CHECKPOINT SYSTEMS INC CKP
January 07, 2015 - 2:47pm EST by
Toby24
2015 2016
Price: 13.09 EPS 0.86 0.88
Shares Out. (in M): 42 P/E 15.22 14.88
Market Cap (in $M): 548 P/FCF 0 0
Net Debt (in $M): -56 EBIT 0 0
TEV ($): 492 TEV/EBIT 9.64 9.04

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  • Recurring Revenues
  • High Retention Rate
  • margin expansion
  • Misunderstood Business Model
  • Non-Core Asset Monetisation
  • Contract Wins
 

Description

I wrote this up to submit to Seeking Alpha only to find an email in my inbox this morning that someone had just posted it to Seeking Alpha. The piece at Seeking Alpha is brief in comparison to this and I think the additional detail I have provided make this a worthwhile contribution to the general thesis on the name, so here is my own work on CKP. The structure is formatted for a submission as a Top Idea at Seeking Alpha but the content is equally appropriate for VIC.

 

I see substantial upside here and with over half of revenue recurring, I think this is an unusual situation where downside is limited and upside is high.

 

 

A Growth Stock at a Value Price: Checkpoint Systems and the Expansion of RFID at Retail

 

 

Summary

  • CKP is a misunderstood multi-year revenue growth and margin expansion story, yet it trades for 6.5x 2015 EV/EBITDA vs ~8.5x historically. And today they have a brighter future than ever.

  • 55% of revenue is recurring, the CEO and CFO sold their prior companies, and CKP is the only global pure-play RFID company. I expect this to be acquired.

  • Analysts don't understand this is a penetration story reliant on the ROI associated with RFID at retail. Brick-and-mortar retail expansion isn't the primary driver. The stock is overlooked and misunderstood.

  • RFID can improve inventory accuracy to over 90%. Retail averages sub 70%. Studies show each 2% increase in accuracy = 1% increase in sales. They are selling a very attractive ROI.

  • CKP is worth at least $20/share today for >50% upside. One year out CKP is likely worth $25/share or more for ~100% upside.

 

 

Checkpoint Systems (“CKP”)

CKP is a leading global manufacturer and provider of technology-driven loss prevention, inventory management and labeling solutions to the retail and apparel industries. Their core loss-prevention business is built on more than 40 years of radio frequency (“RF”) technology expertise. The systems and services included in this business enable retailers and their suppliers to reduce shrink (theft and loss of merchandise) while leveraging real-time data generated by CKPs systems to improve operational efficiency.

 

The business operates through three segments (i) Merchandise Availability Solutions (“MAS”), (ii) Apparel labeling solutions (“ALS”), and (iii) Retail Merchandising Solutions (“RMS”), but the key item to understand is the core of the business is selling a system and solution (security gates at the front of a store, or overhead RFID readers) and earning recurring revenue from the tags and labels that work with those solutions. This is the core business. It’s a razor-razorblade model and it’s evolving from legacy RF technology to modern RFID technology.

 

In 2012 CKP refined their strategy to transition from a product protection business (primarily RF technology solutions) to a provider of inventory management solutions (primarily RFID); solutions that give retailers ready insight into the on-shelf availability of merchandise in their stores, improving inventory accuracy and increasing sales. Their solutions also help customers identify, track, and protect their assets. CKP has a leadership position in key hard goods markets (supermarkets, drug stores, mass merchandisers, and music and electronics retailers) are expanding in soft goods markets (specifically apparel) and are beginning to pursue under-penetrated markets (noteworthy recent win includes the Family Dollar, Zara, and Tesco, and they are currently pursuing white space opportunities in the U.S., like grocers, among other businesses.)

 

Nutshell Thesis

I think CKP should be trading for as much as $20 per share today, or roughly 9x $83mm in 2015 EBITDA (and adjusting for 2015 FCF of ~$40-50mm). The stock has traded at an average of 8.4x over the past seven years so at 9x, I’m advocating for a slight premium and I think CKP deserves a slight premium for two primary reasons:

 

  1. The business is on the verge of entering a multi-year growth period that will drive revenue in two forms (i) hardware and software sales, and more importantly (ii) recurring revenue tag sales that will build on the over 55% of current sales that are already recurring.

  2. CFO, Jeff Richard, has done an admirable job of right-sizing the cost structure through (i) the execution of a global restructuring plan based on lean six sigma initiatives and (ii) an SG&A savings plan. The leaner cost structure will provide attractive operating leverage as the top-line begins to expand and I expect significant margin improvement.

 

I am using 9x for my valuation but I actually think a sophisticated buyer would pay more than 9x to own this pure-play RFID company. CKP is the industry leader and long-term recurring revenue growth is only beginning. The transition to a faster growing more profitable business model makes the historical average multiple no longer an appropriate measuring stick to assess the valuation so I think the 50% upside to my target is actually a conservative return expectation.

 

The reality is the business and opportunity set the company faces have evolved in recent years yet investors haven’t appreciated the transition that’s taken place. CKP has historically been known for selling what are technically referred to as shrink management solutions. These include various solutions but primarily these are the two part systems relying on (i) plastic tags attached to merchandise and (ii) gates near the exit that detect and alert employees if a theft occurs. This wasn’t a business with an opportunity for rapid growth. CKP still sells these legacy systems in segments they refer to as Electronic Article Surveillance (“EAS”) and Merchandise Availability Solutions (“MAS”), but this is a dinosaur technology that will eventually be displaced by radio frequency identification, a.k.a. RFID.

