M&F Worldwide (MFW) is a holding company with 4 unrelated businesses. Its Harland Clarke segment is the largest check producer in the United States, and accounts for 70% of the company’s profit. The Harland Financial business sells internet banking and data analytics software to banks, and accounts for 15% of the company’s profit. The Scantron business sells bar-code based paper and software products to schools, hospitals and survey groups. It accounts for 10% of the company’s profit. Lastly, the Mafco business is the leading worldwide provider of licorice, a niche flavoring used mainly by the tobacco industry, and accounts for 5% of the company’s profit. MFW is 47% owned by MacAndrews and Forbes, the holding company owned by Ron Perelman.
On initial inspection, MFW seems to be massively undervalued. On a net income basis, its profits are $120M annually, and on a free cash flow basis, MFW’s profit is nearly double that. Despite this torrent of cash, MFW’s market capitalization is only $483M, or just 2 years of cash flow. Two reasons are to blame. Firstly, the businesses of check printing and liquorice production are in secular decline. Checks are being phased out slowly in favor of electronic transactions, while tobacco consumption is on the decline in the US. This means that 75% of the earnings are expected to decrease annually. Secondly, the company picked up an incredible convenant-lite low interest rate $1.8B Term loan in 2007, just before the financial crisis hit. The effective interest rate on the term loan is an amazing 2.7%. This loan matures in June 2014, and will have to be refinanced at that time. The value of the company depends on a race between the revenue decline and the refinanced interest rate. I have performed a discounted cash flow analysis with the following assumptions, a 10% year over year decline in revenues, a 12% interest rate on refinancing in 2014, and the company uses all cash on hand and cash flow to pay down debt starting from 2014. Under these assumptions, I find that the company is essentially in a debt trap. The revenue decline proves to be too fast to ever repay the debt in full, therefore all cash flow is shunted to bondholders, leaving none for shareholders. Of course, under different and more optimistic assumptions, it is possible that the company will indeed clear its debt and become cash flow positive again. However, after playing around with a few variables, the resulting value of the company is simply extraordinarily sensitive to the revenue decline and interest rate to be able to say with any certainty what the value of the company is. Furthermore, Ron Perelman is known to be an aggressive acquirer of companies and an avid user of debt, and has indeed continued to make acquisitions with MFW. In fact, a massive and transformative acquisition may be one of the few routes out of the debt trap. In the final analysis, the value of this company is too uncertain for me to take a position.
Normally, I do not bother to write up stocks which I am not willing to take a stake in. However, I am making an exception in this case because MFW has interesting characteristics. Firstly, it appears that MFW actually does better in a recession, and that an economic recovery may actually hurt its prospects. Currently, the check industry is a duopoly split between Harland and Clarke and Deluxe. Both companies have actually seen a slowing of the secular revenue decline in their business during the downturn, as companies stopped investing in their electronic transaction systems. In addition, both Deluxe and Harland and Clarke appeared to have increased their prices during the recession, and their revenues have actually modestly increased. If the economic recovery continues, a combination of resumed investment in electronic transactions coupled with an expected rise in interest rates upon refinancing will be detrimental for MFW. Conversely, a double dip recession may help the company in keeping interest rates low. Therefore, MFW has potential as a hedge against a general economic decline, which makes it an unusual company. Secondly, the above DCF analysis is extremely sensitive to small changes in both revenue decline rates and refinancing interest rates. There is insufficient information to properly value this company, and in such situations, the stock price may well flatten out as market participants await additional information. If the stock price for MFW is flat leading up to June 2014, it is possible that option sellers relying on historical measures of volatility may under-price volatility. In that case, one can buy both calls and puts, and net a profit regardless of which way the stock price moves upon refinancing.
Disclosure : I do not own shares of MFW at this time.
