"Ink is in our veins; ink is in our blood. It is our heritage, our mission and our business to be the very best at putting ink on paper."
Quad/Graphics prints such major U.S. magazines as Time, Newsweek, National Geographic, People, Black Enterprise and Popular Science as well as catalogs for mail order companies as L. L. Bean and Lands' End. The company also offers post-printing services such as distribution of finished pieces to newsstands. The company's shares trade on the NYSE at $12.50 for a market cap of $590 million (47 million shares outstanding).
1906 - The Quadracci family emigrates to the U.S. from Italy. The Quadraccis run a grocery store in Racine, Wis.
1930 - 16-year-old Harry R. Quadracci founds the Standard Printing Company behind the family store. A hobby. As the Depression worsens, the press becomes a source of extra income.
1934 - Quadracci sells his press to William A. Krueger, with whom he founds W. A. Krueger. The company becomes one of the largest printers in the U.S.
1962 - After graduating from Columbia Law School, Harry “Junior” Quadracci joins Krueger and works his way up to vice-president and general manager.
1970 - After a bitter three-month strike, Krueger's management gives in to the demands of its unionized work force. Harry junior, Krueger’s lead negotiator is disenchanted with the company's adversarial relationship with employees and leaves.
1971 – Harry junior takes a second mortgage on his home and launches Quad/Graphics. Harry sells a 30% stake in the new company. With the capital thus raised, he buys an abandoned factory in Pewaukee, Wisconsin. This becomes Quad/Graphics' first plant.
Quadracci convinces key production personnel from Krueger to join him at Quad/Graphics. Quadracci's disenchantment with the hostility between labor and management during his years at Krueger produce an egalitarian, non-hierarchical corporate culture. In return, Quad/Graphics enjoys a loyal and efficient non-union workforce.
In the early '70s, adult men's magazines (Penthouse & Playboy) account for nearly a third of Quad/Graphics' volume.
Quadracci repays investors' initial outlay within two years. The company treats shareholders with due respect.
1974 – Quadracci implements an employee stock ownership plan (ESOP). Over the years they buy back the warrants issued to the company's original investors. By 1997, Quad/Graphics' ESOP is the second largest shareholder of company stock after Quadracci himself.
1976 - Quadracci requires his delivery fleet to haul cargo during their empty return trips. When drivers ask him what kinds of loads they should haul, Quadracci replies, "How should I know?" The incident exemplified a key Quadracci management principle that came to be known as "Management by Walking Away."
1982 - Quad/Graphics forms its own ink manufacturing division, Chemical Research/Technology (CR/T). Today, CR/T produces more than 130 million pounds of ink annually. Offset ink in Wisconsin and gravure ink in Martinsburg, West Virginia.
1984 - The company is named as one of the "100 Best Companies to Work for in America".
1988 - QuadTech Europe established in Weesp, the Netherlands.
1991 - Employs more than 5,000 people. Annual sales are $509 million.
1997 - Purchases a substantial interest in Plural Editoria e Grafica, the commercial-printing arm of Sao Paolo, Brazil-based Folha Group.
2002 - CEO Harry “Junior” Quadracci, the founder, dies at 66. His brother and co-founder Thomas takes over.
2006 - Joel Quadracci (founders son) takes over as CEO.
2010 - Quad/Graphics merges with World Color (Quebecor). Quad management will run the combined company. Quad shareholders (family and employees) get 60% of the combined company’s shares. As a result of the merger, QUAD becomes publicly traded.
Receives Newsweek's Printer of the Year award for the 25th consecutive year.
The company competes with R. R. Donnelley (RRD), Cenveo (CVO) and Valasis (VCI). Quad/Graphics and R. R. Donnelley, combined, have a market share of roughly 15%.
Pre-merger, there were three players in the US capable of high volume publication gravure. Now, just two remain. Quad/Graphics and R. R. Donnelley. Rotogravure presses are expensive to fire-up but they can get you good quality on cheap paper. If you need to print lots of pages, the cost of paper can be significant (just look at COGS).
At first glance, RRD seems to dominate the industry with superior OCF and FCF margins. Quadracci seems to be suffering from some indigestion after the acquisition of Quebecor World. On closer inspection, R. R. Donnelley’s pension liabilities are not only huge, they’re also growing and understated. The company assumes 8.5% return on pension assets. This alone probably explains why Donnelley's bonds yield over 8%.
Like bond holders, the GuruFocus community is not easily fooled. They'll have noticed Quad/Graphics:
Spends more on capex than the competition.
Has reduced its pension liabilities while its peers have increased theirs. Quad assumed multiple defined benefit pension plans as a part of the World Color Press merger.
Pays its suppliers (paper, ink, electricity) in time.
In short, Quad/Graphics treats its suppliers and employees with respect.
In the printing industry, good employee relations and good relations with your suppliers are durable competitive advantages. A strike or lack of paper will put you out of business in weeks. Unlike the competition, Quadracci has a non-unionized workforce. The company is less leveraged and as a result has lower interest expense.
Had R. R. Donnelley decided to fund its new pension liabilities, free cash flow would have been about half of what it now reports. Adjusting for the pension liabilities (I’ll ignore the fact that QUAD is clearly spending double on capex), in 2011, QUAD was twice as profitable as its peers.