 

CKP has positioned the company to be the leader in selling end-to-end RFID solutions to retailers worldwide and the RFID upgrade cycle is just beginning. The evidence suggests, (i) this is a five year plus growth story in its infancy and the best part is, (ii) with the sale of each system CKP creates an annuity stream by also selling the RFID tags and labels ultimately affixed to merchandise. This creates a substantial recurring revenue stream that today amounts to roughly 55% of revenue.

 

  1. IDTechEx forecast in the new report RFID Forecasts, Players & Opportunities 2014-2024 that 25 billion RFID tags will be used on retail apparel and shoes in 2020 and a similar number on other "high value, high complexity mix" items.  In retail, RFID is seeing rapid growth for apparel tagging - that application alone demands 3 billion RFID labels in 2014 - which still has some way to go with RFID penetrating about 7% of the total addressable market for apparel in 2014. Read more here and here.

  2. Checkpoint has explained no core customers have been lost in the past decade.

 

What is unique about RFID is that it serves double duty as an inventory management solution and a shrink management solution. So what once was a company that only sold solutions to manage shrink, is now a company that sells a solution that can do both. This is important because while shrink is an issue all retailers face, the addressable market for shrink management is arguably much smaller than the market for inventory management solutions and grocery is a perfect example of this.

 

In Europe, nearly all of the major grocers use RFID based EAS solutions to manage their inventory and prevent spoilage. In the U.S., the grocery market is largely untouched by RFID. For a company like CKP who earns less than $700mm a year in revenue, this is a huge market opportunity. A few customer wins could drive substantial revenue growth and add substantial recurring revenue. Any significant wins would serve as material catalysts to drive the stock higher and close the gap between the current price and intrinsic value.

 

But this growth isn’t needed for investors to earn a satisfying return because this growth isn’t even accounted for in my 2015 EBITDA estimate of ~$80-85mm. Furthermore, it’s also only one of two free options that could drive the stock higher. In addition to the penetration of new markets, there is a penetration opportunity among existing customers who may have implemented an RFID solution on only a few products, or may still be using EAS to secure most of their inventory. Retailers like Zara have made headlines for adopting RFID applications and studies have shown for every 2% increase in inventory accuracy retailers tend to see about a 1% increase in sales. Studies have also shown that on average retailers maintain inventory accuracy in the 70% range and below and adopting RFID can improve inventory accuracy to levels that exceed 90%.

 

The attractive ROI from implementing RFID has been recognized by sophisticated retailers like Zara and these retailers, the industry leaders in technology adoption, will soon drive adoption past a tipping point where RFID is no longer a “new” perceived to be unproven technology, but one that will become the industry standard.

 

Right now the street is modeling revenue growth of 2.6% in 2015, a mere 4% in 2016 and EBITDA of only $80mm in 2015. Any significant new contract wins will force analysts to increase their estimates and yet the stock is cheap on the current estimate of $80mm in EBITDA. Investors are paying nothing for what I expect will be a multi-year period of above consensus earnings growth.

 

 

The History of CKP and Their RFID Solutions

CKP was founded in 1969 and after a series of acquisitions through the 1990s, early 2000’s, and the divestiture of some non-core assets more recently, they evolved into a global leader in loss prevention, inventory management, and labeling solutions. Today CKP manufactures and sells their solutions to the retail and apparel industries in the U.S. and abroad and the majority of their revenue (over 70%) comes from outside North America.

 

While the future lies within RFID, the core loss prevention business is the legacy earnings driver. Loss prevention, or shrink management, is a space that has historically been dominated by CKP and their main competitor Sensormatic, a division of Tyco. Zebra Technologies (“ZBRA”) provides some solutions that are similar to CKPs offering today but many of their solutions are off the retail floor and in areas CKP doesn’t target. Avery Dennison (“AVY”) also participates in the space, but primarily through tag sales, they don’t provide full end-to-end solutions.

 

Historically Sensormatic was the leader in loss prevention at retail apparel because they used an acousto-magnetic (“AM”) technology system for loss prevention and the gates in their system could stand as much as six feet apart and still function properly. The width between their gates allowed for a natural flow of foot traffic in and out of stores and were perfectly suited to the emerging big-box retailers and department stores in shopping centers around America. This was in contrast to CKPs radio-frequency based loss prevention systems which suffered from one fatal flaw; a maximum gate width of ~3ft.

 

The restriction on gate width made CKPs product less attractive to a host of retailers and CKP ended up owning the European and International markets, where stores were smaller, while Sensormatic owned much of the U.S. market. But this market share structure began to erode a few years ago after CKP rolled out a new EAS system called Evolve and began to take share.

 

The Evolve system was unique in that it was an RF based system with gates that could be placed at a similar distance to Sensormatic’s, which eliminated Sensormatic’s advantage. In addition, the Evolve system included accessories and software that allowed retailers to see new, detailed statistics. For example, a retailer could see which stores, on what days, and at what hours, they were experiencing the highest rate of theft. In addition, they could count how many customers entered the store and how many left without making a purchase, thus important conversion statistics were now available to retailers who installed an Evolve system. But the most important advantage was the Evolve system was easily upgradeable to work with RFID.

 

In 2012 CKP refined their business strategy to transition from a product protection business to a provider of inventory management solutions, a strategy their legacy loss prevention technology prevented them from pursuing. In essence, RFID has opened up the supply chain as an additional revenue opportunity. CKP has developed a portfolio of inventory tracking solutions in the form of RFID products and services principally for closed-loop apparel retailers and department stores. Their solutions address both retailers shrink management and inventory management needs and they are the only pure-play RFID company who can sell a retailer the hardware, software, and tags they need to source-tag merchandise, i.e. at the manufacturing center or distribution center, and then monitor the flow of that merchandise from source to POS.

