PMP merger gets green light

The ACCC has announced that it will not contest the proposed merger between PMP and its largest rival, IPMG, which operates the Hannan print business. The ACCC acknowledged that, although the deal would lessen competition, market conditions had changed since the same deal was proposed and knocked back in 2001.

The merger has been a key part of our investment thesis for PMP and is unquestionably good news for shareholders.

Combined, PMP and IPMG will control about 80% of the heatset print market, primarily involved in printing catalogues and magazines. A decade ago, such market dominance would be unthinkable but, with the magazine industry dramatically smaller and the industry swamped with overcapacity, a decision to knock back the deal would almost have been a death sentence to both firms.

Better industry conditions

The ACCC made specific mention of IVE group, a listed print business that has grown by acquisition, as a major competitor that would restrain the merged group.

IVE is an interesting case study. It recently acquired Franklin, a major catalogue competitor to PMP, and has helped reduce industry capacity. A smaller number of larger market participants should show supply restraint and could lead to industry profits rising. IVE itself trades on an enterprise value to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) multiple of 10 which is high for this kind of business. PMP, in contrast, trades on EV/EBITDA of just 4 times.

The ACCC didn't mention that most of PMP and IPMG's customers are large retailers with dominant market positions. We understand that one of the major supermarkets raised concerns with the ACCC about the deal and we imagine the regulator chuckled a little as they heard the plea for protection.

With the deal now allowed to proceed, PMP should be on surer footing. The business has estimated $40m synergies at the EBITDA line but we think that is a gross underestimation and true savings could be twice that number.

Still cheap?

If we assume the combination of PMP and IPMG can generate $60m of EBITDA and add $40m of synergies, it isn't hard to imagine $100m of additional EBITDA from the new entity, which might be worth about $500m on modest multiples, after restructuring charges.

IPMG will own 37% of the new business so PMP itself could be worth about $270m compared to a market capitalisation of $210m today. In short, there may still be value on offer.

We will need to do more work on the extent of the efficacy gains and how much margin of safety to seek in a poor quality business with an improved industry structure.

The stock is up around 11% today and 14% since we reported on the ACCC's possible intervention just before Christmas. That puts it 39% up on our original Buy recommendation from June 2015, excluding dividends. It's therefore worth keeping a close eye on our 5% maximum recommended portfolio limit; this remains a poor quality business albeit one which has demonstrated capable management.

PMP shows the value of contrarian investing and why we seek ideas where others do not. We've again increased our price guide but our recommendation remains 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.