The small acquisition of Jacaranda, a video and film production specialist, looks a decent bolt-on deal. The company specialises in creating, managing and measuring the effectiveness of video content for global brands. In the financial year to end February 2013, Jacaranda made cash profits of £390,000 on turnover of £1.6m, so the £1.5m initial consideration is a sensible valuation. Of this purchase price £900,000 is cash and there is an earn-out payable annually in cash up to an aggregate amount of £500,000 dependent on the gross profit generated in the three years after the acquisition.
In addition, Communisis has acquired Public Creative, a company that creates and drives brand awareness for clients with digital media and uses web and mobile applications to build customer loyalty. The net consideration of £350,000 equates to seven times cash profits.
Both these bolt-on acquisitions add specific skills and expertise to support Communisis’ strategy of building a range of integrated services in its design segment. They also offer scope for generating additional revenues with the company’s existing clients.
With this thought in mind, last week Communisis made its third acquisition in as many months. The Communications Agency (TCA) is an award-winning agency that specialises in brand response and customer relationship marketing. TCA has long-standing client relationships with leading brands in the financial services, retail and consumer goods sectors. In my view, the acquisition offers great potential for generating additional revenues from Communisis’ existing client base and the cross-selling of other marketing services in social media, video, digital development and content marketing.
Communisis is making a cash payment of £6.55m, of which £500,000 is deferred and dependent on TCA’s financial performance for the year to end October 2014. The company is also issuing shares worth £1.45m. Analyst Johnathan Barrett at brokerage N+1 Singer estimates that the exit multiple is eight times cash profits and the deal will be earnings enhancing for the company in its first full year.
Post these deals, Mr Barrett now expects Communisis to report 2014 pre-tax profits of £14.9m and adjusted EPS of 5.8p, up from £11.6m and 4.7p, respectively, in 2013. These estimates are based on a 15 per cent rise in revenues to £310m and a 30 per cent increase in cash profits to £27.2m. The numbers are also well underpinned by a number of contract wins too.
New contracts driving margins and profits higher
A first quarter trading statement from Communisis highlighted a major contract extension for the provision of external brand building services to a major client, consumer product giant Procter & Gamble (US: PG. - P&G). The agreement covers a range of P&G brands focused on retail across Europe and will now run until 31 December 2019. It has also enabled Communisis to develop the infrastructure to grow overseas activities both with P&G and with other consumer goods brands. The consumer goods segment now accounts for a fifth of Communisis’ revenues, up from only 8 per cent in 2012, and is set to grow even further in the years ahead.
The company is also delivering on its strategy to ramp up the contribution from international contracts. Communisis supports clients in 15 countries operating from 11 European sites, principally providing external brand building services to P&G. Last year, overseas revenues increased from 7 per cent to 18 per cent of the company’s turnover.
And that’s not the only major contract win as earlier this year Communisis was awarded a new 10-year outsourcing arrangement with Lloyds Banking Group (LLOY) to handle all the in-bound imaging and mail processing services for the bank. The company is taking on 14 Lloyds sites in the UK to deal with more than 30m incoming documents each year from the bank's customers. These documents will be scanned into a digital format, indexed and distributed to the relevant bank department for processing. Financial services accounted for 43 per cent of Communisis revenues in 2013. New contracts with Nationwide Building Society and Lloyds should see this contribution rise even further.
Importantly, Communisis’ management team apply stringent criteria to all new contracts being tendered for. Namely, they have to be consistent with an internal objective of delivering double-digit operating margins on sales, generating an internal rate of return of 20 per cent on capital employed and have a maximum payback period of three years. In other words, the rates of return on these new contracts are well in excess of both the cost of equity and the blended cost of the company's capital so enhance earnings per share.
Robust earnings and dividend growth
The combination of the contribution from acquisitions, better margins on new business wins and organic revenue growth are the main reasons why Mr Barrett at N+1 Singer believes that Communisis will grow revenues to £329m next year and drive up cash profits to £31.6m.
On this basis, adjusted pre-tax profits are predicted to rise again to £18.7m as margins on legacy contracts are replaced with more profitable new business, and restructuring benefits feed through. In turn, this is expected to drive current year EPS up by almost a quarter from this year’s EPS estimate of 5.8p to 7.2p in 2015. This means the shares are trading on 10 times current year earnings forecasts, falling to only eight times next year’s forecasts.
It’s worth pointing out that Communisis is well funded to service all these new contracts and the aforementioned three acquisitions. Net debt ended last year at £25.7m, or a modest 18 per cent of shareholder funds. That’s well within the company’s credit lines. These consist of a £55m revolving bank facility which runs until March 2018, and a £5m overdraft that is renewable annually. N+1 Singer expect net borrowings to peak out at £40m at the year-end, before falling back to around £29m by December 2015.
Moreover, with earnings set to ramp up sharply, the board are expected to continue with their progressive dividend policy. N+1 Singer pencil in a 2p a share dividend this year, up from 1.8p a share in 2013, rising to 2.2p a share in 2015. The prospective yields are 3.4 per cent and 3.8 per cent, respectively.
Target price
True, the shares are down on my recommended buy in price of 69p despite the good news and low rating. As I see it the main reason for this underperformance is down to last month's news that Communisis will be taking a one-off cash restructuring charge of £1.5m to rationalise its facility at Cross Gates Leeds which handles direct mail. The other sites in Leeds and in Copley, Halifax are not affected. It certainly makes sense to take costs out of the lower growth areas – around 75 staff will lose their jobs – and deploy capital in the growth segments of the market I have highlighted where the return on investment is much higher. So although exceptional charges are never welcome, in this instance I can understand the rationale behind the decision given that direct mail volumes continue to decline.
In the circumstances, I feel the pull back in the share price in the past month post news of the restructuring is an overreaction. It also means that Communisis’ shares are now rated on 10 times earnings estimates for 2014. That’s hardly an exacting valuation for a company that is expected to grow EPS by 50 per cent in total over a three-year period (2013-2016). It is also a business where contract momentum is clearly building.
So trading on a bid-offer spread of 58p to 58.5p, and offering 45 per cent upside to my year-end target price, Communisis’ shares rate a very decent medium-term buy.
■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
