Last summer, I invested in Francotyp Postalia (FP). Current metrics look as follows:
1) Incl pension liabilities of EUR 17 m;
2) Including dividends paid to shareholders; from 2011 being the turning point after a sequence of large impairments.
The company’s core business contains the development, manufacturing, distribution and servicing of franking machines for physical letters and small packages. Though this is a declining industry, FP has been quite successful in keeping its installed base stable. This is mostly due to the strong demand for the PostBase product family which was launched in 2012. These are small volume franking machines with a throughput of 20 to 80 letters per minute. Target customers are small to medium enterprises. The machine is connected to the internet. Hence, postage can be simply downloaded and the software can be updated on a regular basis. With this product the company claims to have a leading position in the so called A-segment including small franking machines with daily mail volume below 200 letters.
Recently, the company has made good operational progress in North America. At the beginning of 2013, the decertification of FP’s T1000 started, a franking machine that was installed in the beginning of the 1990’s. Decertification is performed by postal companies when older franking systems are to be replaced by a technologically new standard. This meant that 35,000 franking machines were to be decertified by the end of 2015. That equals 50% of the installed base in North America and 15% of total. Interestingly, FP did not only fully replace the installed base so far but will add a couple of thousand franking machines to its installed base in the North America until year end 2015.
PostBase distributions are also performing well in UK and Italy. In the UK sales are supported by the introduction of a discount scheme by Global Mail for automatically franked letters. In addition, FP recently entered the French market. France is Europe’s second largest market for franking machines after UK. FP is endeavouring to achieve a market share of 10% here until 2020 or roughly 20,000 franking machines. French Neopost has a stronghold position in this market, which French La Poste would like to change. As a consequence, La Poste more or less invited FP to join the French market.
With the exception of Germany (40% of installed base), FP is mostly operating in pure leasing markets. This means that the company needs to pre-finance the machines leading to a temporary increase in capital expenditures. While leased franking machines are depreciated over a 5 year period leases generate recurring revenue over 10 to 20 years including services and maintenance, teleporto and consumables. The following table illustrates the increase in the investment in the installed base which is due to strong demand for the new product line Post Base and the ongoing decertification process in North America:
After completion of decertification in North America by the end of 2015, investments in new leases will convert to historic levels. Management expects capex to decline to EUR 14 m in 2016 / 2017.
Consequently, free cash flow should turn positive next year. Below I have put together my forecast for free cash flow in 2016:
Management’s guidance for 2015 EBITDA is EUR 27 m to EUR 28 m. For 2016, I assume EBITDA to be unchanged. EBITDA might be positively affected by high margin recurring revenue coming closer to the bottom line due to smaller numbers of PostBase systems entering the market and hence lower distribution costs. At the same time, for instance a weakening of the euro might have a negative effect.
I assume no changes in working capital despite lower investments in leased franking machines leading to lower inventory levels in the future.
Interest includes mostly debt and finance leases (receipts for leased machines to clients and payments for machines in use in the mail services segment – see below). Here I take a slight increase into consideration.
FP has tax assets in place which are expected to lower actual tax payments for at least the next five years. Nevertheless, I expect tax payments to slightly increase in 2016.
As already mentioned above, current management guidance is a total of EUR 14 m capital expenditures in 2016. Consequently, I expect the company to generate EUR 8 m of free cash flow next year implying an 11% yield.
In 2006, the company started to extent its product offering via a number of acquisitions to become the first multi-channel provider for mail communication in Germany. This happened under the former management. While the investment in the PostBase franking machines turned out to be successful, shareholders are still waiting for the other investments to pay off: apart from franking machines the company offers software solutions (outsourcing solutions from the optimisation of internal processes for written communication, e.g. for invoicing and dunning runs), mail services (collecting and processing business post) and legally binding electronic letters (De-Mail). Combined these three segments produce very low margins and returns on invested capital. For instance, in the first nine months 2015 revenue from mail services grew by EUR 7 m or 22% y-o-y. However, the positive impact on EBITDA was negligible.
In conclusion, I expect the installed base of FP’s franking machines to keep relatively stable for an extended period of time due to the recent high renewal rate in North America and strong demand in new and existing European markets. Except from a likely decline in demand over the long term, the oligopolistic structure of the industry, a recurring revenue stream, strict regulation and support from local postal companies (e.g. discounts on automatically franked letters) provides for attractive industry characteristics. Hence, I assume that cash flow generation should keep strong after 2016. The other segments (mail services, software solutions and De-Mail) provide optionality. Revenue growth in mail services could be a door opener to achieve growth in software solutions which for itself is producing double digit operating margins. De-mail has not added to revenue yet, but management targets a 10% market share resulting in up to EUR 20 m high margin revenue over the long term.
In terms of capital allocation, I expect the company to gradually increase the dividend (after paying 8 cents per share for 2013 and 16 cents per share for 2014). Acquisitions might happen, but I expect the new management to be much more disciplined than the former executives who basically wasted much of the proceeds from the IPO (impairments totalled roughly EUR 80 m from 2006 until 2011). With the largest shareholder, Klaus Röhrig (holding 10.3%) becoming the board’s Chairman in 2013, value creation for shareholders might have become one of the priorities at FP now. Mr. Röhrig was country head for Germany, Austria and Switzerland at Elliott Associates from 2006 to 2011 before founding his own business. So he might contribute to management’s capital allocation skills. At the same time interests with other shareholders should be aligned to a large extent.
From today on, I will increase the position in FP to 4% of my portfolio with a limit of EUR 4.7 per share.
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