With the physical letter volume shrinking, the demand for franking machines is abating. Francotyp Postalia (FP) however is a good example for a company that can prosper in a declining industry. Only two other companies are offering franking machines including Pitney Bowes and Neopost. In addition, the distribution of franking machines is highly regulated. This provides for attractive industry characteristics. FP invested early in the technological enhancement of low volume franking machines. This is (so far) a stable segment and FP is the technological leader grabbing market share from the two other incumbents. While the competition focuses on the development of new services, FP is broadening the geographic footprint entering new markets and investing in new leasing equipment. With the replacement cycle of old franking machines in the US mostly completed, I was invested to participate in strong free cash flow generation from a highly predictable recurring revenue stream over the coming years.
In 2016, the management changed. The new CEO released a road map leading all the way to 2023. Ambitious goals were announced. So far however, there has been a high amount of “non-recurring” costs. Investment in efficiency and new product development have been made. For me it is difficult to quantify future cost efficiencies and to predict whether investments in new products will turn out to be successful.
Moreover, the company’s other business lines are weak. The mail services segment barely breaks even and suffers from intense competition and deteriorating economics. The software segment generates healthy margins but revenues are stagnating and they recently lost their largest client. More resources might be needed to restructure or reposition this part of the company.
From a valuation perspective a 3.5 times EBITDA multiple looks attractive. In my investment case, I assumed that required investments will go down leading to lower D&A and therefore higher EBIT over the years. Therefore, we would also see higher free cash flows and cash return to shareholders. Unfortunately, this has not been the case so far. Cost overruns and continued investment will cap EBIT at EUR 10 m in 2017. Consequently, the company is valued at ten times operating profit (For comparison, shares of competing Neopost can be bought at eight times EBIT). With EUR 4.5 m of free cash flow in 2017, FP trades at a 6% yield. As I do not see much improvement in 2018 as well, this turns out to be a high valuation for this type of company. FP is operating in a declining industry (although they are increasing their market share) and has to carry around the mail services business that might never be generating noteworthy profits in the future but requires substantial resources. I think it is time to move on and to sell the shares.
I started selling shares on February 15, 2018 with a limit of EUR 4.3 per share. At this sales price, this investment generated a 11.9% total return and a 3.8% IRR over a 3.5 year holding period.
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