Management continues re-investing FCF into Global Ecommerce

-          Most of the tradable debt instruments, including the 2027 and 2029 maturities, are small issues with limited liquidity

Catalyst

-          Sale of the Global Ecommerce

-          Replacement of CEO

-          Additional activist intervention / pressure

-          Other sale opportunities, such as Pitney Bowes Bank

-          Potential sale of the entire Company