Wausau Paper (WPP)
Wausau is a producer of paper and tissue. In the tissue segment, WPP makes tissue for the away-from-home market (for bathrooms in offices, etc.). In the paper segment, WPP makes specialty papers for food processing and industrial uses. In the past few months, Wausau has sold off their printing and writing paper assets as well as their remaining timberland assets.
WPP has spent the past several years restructuring their operations to focus on the tissue business and divest non-core assets. They reorganized the printing paper and specialty paper units into separate manufacturing plants with the plan to eventually exit the declining printing paper business. WPP could not find a buyer for the printing paper plant and on December 7 they announced they would be shutting down the plant and selling the brand names to Neenah Paper. They expect to net $20 million after plant closure expenses from the brand name sales and liquidation of working capital. On December 16, WPP announced they would be selling off their remaining timberland assets for $42.9 million.
Starboard Value emerged as an activist in July and currently owns 9.3% of WPP. They have sent three letters to the WPP board. Their thesis is that WPP should focus on the relatively stable, high-margin tissue business and sell everything else. Since July, WPP has made progress to that end with the printing paper and timberland sales. In their January 11 letter, Starboard asked for the company to sell the specialty paper business as well as consider the sale of the entire company.
The tissue business has been a steady top line grower with stable EBITDA margins in the 22% range (chart from Starboard letter):
2011 was a rough year for the tissue business, with softening demand and record high pulp input prices. Through 9 months of 2011 tissue sales were down 3% year over year and EBITDA declined from $57.6 million to $44.9 million.
Wausau is investing $220 million in an expansion of the tissue segment that will be operational in 2013. This expansion will add to their parent roll production capacity and position them to enter the premium end of the away-from-home market where they think their “green” focus will be popular. They are targeting an eventual $70 million incremental EBITDA contribution and a 14% after tax IRR for this project. Starboard in their letter stated that management has told them that $20 million of incremental EBITDA will come from in-sourcing parent roll production that is currently outsourced. So the bulk of the gain will have to come from expanding sales by entering the premium market. Starboard has questioned the riskiness of such a large investment to enter a market in which WPP is unproven.
WPP stopped breaking out the specialty paper financials from the rest of the paper segment in 2010, so it is hard to know how profitable it is currently. In a recent investor presentation, the company stated that specialty paper sales in 1H 2011 were $197 million. EBITDA margins based on the historical numbers in this segment are 6-7%. If we assume run rate revenue is $394 million that is about $25 million in EBITDA.
How much is WPP worth? Here is the current market valuation:
Given the valuation gap between the tissue and paper assets it is probably best to value WPP on a sum of the parts basis.
It is probably fair to say the tissue segment can do $70 million a year in normalized EBITDA, and perhaps more given they were hit in 2011 by high pulp prices that probably will decline. Starboard valued the tissue segment at 7-8X EBITDA based on the comps of CLW and KMB. The tissue segment of WPP on its own would probably trade somewhere in between CLW (currently 6.8X) and KMB (8.8X).
Starboard valued the combined printing and specialty paper segment at 4.5X-6X EBITDA. We could argue that having shed the printing paper business that the specialty paper segment should be valued at the higher end of that range. However, the fact that Wausau couldn’t give their printing paper plant away might show this range is a bit optimistic. There are no precise comps for this segment, but 5X EBITDA is probably fair.
Adding in the recent asset sales, we get about $10.50 a share, which leaves WPP modestly undervalued. (They also have some hydroelectric assets I have not assigned any value to, but which Starboard valued at $10 million.) Given the minimal attractiveness of the remaining paper segment and the execution risk of the large new tissue project I would need more of a margin of safety to buy WPP.
Information Services Group (III)
Information Services Group (III), through its wholly owned subsidiary TPI, is the largest third-party outsourcing consultancy firm. III was formed as a SPAC in 2006 and bought privately held outsourcing advisor TPI in November 2007 for $230 million. Senior management comes from AC Nielsen where they had success consolidating the media measurement industry. The original strategy was to use III as a platform to roll up small data and industry-centric consulting firms and fold their expertise into TPI, with management originally envisioning a $1 billion in revenue enterprise. The onset of the recession and shifting dynamics in the outsourcing industry have scuttled those plans, although III did do two small acquisitions in 2011.
