Description

Investment Thesis

W/S Packaging is one of North America’s largest suppliers of labels to the food and beverage, CPG, and pharmaceutical end markets.  The firm has 17 manufacturing sites in North America and supplies customers of all sizes, from start-ups to Fortune 500 companies.  Platinum Equity purchased W/S in February from J.W. Childs.  In late March, W/S came to market with a 1st lien private placement that priced at 9%.  The notes trade under the ticker WSPKHD and are priced in the low-103s.  They are trading very wide of the single-B index, which is yielding 7% with spreads near 390 bps.  There is a good chance they get taken out at the first call date in April 2020, in which case holders would realize an annualized yield of 9.5%. 

W/S’s offering documents are not public.  Therefore, we will provide only publicly available information and our own research findings.  The documents are accessible with approval on Intralinks. 

Company Overview

The labeling industry is a mission-critical component for almost any manufacturer trying to reach the end consumer.  Labels are highly visible, are used to effectively differentiate products, and add significant value because they are usually very inexpensive relative to the cost of the product.  In addition, labels display legally required information like chemical makeup or nutritional value in a cost-effective manner. 

W/S primarily sells pressure sensitive labels, which account for approximately 70% of revenues.  Pressure sensitive labels are self-adhering and can be made in a wide variety of materials.  They are used in multiple end markets, including food and beverage, health, beauty, and pharmaceuticals.  Label industry players have consistently touted the conversion to pressure sensitive labels from other traditional types as a primary growth driver for the industry as customers seek to differentiate their products.  Pressure sensitive is primarily taking share from cut-and-stack (think beer bottle labels).  Freedonia recently released the 12th edition of its Labels Market in the U.S. report, which forecasts 3.5% annual growth in pressure sensitive labels to 2021.  Competitor Multi-Color (LABL), which had a similar percentage of sales from pressure sensitive until a large acquisition completed last year, stated the following at a recent conference. 

“…why is the label space growing much better than packaging? We're not only getting perhaps the 1% or 2% of growth for the packaging space, but the rest of the growth is made up of premiumization in the label space. So premiumization in terms of customers wanting more value out, more bling on their labels, premiumization in terms of moving from a less expensive label to a more expensive label, perhaps a 100% decoration through going to a shrink sleeve or going to a pressure-sensitive label and away from a cut and stack label. So, I don't want to bore you with the technology, but the trends in the label space are to more expensive labels with more value on them, more information required either the regulatory or by the customer on the label, more security features, more just in time supply, therefore, small orders are high selling prices.”

The label industry is competitive but highly fragmented.  Canadian firm CCL Industries (CCL/B CN) is the largest player.  We estimate CCL's share of the $35 billion global label market to be about 8%.  With the Constantia purchase, Multi-Color now has about 5%.  These are the only two global label players.  They both focus on higher volume, large customers that may have global printing needs.  The big guys don’t really compete with W/S despite generating similar revenues in the states ($511mm for LABL in FY17 and $431mm for W/S) and having a similar footprint (~16 facilities).  Fort Dearborn is a relatively large domestic competitor that was also recently bought by PE.  Dearborn’s sales in the twelve months ended June 30, 2016 were $416 million, according to Moody’s.  Dearborn has 17 facilities across the U.S. and Canada and had 1,675 employees at the time of the acquisition.  However, Dearborn is much more exposed to cut-and-stack.  Overall, the U.S. label market is estimated to be roughly $8.75 billion, so Multi-Color, W/S, and Dearborn each have around 5%.  CCL’s share in the U.S. is probably about twice the size. 

The label industry is recession-resistant.  While we can’t comment on W/S specifically, Multi-Color’s sales were down only modestly in 2009 due to the SABMiller/Molson Coors merger and pullback from P&G, which at the time was a huge customer.  CCL’s Label segment sales were down 1% in 2009 and rebounded 7% in 2010. 

You can back into W/S’s margins using the Moody’s initiation note.  W/S’s EBITDA margins are frustratingly low compared to peers.  Based on W/S’s smaller customer base (as opposed to global customers like LABL and CCL have), theoretically it should have higher margins than both larger peers.  Higher volume production runs like those handled by LABL and CCL typically result in lower margins.  Large global buyers have some bargaining power, and printers can spread costs out over more units.  Additionally, the runs are more uniform.  In contrast, W/S should be earning more on its small runs.  You could argue that the large players are leveraging overhead to a larger degree, but Multi-Color had better margins a decade ago when it was a bit player.  There is more detail in the offering documents regarding Platinum’s strategy for improvement.

