Patience pays at PMP

It didn't look like an obvious buy.  When we first recommended PMP as a buy 18 months ago in PMP: Back from the brink, it didn't appear profitable or cheap – but that was precisely the point.

Behind the façade of poor profitability was a cash generating machine. As we explained at the time, PMP has spent twice its market capitalisation on capital expenditure to enlarge its printing fleet in recent years.

As the industry permanently changed and declined it became clear that expenditure was a mistake and that the business was depreciating an asset base that it would not replicate.

About $30m a year in depreciation was being passed through the profit and loss account, but PMP was spending just $5m on capital expenditure. Although profits appeared weak, free cash flow was strong with the business trading on a free cash flow yield of over 20% at the time highlighting that the best opportunities aren't always the most obvious ones.

The icing on the recommendation, however, was that PMP could dramatically lift margins and profits by buying out peers.

A new deal

That is exactly what it has pledged to do today, announcing the $120m purchase of privately owned rival IMPG which owns the Hannanprint, Inprint and Offset Alpine businesses.

The merger of these two is a big deal. It creates much needed scale and allows more work to be run through an efficient fixed asset base, lifting margins. PMP has immediately identified $40m of savings and we suspect there will be more.

The new group will sell under-utilised printers and work to lower chronically oversupplied industry capacity. Management is targeting about $112m of earnings before interest, tax, depreciation and amortisation (EBITDA) from the enlarged group.

The purchase will be funded entirely with the issue of 188m new shares. Assuming a 63c share price, that implies a purchase price for IMPG of about $118m.

The Hannan family will receive board representation as well as 37% equity in the combined group. At less than 6 times EBITDA, this doesn't appear dirt cheap but including the benefit of synergies, the price falls to just 2x EBITDA.

Long-term gain

To realise those cost benefits, PMP will likely utilise cash to shed staff and facilities so dividends and buybacks have been suspended for now and a new debt facility has been established. In the short term at least, cash consumption will rise but it will be more than offset by future benefits.

The market agrees and has sent PMP's share price soaring 34% with the announcement.

All takeovers entail risk but the scope for savings is enormous. We've lifted our buy price and portfolio limit to account for the savings made by an enlarged group.

We've long maintained that a successful takeover could lift value to over $1 a share. That view doesn't change but neither does our demand for a margin of safety. This is a wonderful deal and a decent price and our investment case for PMP is well on track. We would upgrade again at around 70c. For now, HOLD.

Note: The Intelligent Investor Equity Income portfolio owns shares in PMP. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Disclosure: The author owns shares in PMP.