 

Currently the key benefits of RFID are derived from RFIDs ability to drastically improve inventory accuracy and reduce cycle count times. The amount of product retailers think they have on hand, also referred to as perpetual inventory (“PI”) is usually wrong. Many previous studies have shown inaccuracy of a typical retail store’s PI count by 51%, 65% and 55% and the categories of inaccuracy, understock (a.k.a. phantom inventory) and overstock tend to contribute to the measuring problem about 50/50. Figures quantifying the consequences of overstock and resulting markdowns aren’t easy to track down but its estimated out-of-stock issues related to inefficient inventory management cost the retail industry upwards of $60 billion per year. Regardless of their contribution, both lead to stocking issues that compromise efficiency and cost the industry billions.

 

Current solutions include RFID and manual inventory counts, but manual counts are time consuming, expensive, and also subject to human error. In a study conducted at Bloomingdales, researchers found implementing RFID improved overall inventory accuracy by 27% and performing a cycle count of inventory took 96% less time using RFID.

 

ABI Research also notes many adopters have found ROIs are realized within six to twelve months of adoption and primary benefits have included the following:

 

    • Reduction in Out-Of-Stock by 60% to 80%

    • Better Inventory Accuracy: between 98% and 99.9%

    • Reduction in Cycle Count Time by 75% to 92%

    • Reduced Inventory Carrying Costs by 30% to 59%

    • Reduced Receiving Time by up to 91%

    • Improved conversion Rate by up to 92%

    • Increased Units/Transaction and $/Transaction by 19% and 6%, respectively

    • Increased Sales from 4% to 21%

 

Other Benefits of RFID, some of which are more conceptual at the moment but are by no means unrealistic, include the following:

 

  • RFID can provide retailers with up-to-the-minute item-level data to inform merchandise assortments & promotions.

  • Product Safety: RFID tags can ensure products are not counterfeits, haven’t been tampered with, and aren’t out-of-date. Key areas affected are pharmaceuticals and food & beverages.

  • Improved Shopping Experience: RFID is already at work in “smart carts,” which identify products as they are placed in the cart and maintain a running total of merchandise cost.

  • Merchandising and Marketing: RFID tags can carry a wealth of information, and that information can be integrated with other devices throughout the store. For instance, a kiosk could read the tag of a wine bottle held in front of it and offer a description plus food matching tips. Also, RFID tags can uniquely identify items which provides the advantage of notifying retailers exactly what was stolen, when it was stolen, and from where it was stolen (EAS applications).

  • Product Functionality: RFID tags can give information to other devices for other purposes. For example applications in pharmacies include placing a tag under the label of prescription drugs so when visually impaired customers pass the bottle under a reader device, the dosage instructions are read out loud. (Apparently some pharmacies in Chicago have implemented this type of a solution).

    • In addition, tags can register environmental conditions like temperature, vibration, humidity, air pressure, etc.

  • RFID can ensure all display items are on the sales floor and in the correct area

  • RFID can differentiate alarms at point-of-exit to distinguish high-value items being stolen from low-value items being stolen.

  • At POS, RFID can provide quick, intelligent deactivation for mobile transactions, reducing false alarms and integrating with visitor data for conversion analysis.

  • RFID can provide retailers with unique loyalty program opportunities whereby customers who opt-in are recognized when they enter a store and are provided with relevant, in-stock product recommendations.

  • Replenishment can be enhanced with software prioritizing prompts to replenish “never out of stock” items.

  • Active RFID,” an evolution of the existing technology that exists but is currently too expensive for wide scale adoption could allow retailers to adjust product pricing in real-time by changing the prices listed on the “active” tags of a product through software.

 

The benefits of RFID were largely theoretical for a long time but more and more companies have adopted the technology and it is now proven. In 2003 Wal-Mart began asking suppliers to tag pallets and cartons with RFID to improve the efficiency of their supply chain and by 2010 they had adopted RFID in a host of individual categories, pushing RFID adoption to item level tagging. Three of the largest publicly announced RFID implementations of late are all CKP customers (Kohl’s, Decathlon, Inditex) and as more companies adopt RFID, CKP management expects economies of scale will lead to further declines in the cost of tags and make the ROI even more attractive. The technology also continues to improve, tag sizes have shrunk by ~90% since they were first developed and this has expanded the total addressable market to include products that were formerly considered inappropriate for an RFID system. Today CKP has over 20 pilots in place and any significant contract announcement could lead to material earnings growth.

 

 

CKP Today

CKP’s product portfolio is sold through three segments: (i) Merchandise Availability Solutions, (ii) Apparel Labeling Solutions, and (iii) Retail Merchandising Solutions.

 

Merchandise Availability Solutions (“MAS”)

MAS is the largest segment within CKP and generated 67%, 65% and 64% of total revenues in 2013, 2012, and 2011, respectively. The MAS business consists of three pieces:

 

  • EAS Systems and Consumables: diversified line of security and inventory management solutions that help retailers combat theft, reduce out-of-stocks and improve inventory accuracy (this includes the gates you see at the entry and exit points of retail stores). CKP has the #1 or #2 market position here across all major global markets.

  • Alpha High-Theft Solutions: Protects high-risk merchandise and safely displays merchandise allowing customer interaction (EX: plastic cases around video games, cords attached to digital cameras, locks on liquor bottle tops). CKP is the market leader in high-theft merchandise protection.

  • Merchandise Visibility Solutions: offers a complete end-to-end solution of RFID hardware & software, service and supply for inventory tracking and management purposes. OATSystems, an acquisition they made a few years back, is a recognized leader in RFID-based application software.

