Valassis

What a difference a year makes!  A year ago Valassis was trading at a dollar; its bank debt was in the 50s, and its bonds were in the 20s. We owned the entire capital structure and it was our largest position. We believed that despite leverage from the purchase of Advo (a mailed coupon service) and tight covenants -- the company would survive, even thrive as it had the right management team and business (saving consumers' money, driving them directly towards certain products and retailers) for these tough times.  Today, the stock is at $34 and the bonds are above par. We have exited the debt but the stock is still a top five position -- not because of the large embedded and taxable gains. Rather, we believe that Valassis stock is worth, and will trade, above $40 a share and that the downside is limited from current levels.

Why the discount?  For one, the company is still relatively underfollowed and misunderstood. Its core business used to be the free standing insert business (coupons delivered via newspapers), and the stock would trade down on the endless flow of poor newspaper circulation numbers. But the reality is that, due to intense pricing competition from newscorp, the FSI business is essentially breakeven and so not a driver of company value - though that is about to change.

Before the crash, Valassis took on a large amount of debt to buy the Advo business and actually had to sue to cut the price as the amount of cash flow was misrepresented by Advo management.  This debt is what almost bankrupted the company. That said, the shared mail Advo business now provides a vast amount of the company's profitability and is the future as more and more FSI business is migrated over to that platform.

I am modeling about $300mm of EBITDA for 2010 (though I believe the secular growth in coupon usage could make this number conservative).   If the company were to use all $300m of after tax proceeds from the Newscorp settlement to buy back the 8.25% bonds, net debt would fall to about $500mm.  8x 300 is 2.4 billion. $1.9 billion is $38 per share, a not bad percentage return from here. The kicker is that a little understood part of the News settlement is an operating agreement to buy space on either of VCI's shared mail or FSI platform.   It is possible that this spend will drive about $50mm or more in incremental EBITDA. 8x 50 would yield $400mm in incremental value or $8 a share. When you combine these two numbers, you derive $46 in share value.

But let's look at free cash flow per share. EBITDA is $300, less $20m in Capx and $10m interest expense or $270 in pretax cash flow or $162 in after tax cash flow -- so $3.24 per share. 10x that number is 32.4.  If you add $30mm in after tax free cash flow from the settlement mandated Newscorp purchases, it adds another $0.60 of earnings per share or another $6 to the share price at 10x earnings. The blended cash EPS number is about $3.84 pro forma. If it were to trade at a market multiple of 16x, the stock would be at $63 a share, almost a double from here.

Another way of looking at this stock is to subtract the cash from the settlement (about $6 a share). You are creating the stock for about $28 a share with $3 of cash EPS before any financial engineering or 9.3x earnings. So even before the debt paydown and any possible share buyback, the stock is still cheap on any terms.  The only thing missing to make it a better deal still is a coupon!

And did I mention that the business is improving?   Advertising is coming back.  The Great Recession has sent coupon usage through the roof while the slow "new normal" looks destined to keep the public avidly clipping coupons for years to come..