7/3/12

A Great Company at a Wonderful Price in a Terrible Industry - QUAD

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A Great Company At A Wonderful Price In A

Terrible Industry - QUAD

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Quad/Graphics (QUAD) treats its shareholders, customers, suppliers and

employees with respect and trades at less than 2x owner earnings for 2011.

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Apr 16, 2012 | About: QUAD +0.97%

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"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."
batbeer2
Articles (42)
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QUAD STOCK PRICE CHART

Quad/Graphics prints such major U.S. magazines as Time, Newsweek,
National Geographic, People, Black Enterprise and Popular Science as well

1D

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

40

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).

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35 followers

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14.52 (+0.97%)

0
Oct '11

1906 - The Quadracci family emigrates to the U.S. from Italy. The Quadraccis run a grocery store in

Jan '12

Apr '12

Jul '12

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.

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1970 - After a bitter three-month strike, Krueger's management gives in to the demands of its
unionized work force. Harry junior, Kruegers lead negotiator is disenchanted with the company's
adversarial relationship with employees and leaves.

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1971 Harry junior takes a second mortgage on his home and launches Quad/Graphics. Harry

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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.

guruhl

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

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7/3/12

A Great Company at a Wonderful Price in a Terrible Industry - QUAD

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

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(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.

The Next Borders? by The Science of Hitting

1984 - The company is named as one of the "100 Best Companies to Work for in America".

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Benjamin Graham - 'The Memoirs of the Dean of Wall

Street' by Jose Vasquez
Josh Zachariah

1988 - QuadTech Europe established in Weesp, the Netherlands.

Value Idea Contest Submission: J.C. Penney by The Science

of Hitting

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.

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2006 - Joel Quadracci (founders son) takes over as CEO.

Carl Icahn Perturbed with Forest Labs: Interview

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
companys shares. As a result of the merger, QUAD becomes publicly traded.
Receives Newsweek's Printer of the Year award for the 25th consecutive year.
Competition
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%.

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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).

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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. Donnelleys pension liabilities are not only huge, theyre 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 (Ill ignore the fact that QUAD is
clearly spending double on capex), in 2011, QUAD was twice as profitable as its peers.
Pension accounting
... 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.
Financial strength

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A Great Company at a Wonderful Price in a Terrible Industry - QUAD

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.
QUADs 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.
Management
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.
Specific risk
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

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A Great Company at a Wonderful Price in a Terrible Industry - QUAD

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.
Catalysts
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.
Read more
recent 10k
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
Bowne bought
Quadwatch - Former, disgruntled, emplyee.
Ready fire aim - Book about Harry Quadracci.
Decent overview of QUAD's 5-year numbers.
Disclosure
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.
About the author:
I'm contrarian by nature, working on my analytical skills. I seek out stocks both Benjamin Graham
and Philip Fisher would consider suitable for investment.

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A Great Company at a Wonderful Price in a Terrible Industry - QUAD

Related links:
John Paulson

Tickers in the article:

QUAD

RRD

0.97%

-0.85%

VCI

CVO

VPRT

3.38% 21.24% -0.93%

What Worked in the Stock Market for Long-Term Investors?

Extensive research has found that the companies with predictable revenues and earnings outperform the
market average; they also suffer lower probability of loss. As a matter of fact, this kind of companies are
exactly what Warren Buffett wants to buy and hold forever. Please read the research about what worked
in the stock market:
Part I: What worked in the market from 1998-2008? Part I: Predictability Rank
Part II: Role of Valuations
Part III: Intrinsic Value, Discounted Cash Flow and Margin of Safety

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Comments
Tonyg34 - Apr 16, 2012 at 10:06 AM
they also have negative earnings
you imply that this from funding the pension and the quebecor world acquisition. what is your outlook
for normalized earnings? what has been the rate of decline in earnings?
buying anything below asset value is good, but not if the asset value shrinks (eventually the company
will catch up to its stock price, instead of the other way around)
I just worry the company could go the way of standard register (SR),
random thought, this company reminds me of a previous GuruFocus discussion on Rimage (RIMG) leader in loser category, good dividend and fcf, horrible roe/net margins, no real growth prospects

Batbeer2

- Apr 16, 2012 at 10:21 AM

Hi Tonyg34
>> they also have negative earnings
IMHO they have positive earnings. The outright owner of QUAD would have been richer in december
of 2011 than in january.
The IRS understands this, QUAD paid about $ 25m of income tax.
>> you imply that this from funding the pension and the quebecor world acquisition.
Yes.
I don't have an outlook for normalized earnings. I try not to predict. Having said that, I will delve into the
GAAP earnings number and try to reconcile why it is so much different from (adjusted) FCF.
Who was the guy who famously said "earnings are an opinion, cash is a fact" :o)
QUAD reminds me more of Staples than of Rimage.

- EDIT Your questions were adressed by the company in this presentation. As I understand it, the company
expects 2012 FCF of at least $ 300m. If they are right, 2012 GAAP earnings should come in at roughly
$ 100 m. (FCF - D&A + Capex => $ 100m). In 2008, pre-merger, QUAD reported GAAP earnings of $
100m on revenue of $ 2 B.
You may want to go to: [investing.businessweek.com] You'll get a feeling for the (pre-merger)
numbers.

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A Great Company at a Wonderful Price in a Terrible Industry - QUAD

Onthefringe - Apr 16, 2012 at 2:54 PM

Wow. Thorough. Bookmarked.

Benethridge

- Apr 16, 2012 at 6:02 PM

Nice analysis. Very Phil Fisher-like.

Bob_in_Maryland

- Apr 16, 2012 at 9:25 PM

Why not make this a 5+ star article? You know? AND the price is right!
BUT. was it you who said said the industry is terrible?
That might cause the reader to feel (s)he was sent out on a misdirected play. ... Nothing wrong with
that but there are a lot of associated "industries" playing the same game and - for sure - they are NOT
in many specific portfolio's for just this reason.
Will continue with the DD but this story appears to be a truly awesome one. For anyone associated
with journalism, libraries, computers, information dissemination, etc. this relates to a saga that more
than deserves further publicity, understanding and/or appreciation. Seems as though QUAD has
structured itself in a way that is truly visionary. You are entitled to a great debt of appreciation.
So cool! What a discovery!
- Bob

Portfolio14 - Apr 16, 2012 at 10:57 PM

This is an outstanding writeup.

Batbeer2

- Apr 17, 2012 at 12:22 AM

Hi all,
Thanks for the kind words. Glad you like the article. It was fun to write.

Kfh227

- Apr 17, 2012 at 7:35 AM

nice to see someone use debt correctly. as an owner, you care about debt relative to FCF. it is also
important to note interest rates on the debt.

Nabeel fazal, please post a comment:

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