 

Apparel Labeling Solutions (“ALS”)

ALS is the second largest segment by revenue and represented 26%, 27%, and 26% of total revenue in 2013, 2012, and 2011, respectively. CKP provides apparel retailers, brand owners, and manufacturers (much of this is source-tagging product where it’s manufactured) with a single source of apparel labeling products facilitated by web-based data management for on-demand printing (includes price tickets, graphic tags, care labels, and woven labels). This business also includes RFID labels. Apparel labels and tags are carriers for RFID to provide a seamless MAS solution.

 

Retail Merchandising Solutions (“RMS”)

The RMS segment includes hand-held labeling applicators and tags, promotional displays (supermarket displays or signage for in-store communication), and customer queuing systems. RMS, which is focused on European and Asian markets, represents approximately 7% of revenue.

 

 

The Opportunity & Outlook

RFID is emerging as the dominant product category across MAS and ALS segments and the appeal is the ROI it offers retailers. CKP helps retailers sell more merchandise. This is the key item to understand. They provide other services as well, but the bottom-line is they help retailers sell more merchandise and they are the only capable provider of a complete end-to-end RFID solution that allows retailers to sell more stuff. The returns are too attractive for retail CFO’s to ignore and broad adoption is not a question of “if” but a question of “when.” This brings me to the first of seven reasons I like CKP as a long; the attractive growth opportunity.

 

1. Attractive Growth Opportunity
CKP has a unique position and they are in the early innings of a multi-year growth period on increased adoption of RFID at retail. The ROI and statistics (stats available here and
here) make this clear. The technology is now proven yet the stock remains depressed on what appears to be skepticism from the street that RFID will be adopted on a wide-scale. I think the slow rate of adoption is due to some unusual developments that will subside in 2015 and beyond.

 

In 2013 and 2014 there were a host of security breaches at major retailers and these breaches prompted CTOs and IT departments to allocate dollars toward critical security infrastructure updates. This was emergency spending that stole dollars away from RFID and other supply chain management solutions that can enhance sales at an attractive ROI. But all this spending on security upgrades did was push projects like RFID initiatives out to the future. It doesn’t mean RFID initiatives aren’t still attractive projects. It would be foolish for retailers not to ultimately allocate budget dollars to these projects. The appeal of RFID is clear; retailers just had other more pressing items to address.

 

As an example, consider the breach at a retailer like Target, which no doubt prompted other retailers who had not been victims of an attack to reallocate budget dollars to upgrade their own systems. In response to the breach, Target Chairman, President, and CEO Gregg Steinhafel issued an email statement saying,

 

Target was certified as meeting the standard for the payment card industry (PCI) in September 2013. Nonetheless, we suffered a data breach. As a result, we are conducting an end-to-end review of our people, processes and technology to understand our opportunities to improve data security and are committed to learning from this experience. While we are still in the midst of an ongoing investigation, we have already taken significant steps, including beginning the overhaul of our information security structure and the acceleration of our transition to chip-enabled cards.” 

 

According to their Q4 report to investors, Target spent $61mm through February 1st 2014 responding to the breach and later announced they would spend $100mm for registers and other technology that read the newest chip enabled credit cards.

 

Publicly traded FireEye (“FEYE”), one of the companies benefiting from this upgrade activity is expected to report revenue of $625mm in 2015 compared to revenue of $424mm in 2014, up 47% yoy (and that’s not an easy yoy comp due to the Mandiant acquisition because Mandiant was acquired in December 30, 2013). FEYEs revenue growth demonstrates the recent rapid shift in spending on security initiatives that’s taken place, and I believe this spending has displaced spending on initiatives like RFID.

 

ZBRA and CKP have both commented that budgets were squeezed this year and projects were delayed. Unlike CKP, Zebra sells some of the security related upgrades that were made in 2014 in response to the breaches, so this behavior didn’t really hurt them as much as it did CKP. CKPs lack of growth seems to have bred skepticism regarding the future of RFID but the fact is most retailers have inventory accuracy in the ~60% range, RFID can take that well into the ~90% range, and on average retailers have seen 1% sales improvements for every 2% improvement in inventory accuracy.  The ROI is undeniably attractive.

 

While it’s difficult to quantify the exact impact retailers response to security breaches had on the uptake of RFID, it’s too much of a coincidence that CKP saw deals get pushed out while retailers ramped spending on security.

 

On the 3Q’14 earnings call, George Babich, the CEO of CKP explained a few times the lack of business is not due to losing deals to competitors but simply deals being pushed out:

 

We don't know exactly what will be the catalyst for those retailers to pull the trigger. And as I've said many, many, many times since I've gotten involved with Checkpoint, this is a very lumpy business and -- that we would strive to improve upon those elements of the business that we can control, being margins and mix and pricing and cost and SG&A, cash, working capital and so on. So we need to work through the tough economic times and I believe we will. These retailers aren't choosing to go with another solution, with a competitor of ours. It's just -- it's a little bit of just hitting the pause button. And as you know, Jeff, every year, retailers line up in the first half of the year, these projects, and they're ready to pull the trigger if they have a good year once you get to the mid-year point. But at mid-year, if it's not looking as good for them as they had hoped, they can easily just give us a call and postpone. So that's pretty much what we're facing right now.”

 

I said last quarter, after our 3, 4 months with outside consultants, that we were pretty confident that we are a significant player in the RFID space with respect to Merchandise Visibility. We offer end-to-end solutions, as you know, including a rapidly growing RFID label business. Those markets are expected to grow double digits for the next 5 to 10 years actually, so it's -- they're very strong markets. But there is, obviously going to be more competition, but we have done very well in the pilots that we're in. We feel very extremely confident about our solution. And the only thing that I would say has happened is retailers have slowed a little bit on their pace of adoption, just slowed a little bit. And it's -- I think it's a temporary thing because the ROI is clearly there. But I would not -- again, I would not attribute to any of the revenue guidance that we gave to additional competition or us losing business to competition, that's just not the case.”