III Market Valuation
Revenues declined from $175 million in 2008 to $132 million in 2009 and 2010. While the core business has remained flat, III acquired two businesses in the beginning of last year that should boost revenues to the $180 million range for 2011. One was Compass, a benchmarking and analytics firm, and the other was STA, an IT sourcing consultant.
III Revenues (from IR presentation Nov 11)
Management has guided for adjusted EBITDA (backing out stock comp and acquisition and restructuring charges) of $19-21 million. They have done $13.1 million in adj. EBITDA through three quarters of 2011, although they did $6.1 million in the third quarter alone. If they can hit even the lower end of that range III might be a fairly cheap stock.
III Adjusted EBITDA (from IR presentation Nov 11)
I think we should subtract stock comp of about $3 million from EBITDA (it ain’t free), so that gives us $16 million in EBITDA on $99 million of enterprise value or a 6.2X multiple. That doesn’t sound extremely cheap in absolute terms, but on a relative basis consulting comps like Huron Consulting, Hackett Group, and FTI Consulting trade in the 7-9X range. Also capex is very low at around $1.5 million, so EV/EBITDA-capex is only 6.8X.
III looks cheaper on a free cash flow basis. Due to the leverage, low capex, and amortization of intangible assets shielding income from taxes (~$10 million a year), III should generate very strong free cash flow. Working from $19 million in adj. EBITDA- assuming $3 million in cash interest, $11.3 million in D&A, a 38% tax rate, and 1.5 million in capex, III would do $12.7 million in FCF or a 28% levered FCF yield. However, the equity is levered with $54 million in net debt to a $45 million market cap. On an unlevered basis (FCF to the firm/EV) the FCF yield drops to 15%.
My concern with III is that their core business is stuck in a rut, having been essentially flat the last few years with declining margins. While the outsourcing industry is predicted to grow 5% a year, it is not clear that outsourcing advisory will grow at that same rate. There could be a number of reasons for this divergence:
- As the outsourcing phenomenon matures, most large transformational outsourcing projects have been completed and the average outsourcing project has grown smaller. Consulting firms are typically geared towards large, long engagements where they can easily deploy a large amount of their human capital. Additionally, clients may feel the potential savings from advisory services in small projects do not warrant the advisory fees.
- Another impact of outsourcing industry maturation is that a great deal of knowledge has already been transferred from the industry experts to their clients. A company might feel they no longer need consultants after multiple outsourcing projects.
It also seems likely that TPI is losing market share. While they were the first outsourcing advisory specialist and are still acknowledged as the industry leader, they have plenty of competition including other outsourcing specialists as well as traditional advisory firms who have all felt the need to offer outsourcing advisory as the industry has expanded.
Carlson Capital, a 9% owner, sent a letter to the board of III on January 11th requesting that they explore a sale of the business and a change in board composition. Their central point is that the holding company structure of III is adding unnecessary overhead to TPI, therefore the value of TPI would be enhanced if it was taken private or folded into another larger consulting company. TPI is extremely cheap on an EV/revenue basis with a multiple of .55 (on 2011E revenues of $180 million) compared to 1-1.5X for peers, which could offer an attractive buy for a larger acquirer who can cut out overhead.
There have been two recent deals in the outsourcing advisory space, with PwC buying public Diamond Management in August 2010 and KPMG buying privately held EquaTerra in February 2011. PwC paid 14.5X trailing EBITDA for Diamond, so clearly a larger acquirer can pay up given the SG&A synergies and the potential for cross selling services. However, industry analysts have noted these companies are not an obvious fit with the Big Four or larger consulting firms. One of the values of firms like TPI is their independence and lack of bias in directing a client to the appropriate service provider. This source of value is mitigated at least to some extent if the corporate parent is offering outsourcing services themselves. It is also not clear that III has any interest in pursuing a sale of the company. For now it sounds like CEO Michael Connors wishes to pursue his vision by continuing to do tuck-in acquisitions.
While III is somewhat cheap, I will stay away for now given my lack of confidence in the stability of the business, a decent amount of leverage, and management that does not appear willing to change direction.
Disclosure: No position in any stocks mentioned
Elie Rosenberg runs a value investing research website at valueslant.com. Sign up here to get his free value investing ideas and analysis by email and get his free ebook, "16 Ways to Find Undervalued Stocks."