We spoke with public and private market contacts to try to nail down the margin question.  Multiple contacts highlighted the disparity of margins across the industry, noting that a skilled operational team should reasonably be able to attain industry average EBITDA margins in the 15-20% range.   Multi-Color has been consistently stating that it’s acquisition targets usually have 15% EBITDA margins.  On $431 million in revenue (calendar 2017) a 15% EBITDA margin puts W/S’s EBITDA at $65 million versus the Moody’s implied EBITDA of under $40 million.  We heard anecdotally that WS was mismanaged and that Platinum’s involvement should be very positive. 

Even with below-market revenue growth, we believe W/S will be able to materially increase earnings and reach the lower end of industry EBITDA margins by 2020.  If achieved, we model net leverage dropping to just 3x, assuming no alternative uses of cash.  Platinum might exit at this point unless it sees potential to roll-up small competitors at mid-single-digit EBITDA multiples.  At ~$70 million in EBITDA and a 9x multiple, Platinum could get taken out for over $400 million after debt repayment and realize a 3x on its equity investment.  The notes are callable at 104.5 in April 2020, opening the opportunity for a buyer to take them out at a reasonable premium.  W/S can also call 10% of the issue annually at 103.  Including two years of 103 calls, the blended yield to 2020 is 9.5%. 

Platinum Equity

Platinum was founded in 1995 by Tom Gores (owner of the Detroit Pistons) and now has $13 billion under management.  It is investing its fourth fund (fifth including the pre-fund capital) with total capital of $6.5 billion.  The firm owns 30 companies in total, and Partners IV has been quite active since its launch in 2016.

While it may not be unique among like firms, Platinum prides itself on its operational expertise.  In fact, it has trademarked the acronym “M&A&O.”  The firm has a long history with over 200 transactions in the last 22 years, most of which were focused in the middle market across a variety of industries.  The firm targets enterprise values between $100mm and $5 billion.  It’s tough to do an exhaustive analysis of Platinum’s record because much of the information is private, but multiples sources claim that each Platinum fund has been a top performer for the vintage year, and Platinum has been ranked a top five PE firm by PEHub.  According to a March 2017 article, Fund III’s 42% IRR is the best performance for a fund larger than $1 billion raised between 2010 to 2013.  

Platinum is experienced in the packaging space via BWAY (which it sold in 2016 after owning for 4 years) and more recently Mactac, which is more closely involved in the label market as a supplier of pressure-sensitive materials.  Platinum bought the firm from Bemis in 2014 for ~$160 million, increased EBITDA 40% in a year, and sold it in two pieces for a total of $515 million.  

It’s worth noting another PE firm’s involvement in the space.  Label competitor Fort Dearborn was acquired by PE behemoth Advent International in Q316.  Advent has $42 billion under management.  It started investing its 8th fund in 2016 with $13 billion in committed capital.  The stated strategy is to invest in situations with potential for operational improvement and long-term revenue and earnings growth.  A Moody’s note covering the Dearborn debt issuance mentioned the firm would continue to pursue an acquisition strategy.  Advent was likely attracted to the fragmented industry and will probably attempt to buy smaller competitors.

Advent bought Dearborn for $830 million from the significantly smaller KRG Capital.  They levered it up to 6.5x despite having much higher exposure to lower growth cut and stack labels.  Assuming the debt outlined in the Moody’s note was correct, the multiple implies EBITDA of $96 million for an EV/EBITDA multiple of 8.6x.  This seems to be on the low side of industry multiples, but this could be due to abnormally high margins and/or limited opportunity for operational improvements.  The EBITDA margin appears very strong relative to peers at 23%, which seems unlikely to be normalized.  Our contacts thought this figure was incorrect.  At a market margin of say 18%, the multiple is in line with comps at 10x. 

Recommendation: Buy 9% 1^st liens

Risks: high leverage, sponsor friendly capital allocation

Catalyst

operational improvement, deleveraging