 

 

2. CKP is Misunderstood

The street seems to have a couple of other knocks on CKP that I disagree with.

 

First, the street seems to believe reduced brick and mortar retail growth (new stores) and reductions in retail selling square footage (fewer big box operators, goodbye Sears?) are headwinds for CKP and their products and solutions. But RFID at retail is a supply chain solution with a large and arguably untapped TAM. CKP doesn’t need retail expansion to succeed, they need CFO’s to act rationally and adopt a high ROI initiative of implementing an RFID solution. CKPs products are good for their customers and CKPs success selling will be based primarily on their ability to penetrate the market, not grow on the heels of retail expansion. The business opportunity is misunderstood and there are enormous white space opportunities. For example, spoilage at grocery is a billion dollar problem and while CKPs solutions exist at European grocers, the U.S. is essentially untouched.

 

Second, the depressed multiple could also be due to their exposure to Europe, about 42% of their business. This is a concern that has always been out there. It’s not new but its’ possible folks have been and will continue to be managing their books to reduce regional exposure to Europe. The European retail market hasn't exactly been a strong market lately. So, yes, contract wins abroad could come at a slow pace, but (i) CKP isn’t laying out herculean guidance, and (ii) CKP helps retailers sell more stuff; it’s a product that helps companies grow earnings and it’s a worthwhile investment. Some might argue it’s somewhat recession resistant.

 

Regarding item number one, guidance, CFO Jeff Richard and CEO George Babich have been demonstrating through guidance they are conservative when it comes to forecasting, and they have been fairly clear guidance doesn’t bake in any big successes, just little battles on continued cost savings, pricing optimization, etc.

 

They have realized enormous cost savings over the past couple years through a lean six sigma based restructuring initiative and another SG&A cost savings initiative and this success is apparent in the numbers. Revenue has declined from ~$690mm in 2012 to $673mm on general weakness in the retail environment (fewer sales mean fewer items to tag and less interest in retailers making capex investments) but gross profit has increased from ~$270mm to ~$280mm and EBITDA has increased from ~$39mm to ~$71mm.

 

 

 

More recently CFO Jeff Richard has discussed their efforts to restructure the sales force compensation system. Salesmen are now paid based on the profitability of business they book and not just the revenue they book. This will take time to flow through the business but I’d expect margin expansion in 2015 as much of 2014’s business was booked under this new system. And 2015 revenue should come with much more attractive margins as well, especially compared to the margins the business has historically generated.

 

So if the pace of wins in Europe is slower than the street expected, that is one thing, but the stock is cheap on what seem to be reasonable expectations from management and the street (consensus is for only 2.6% revenue growth next year and a 9% increase in EBITDA).

 

Then there is item number two, the product being arguably somewhat recession resistant. In periods of weakness, CKP has said they see retailers try to squeeze out more margin, and this typically means initiatives like improving shrink management and optimizing their supply chain and inventory controls. So while it’s only natural for retailers to cut back or delay capital projects, the RFID solution is an ROI based C-suite sale that involves CEO George Babich and CFO Jeff Richard when the deals reach a certain size. Jeff Richard is well versed in six-sigma lingo and is uniquely qualified to pitch a product that cuts costs and increases top-line and George Babich is a former retailer himself from his days at Pep Boys where he was President and CFO. Their ability to sell is proven.

 

Under George and Jeff’s leadership CKP has won a contract from Tesco Express Stores (“TSCO”) to implement a global EAS program to improve on-shelf availability of products and the consumer shopping experience and more recently they penetrated the formerly unprotected market of dollar stores by winning Family Dollar (“FDO”). Zara was also an impressive win because Sensormatic has historically dominated retail. RFID is a smart investment for retailers and CKPs management team is the right team to sell it.

 

 

3. Market Share Gains Reveal a Competitive Advantage

CKP is the only company with an end-to-end solution making it an easier sale to CFO’s, which is largely what RFID has become; a CFO sale. CKP’s Tesco contract was won from their largest competitor, Sensormatic, and CKP has continued to take share from Sensormatic, even winning apparel business in the U.S., a market that has historically been dominated by Sensormatic because of their initial advantage years ago in gate width. These share gains and the progress they have made penetrating new markets like the dollar stores demonstrate the advantage they have over their peers by being a one-stop-shop provider of inventory management solutions.

 

 

4. Margin Expansion Underway & Consensus Appears Conservative

The old CKP management team mismanaged the business. The sales team wasn’t compensated properly, their supply chain wasn’t optimized, and there was a tremendous amount of fat to be cut in terms of excess costs, an issue demonstrated by the success current management has had at increasing margins on shrinking revenue. Significant improvements have been made, costs have come out, and the headcount has been reduced. Management eliminated 2,400 employees in 2013 alone and expects SG&A savings currently running at $12-15mm in 2014 to reach $15-20mm annualized for 2015. In the 3Q’14 press release management also laid out expectations for incremental savings of $2mm by the end of 3Q’15. These savings are expected to come from a Profit Enhancement Plan driven by additional strategic headcount reductions and streamlining manufacturing processes.

 

For a company with consensus 2014 EBITDA of about ~$74mm, incremental savings of $5 to $7mm is material; an increase of ~6-10% yoy. If results are better than flat, investors should see an increase in EBITDA exceeding this 6-10% range, so not a whole lot needs to happen for CKP to produce a significant increase in year-over-year EBITDA. With a rationalized cost structure, any top-line growth from any one of the 20 pilots currently outstanding should drive EBITDA well beyond the $80mm consensus expectation.