... can be complicated. In this case, M&A activity makes it worse. The $ 250 million of reduced pension liabilities I use come from page 95 of the most recent 10k. For the 2011 column, you can compare "Projected benefit obligation, beginning of year" versus "end of year". That's just the liabilities side.
You would have to add back the pension assets to get the net value. I use $412 million. There's a problem there. QUAD accounts for the assets at "fair value" using their own, less agressive, assumptions than Quebecor used. I use the 2011 "fair value" number for the assets. This is wrong but IMO conservative.
QUAD transferred some obligations to Transcontinental after funding those obligations with assets based on less aggressive assumptions than Quebecor used before. That is as fair as it can be to (former) employees but the bottom line takes a (nonrecurring) hit.
Summary: QUAD services its debt with ease.
The company paid an interest of about $ 100m on debt of $1500 million. The debt comes due in five years.
QUAD’s run-rate OCF (adjusting for lower pension contributions and debt) is roughly $400 million. At that rate, QUAD could conceivably retire its debt in four years (before it comes due) while spending more on capex than its competitors.
Taking care of the pension liabilities first is tax-efficient and smart from an owner's perspective. It does temporarily depress (operating) income.
Joel Quadracci is paid about $1 million which is a bit less than the CEOs of CVO and RRD. Unlike them, Joel (along with his mom) have 200 times his annual salary tied up in common stock. His interests are aligned with the interests of minority shareholders.
QUAD's management could easily have issued some more debt and used the cash to retire all of the pension liabilities. This would have done wonders for (operating) income at the expense of higher taxes. This company is managed not like your average publicly traded company. It's managed like a family business.
Employees own about 20% of the company. Not only are the interests of management aligned with minority shareholders, the interest of employees is too.
Joel Quadracci and John Paulson have bought shares at higher prices.
1) The company's stock is divided into three classes: class A, class B and class C. The class B and class C stock have ten votes per share. "A" stock is entitled to one vote. All of the class B stock is owned by the Quadracci family.
2) The company continues to manage the bankruptcy claim settlement process for the Quebecor World bankruptcy proceedings in the U.S. and Canada.
3) Some of the industries that the company serves have been subject to consolidation, leading to a smaller number of potential customers. If smaller customers are consolidated with larger companies using other printing companies, the company could lose its customers to competing printing companies.
4) Some of the company's customers are highly leveraged. Any increase in the nonpayment or nonperformance by customers could adversely affect the company's results of operations and financial condition.
5) Changes in postal rates, postal regulations and postal services may adversely impact demand for Quad/Graphics' products and services.
6) Computers are becoming increasingly connected and portable. In the future, QUAD's services may no longer be required. No one will be putting ink on paper in creative and efficient ways. As it is, QUAD's (pre-merger) revenue quadrupled since 1991. I remember in 1991. Computers were becoming increasingly connected and portable. Many smart people were predicting the demise of the printing industry.
Owner earnings and fair value
In 2009, R. R. Donnelley bid $1.3 billion for Quebecor World (in bankruptcy!). That bid alone is twice what Quadracci currently trades for. That's absurd since pre-merger, Quad was worth more than Quebecor. $2 billion => $40 per share
I define owner earnings as the ability to reduce your liabilities, pay a dividend and buy back shares after paying your bills and maintaining your business. In 2011, QUAD spent more on capex than the competition and paid all its bills on time. Meanwhile:
QUAD reduced its pension liabilities by $250 million
Spent $30 million on dividends.
Reduced debt by more than $100 million.
From an owner's perspective, the company earned $380 million => oEPS of $7.50.
R. R. Donnelley recently paid $500 million for Bowne. Bowne, with $750 million of revenue could charitably be said to be worth 25% of Quad/Graphics. The transaction implies QUAD is worth $ 2 billion => $40 per share.
Quad/Graphics paid $ 25 million of income tax in 2011. This implies the IRS sees earnings of roughly $ 100 million after otherwise taxable pension fund contributions. The IRS says QUAD earned roughly $ 100 m in 2011. => iEPS of $2.50
Why is this cheap?
Quebecor World emerged from bankruptcy with distressed debt players such as Avenue Capital and Centerbridge owning significant stakes. These shareholders may now be selling their shares.
Reported earnings are depressed because QUAD "diverts" operating income to reduce its pension liabilities. This is a huge, temporary drag on GAAP earnings and FCF.
Some fear management treats employees well at the expense of shareholders. In this case, employees are significant shareholders. In fact, (former) employees cashing out now that the company is finally publicly traded may be a reason for the low price.
At some point, the pension funds won't require further funding. This should cause operating income to jump.
R. R. Donnelley is showing signs of distress (high bond yields, aggressive assumptions for the pension funds etc.). Should this giant run into trouble, Quad's revenue and margins will benefit.
The company raised its dividend 25% to $ 1 per share and may repeat that or buy back more shares.
Adjusting earnings for pension liabilities properly - If it's cheap enough, you don't have to do the calculations properly.
Donnelley's attempt to buy Quebecor World
Make it new
Quadwatch - Former, disgruntled, emplyee.
Ready fire aim - Book about Harry Quadracci.
Decent overview of QUAD's 5-year numbers.
This is not a recommendation to buy or sell anything. At the time of writing, I had no position in any of the stocks mentioned. Any and all questions welcome.