A Commercial Printing Update

With the release of the February print shipments data, we have now experienced a string of eleven consecutive months of positive comparisons to the prior year. While January & February were up about 4% over the previous year, these solid monthly gains had more to do with the dreadful 2009 but it remains good news. As we await the first quarter results of 2011, it seems the printing and graphic arts community has settled into a relatively good year.

2010 stopped the bleeding of the “great recession” and those double-digit declines in revenue are in the past for now. However it is obvious the industry has reached its inflection point on capacity, the digital press revolution, and the demand/supply imbalance that has plagued commercial printing for the past 50 plus years.

Is there a CEO left who has not opened their quarterly report with a note about price competition fed by too many presses? When one views commercial print from 30,000 feet, the only significant economic indicator that has changed since 1995 is that print demand no longer follows GDP growth. Yet before 1995 and since, we have always had an imbalance of print supply and demand and still we continue to listen to CEO’s quarterly lament price erosion as they whine to the analysts through the magic of Quick Time Player and the Power Point slides hosted by Adobe.

For those clients new to my firm and new to the industry, this price lament seems to make good sense. They come to me with the belief that when Quad buys World Color, RRD buys Bowne, or CGX makes another targeted acquisition, price parity will be reached and EBITDA to revenue margins will quickly improve. Wrong! We are not even close to some form of demand supply relationship.

When the industry recapitalize during 2003-2007, it was during the last golden age of printing shipments. Commercial shipments held steady during those years near $105Bn. Cash flows and earnings were solid and new offset and digital presses replaced the 1990's older press installations. Unfortunately when these new presses replaced tired iron, in many cases it was a one for one replacement. Replacing a 1500 fpm 32 page press with a new Sunday 48 page 3000 fpm press simply added capacity if the printer did not remove two presses from the floor. Still, productivity gains on the press were greater than most price reductions and margins were pretty stable during that period for the well managed public or private companies.

When all those presses hit 2008-2009 and print shipments leveled off at $87.5 Bn last year, that $18Bn is not coming back in 2011 as it did in the 1991 and 2001 normal business recessions. The demand supply imbalance is even worse than 2007. eContent, the iPad, and changes in the allocation of advertising dollars from print to other media produced the perfect storm of reducing the new top for commercial printing shipments to be in the neighborhood of $88 Billion for 2011. This will continue to erode at 3-5% over the next several years. We see print shipments at $70-$75Bn by 2014.

Specifically, magazine circulation and ad pages will never return to the 2007 levels. The economic model of ad pages carrying editorial and cheap subscriptions is dead. Newsstand draws will continue to be reduced as well. Try to find Golf Digest, the Economist, GQ or any special interest magazine if one is not in an airport, commuter train station, library or newsstand in Manhattan. The days of $12 a year for the $4.00 newsstand magazine are long gone as well. Publishers are focused on Apple and the iPad subscription model and how to blend the print version with the tablet version for those of us who still like both.

Direct Mail still uses the best tacking portal in the world to deliver its message, the USPS mail slot or mailbox. The inroads the digital printing are making in both in-line operations on web offset presses and the new digital web fed press from leaders like HP and Creo/Canon will keep this segment relevant and part of any media budget. We may actually see solid year over year growth in this segment. Books and Free Standing Ad Inserts will suffer less than magazines. The El-Hi market will not face eContent until the price point on the tablet can be afforded by everyone. Trade will suffer a little more each year as Kindle and others take its share. The FSI remains a great store driver on sales and the key retail dates around holidays. Vertis will eventually be acquired by RRD or Quad and it should!

While print is still viable and will continue to blend with eContent for the foreseeable future, unfortunately print pricing will not stabilize. There remains too much supply as plant closures have not reduced industry capacity nearly enough (in spite of the plants Quad has closed since its acquisition of World). If one may recall, Quad shut down one Sunday press or equivalent in each of its locations in 2009. Those were not old presses either. Some of the World Color volume from closed tired iron is loading that equipment today. Remember, this is an $87Bn industry with less than 20% controlled by RRD and Quad. Add Cenveo, Brown. Vertis and CGX, one can raise that bar to a +20%. Still, there is ample open time across the industry to keep price pressure on everyone.

Print productivity continues to drive down the cost of a 32-page 4/C form while paper and ink add to any publisher or catalogers burden with price increases. Print buyers rely on the printer in their supply chain to negotiate price reductions. Paper companies took out machines almost monthly in the last decade so supply and demand is in better shape throughout that industry, newsprint being the exception. Add postal increases and ink recently as well, media buyers will continue to look at options other than print. BTW, eContent pricing per unit tends to go down over time. Still another reason why we will not return to the $100Bn of print shipments we saw in 2007.

So in addition to those is the supply chain raising prices, printers who added both offset and digital additions in the last five years are chasing incremental fill for all that open time. Weekly we see two printers in the same geography merging to take the volume of two and better utilize one plant. The next five years will see those announcements almost daily as bank financing, continued print shrinkage, and price pressures force the consolidation from 20,000 printers to 7500 by 2015.

Yet for those public companies in this segment, Wall Street still likes many of them. CGX, VistaPrint, RRD, and Quad are well respected and many see these companies as the potential winners by 2015. Mr. Burton still struggles to convince the street that his portfolio of companies will return to revenue gains from same store sales as he deals with a debt load that may not permit him to add more to his well run roll-up. He remains my hero as the executive who can manage cost through good times and bad.

In closing, recent transactions seem to be fetching a 2-4X EBITDA versus the old 5-6X multiples. Coming off the poor LTM’s of 2009 and 2010 along with a lack of firms shopping or participating in any auction also contribute to the poor multiples. However, for those really well run companies who invested properly and saw EBITDA return to an acceptable percentage of revenue (north of 10%), deals are being consummated.