 

 

5. Recurring Revenue

Roughly 55% of the business is recurring revenue from tag sales generated off of the installed base of systems and CKP rarely ever loses customers.  Tags and label sales fluctuate in response to the natural vicissitudes of retail sales but they fluctuate within a fairly steady band. This makes for a relatively steady earnings stream and I think investors have overlooked the quality of CKP’s business model. Companies with attractive growth prospects and substantial recurring revenue rarely trade at mid-single-digit EBITDA multiples. This is an underappreciated earnings stream that alone deserves a double digit multiple and outside of a SOTP should drive a blended multiple to at least 9x EBITDA.

 

There really aren’t any good comps to CKP, but in thinking about businesses with recurring revenue derived from a large installed base, the auto dealerships are an example that comes to mind. Companies like Asbury Automotive, Group 1 Automotive, and Lithia Motors report ~30-40% of their gross profit dollars coming from parts and service business, business generated off of the maintenance relationships on the installed base of cars they have sold.

 

In theory, this model of selling a product and clipping coupons on servicing that product later is not all that different from the model CKP runs. CKP is just selling a different product. What stands out in stark contrast to the auto dealerships, though, is the retention rate of the customers’ business after the sale of the initial product. When CKP sells a system, the tag sale business associated with the system doesn’t churn off at anywhere close to the churn rates the dealerships see. Dealerships see anywhere between 35-60% retention five years down the road after selling a car, whereas CKP tends to continue to provide all the tags the customer needs (the wide margin among dealerships is due to luxury car dealerships generating much higher retention of parts and service business than low-end cars, see the GPI write-up from 7/30/13 by VIC member PGTenny for background).

 

CKP’s business model has a more resilient recurring revenue stream associated with its installed base of products yet it trades at a mid-single-digit EBITDA Multiple, half the 12-13x EBITDA multiples being paid for dealership companies with arguably comparable business models.

 

 

6. Management is Conservative

Recently Europe and Asia have been weak and deteriorating markets for CKP and they had a potentially significant customer delay a contract last quarter. Normally, an unexpectedly weak market and a contract delay would force a company to revise their earnings guidance downward but CKP presented the news last quarter and didn’t have to update earnings guidance.  They maintained EBITDA guidance of $70mm to $80mm for the year and only reduced top-line expectations.

 

The management team at CKP has under promised and over delivered on nearly every goal they have laid out (mostly savings related goals) and their track record of conservative earnings guidance is not only refreshing it provides some comfort that current expectations are likely to be beaten.

 

 

7. CKP Is Cheap and an Acquisition Target

The stock is trading for 6.4x the high end of their 2014 EBITDA guidance compared to a historical multiple of ~8.4x over the last seven years yet they are more profitable and they are on the verge of what will likely be substantial top-line growth and continued margin improvement. More importantly, CKP is essentially the only publicly traded pure-play on the RFID upgrade cycle and likely a very attractive acquisition candidate to Private Equity or one of their larger competitors like 3M, Avery Dennison, Roper, or Zebra (although Zebra is probably three years away at minimum considering their recent acquisition).

 

 

Valuation

At 9x $83mm in 2015 EBITDA plus FCF of $40-50mm I arrive at a ~$20 target. I think that is where the stock should be trading today. By year-end 2015 I think we will be looking at forward EBITDA approaching $100mm and at 9x $100mm plus incremental FCF the stock would be trading for ~$25.

11

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Customer wins & buyback

One or two significant customer wins could really drive numbers. If management decided to establish a repurchase program and buyback stock at today’s price level, this would juice the returns investors realize from this multi-year RFID upgrade cycle in its infancy.

 

Divest non-core RMS division: Checkpoint also has one division that doesn’t really fit the business and this could be monetized.  The segment is called RMS and it’s a handheld reader business that at ~1x sales might fetch $50mm or so.  They explain the problem is this resides in Germany.  Most of the cash is abroad as well so repatriation is an issue. But with the ever changing landscape in Washington, perhaps we get a tax holiday that allows this value to be realized.

 

Management Sells the Company

Both the CEO and CFO sold their prior companies and as a pure-play RFID solution provider they could be a great fit for 3M, Avery, Roper, or Zebra (but again, Zebra probably 3 years away considering their recent acquisition).

    sort by    

    Description

    I wrote this up to submit to Seeking Alpha only to find an email in my inbox this morning that someone had just posted it to Seeking Alpha. The piece at Seeking Alpha is brief in comparison to this and I think the additional detail I have provided make this a worthwhile contribution to the general thesis on the name, so here is my own work on CKP. The structure is formatted for a submission as a Top Idea at Seeking Alpha but the content is equally appropriate for VIC.

     

    I see substantial upside here and with over half of revenue recurring, I think this is an unusual situation where downside is limited and upside is high.

     

     

    A Growth Stock at a Value Price: Checkpoint Systems and the Expansion of RFID at Retail

     

     

    Summary

     

     

    Checkpoint Systems (“CKP”)

    CKP is a leading global manufacturer and provider of technology-driven loss prevention, inventory management and labeling solutions to the retail and apparel industries. Their core loss-prevention business is built on more than 40 years of radio frequency (“RF”) technology expertise. The systems and services included in this business enable retailers and their suppliers to reduce shrink (theft and loss of merchandise) while leveraging real-time data generated by CKPs systems to improve operational efficiency.

     

    The business operates through three segments (i) Merchandise Availability Solutions (“MAS”), (ii) Apparel labeling solutions (“ALS”), and (iii) Retail Merchandising Solutions (“RMS”), but the key item to understand is the core of the business is selling a system and solution (security gates at the front of a store, or overhead RFID readers) and earning recurring revenue from the tags and labels that work with those solutions. This is the core business. It’s a razor-razorblade model and it’s evolving from legacy RF technology to modern RFID technology.

     

    In 2012 CKP refined their strategy to transition from a product protection business (primarily RF technology solutions) to a provider of inventory management solutions (primarily RFID); solutions that give retailers ready insight into the on-shelf availability of merchandise in their stores, improving inventory accuracy and increasing sales. Their solutions also help customers identify, track, and protect their assets. CKP has a leadership position in key hard goods markets (supermarkets, drug stores, mass merchandisers, and music and electronics retailers) are expanding in soft goods markets (specifically apparel) and are beginning to pursue under-penetrated markets (noteworthy recent win includes the Family Dollar, Zara, and Tesco, and they are currently pursuing white space opportunities in the U.S., like grocers, among other businesses.)

     

    Nutshell Thesis

    I think CKP should be trading for as much as $20 per share today, or roughly 9x $83mm in 2015 EBITDA (and adjusting for 2015 FCF of ~$40-50mm). The stock has traded at an average of 8.4x over the past seven years so at 9x, I’m advocating for a slight premium and I think CKP deserves a slight premium for two primary reasons:

     

    1. The business is on the verge of entering a multi-year growth period that will drive revenue in two forms (i) hardware and software sales, and more importantly (ii) recurring revenue tag sales that will build on the over 55% of current sales that are already recurring.

    2. CFO, Jeff Richard, has done an admirable job of right-sizing the cost structure through (i) the execution of a global restructuring plan based on lean six sigma initiatives and (ii) an SG&A savings plan. The leaner cost structure will provide attractive operating leverage as the top-line begins to expand and I expect significant margin improvement.

     

    I am using 9x for my valuation but I actually think a sophisticated buyer would pay more than 9x to own this pure-play RFID company. CKP is the industry leader and long-term recurring revenue growth is only beginning. The transition to a faster growing more profitable business model makes the historical average multiple no longer an appropriate measuring stick to assess the valuation so I think the 50% upside to my target is actually a conservative return expectation.

     

    The reality is the business and opportunity set the company faces have evolved in recent years yet investors haven’t appreciated the transition that’s taken place. CKP has historically been known for selling what are technically referred to as shrink management solutions. These include various solutions but primarily these are the two part systems relying on (i) plastic tags attached to merchandise and (ii) gates near the exit that detect and alert employees if a theft occurs. This wasn’t a business with an opportunity for rapid growth. CKP still sells these legacy systems in segments they refer to as Electronic Article Surveillance (“EAS”) and Merchandise Availability Solutions (“MAS”), but this is a dinosaur technology that will eventually be displaced by radio frequency identification, a.k.a. RFID.

     

    CKP has positioned the company to be the leader in selling end-to-end RFID solutions to retailers worldwide and the RFID upgrade cycle is just beginning. The evidence suggests, (i) this is a five year plus growth story in its infancy and the best part is, (ii) with the sale of each system CKP creates an annuity stream by also selling the RFID tags and labels ultimately affixed to merchandise. This creates a substantial recurring revenue stream that today amounts to roughly 55% of revenue.

     

    1. IDTechEx forecast in the new report RFID Forecasts, Players & Opportunities 2014-2024 that 25 billion RFID tags will be used on retail apparel and shoes in 2020 and a similar number on other "high value, high complexity mix" items.  In retail, RFID is seeing rapid growth for apparel tagging - that application alone demands 3 billion RFID labels in 2014 - which still has some way to go with RFID penetrating about 7% of the total addressable market for apparel in 2014. Read more here and here.

    2. Checkpoint has explained no core customers have been lost in the past decade.

     

    What is unique about RFID is that it serves double duty as an inventory management solution and a shrink management solution. So what once was a company that only sold solutions to manage shrink, is now a company that sells a solution that can do both. This is important because while shrink is an issue all retailers face, the addressable market for shrink management is arguably much smaller than the market for inventory management solutions and grocery is a perfect example of this.

     

    In Europe, nearly all of the major grocers use RFID based EAS solutions to manage their inventory and prevent spoilage. In the U.S., the grocery market is largely untouched by RFID. For a company like CKP who earns less than $700mm a year in revenue, this is a huge market opportunity. A few customer wins could drive substantial revenue growth and add substantial recurring revenue. Any significant wins would serve as material catalysts to drive the stock higher and close the gap between the current price and intrinsic value.

     

    But this growth isn’t needed for investors to earn a satisfying return because this growth isn’t even accounted for in my 2015 EBITDA estimate of ~$80-85mm. Furthermore, it’s also only one of two free options that could drive the stock higher. In addition to the penetration of new markets, there is a penetration opportunity among existing customers who may have implemented an RFID solution on only a few products, or may still be using EAS to secure most of their inventory. Retailers like Zara have made headlines for adopting RFID applications and studies have shown for every 2% increase in inventory accuracy retailers tend to see about a 1% increase in sales. Studies have also shown that on average retailers maintain inventory accuracy in the 70% range and below and adopting RFID can improve inventory accuracy to levels that exceed 90%.

     

    The attractive ROI from implementing RFID has been recognized by sophisticated retailers like Zara and these retailers, the industry leaders in technology adoption, will soon drive adoption past a tipping point where RFID is no longer a “new” perceived to be unproven technology, but one that will become the industry standard.

     

    Right now the street is modeling revenue growth of 2.6% in 2015, a mere 4% in 2016 and EBITDA of only $80mm in 2015. Any significant new contract wins will force analysts to increase their estimates and yet the stock is cheap on the current estimate of $80mm in EBITDA. Investors are paying nothing for what I expect will be a multi-year period of above consensus earnings growth.

     

     

    The History of CKP and Their RFID Solutions

    CKP was founded in 1969 and after a series of acquisitions through the 1990s, early 2000’s, and the divestiture of some non-core assets more recently, they evolved into a global leader in loss prevention, inventory management, and labeling solutions. Today CKP manufactures and sells their solutions to the retail and apparel industries in the U.S. and abroad and the majority of their revenue (over 70%) comes from outside North America.

     

    While the future lies within RFID, the core loss prevention business is the legacy earnings driver. Loss prevention, or shrink management, is a space that has historically been dominated by CKP and their main competitor Sensormatic, a division of Tyco. Zebra Technologies (“ZBRA”) provides some solutions that are similar to CKPs offering today but many of their solutions are off the retail floor and in areas CKP doesn’t target. Avery Dennison (“AVY”) also participates in the space, but primarily through tag sales, they don’t provide full end-to-end solutions.

     

    Historically Sensormatic was the leader in loss prevention at retail apparel because they used an acousto-magnetic (“AM”) technology system for loss prevention and the gates in their system could stand as much as six feet apart and still function properly. The width between their gates allowed for a natural flow of foot traffic in and out of stores and were perfectly suited to the emerging big-box retailers and department stores in shopping centers around America. This was in contrast to CKPs radio-frequency based loss prevention systems which suffered from one fatal flaw; a maximum gate width of ~3ft.

     

    The restriction on gate width made CKPs product less attractive to a host of retailers and CKP ended up owning the European and International markets, where stores were smaller, while Sensormatic owned much of the U.S. market. But this market share structure began to erode a few years ago after CKP rolled out a new EAS system called Evolve and began to take share.

     

    The Evolve system was unique in that it was an RF based system with gates that could be placed at a similar distance to Sensormatic’s, which eliminated Sensormatic’s advantage. In addition, the Evolve system included accessories and software that allowed retailers to see new, detailed statistics. For example, a retailer could see which stores, on what days, and at what hours, they were experiencing the highest rate of theft. In addition, they could count how many customers entered the store and how many left without making a purchase, thus important conversion statistics were now available to retailers who installed an Evolve system. But the most important advantage was the Evolve system was easily upgradeable to work with RFID.

     

    In 2012 CKP refined their business strategy to transition from a product protection business to a provider of inventory management solutions, a strategy their legacy loss prevention technology prevented them from pursuing. In essence, RFID has opened up the supply chain as an additional revenue opportunity. CKP has developed a portfolio of inventory tracking solutions in the form of RFID products and services principally for closed-loop apparel retailers and department stores. Their solutions address both retailers shrink management and inventory management needs and they are the only pure-play RFID company who can sell a retailer the hardware, software, and tags they need to source-tag merchandise, i.e. at the manufacturing center or distribution center, and then monitor the flow of that merchandise from source to POS.

     

    Currently the key benefits of RFID are derived from RFIDs ability to drastically improve inventory accuracy and reduce cycle count times. The amount of product retailers think they have on hand, also referred to as perpetual inventory (“PI”) is usually wrong. Many previous studies have shown inaccuracy of a typical retail store’s PI count by 51%, 65% and 55% and the categories of inaccuracy, understock (a.k.a. phantom inventory) and overstock tend to contribute to the measuring problem about 50/50. Figures quantifying the consequences of overstock and resulting markdowns aren’t easy to track down but its estimated out-of-stock issues related to inefficient inventory management cost the retail industry upwards of $60 billion per year. Regardless of their contribution, both lead to stocking issues that compromise efficiency and cost the industry billions.

     

    Current solutions include RFID and manual inventory counts, but manual counts are time consuming, expensive, and also subject to human error. In a study conducted at Bloomingdales, researchers found implementing RFID improved overall inventory accuracy by 27% and performing a cycle count of inventory took 96% less time using RFID.

     

    ABI Research also notes many adopters have found ROIs are realized within six to twelve months of adoption and primary benefits have included the following:

     

     

    Other Benefits of RFID, some of which are more conceptual at the moment but are by no means unrealistic, include the following:

     

     

    The benefits of RFID were largely theoretical for a long time but more and more companies have adopted the technology and it is now proven. In 2003 Wal-Mart began asking suppliers to tag pallets and cartons with RFID to improve the efficiency of their supply chain and by 2010 they had adopted RFID in a host of individual categories, pushing RFID adoption to item level tagging. Three of the largest publicly announced RFID implementations of late are all CKP customers (Kohl’s, Decathlon, Inditex) and as more companies adopt RFID, CKP management expects economies of scale will lead to further declines in the cost of tags and make the ROI even more attractive. The technology also continues to improve, tag sizes have shrunk by ~90% since they were first developed and this has expanded the total addressable market to include products that were formerly considered inappropriate for an RFID system. Today CKP has over 20 pilots in place and any significant contract announcement could lead to material earnings growth.

     

     

    CKP Today

    CKP’s product portfolio is sold through three segments: (i) Merchandise Availability Solutions, (ii) Apparel Labeling Solutions, and (iii) Retail Merchandising Solutions.

     

    Merchandise Availability Solutions (“MAS”)

    MAS is the largest segment within CKP and generated 67%, 65% and 64% of total revenues in 2013, 2012, and 2011, respectively. The MAS business consists of three pieces:

     

     

    Apparel Labeling Solutions (“ALS”)

    ALS is the second largest segment by revenue and represented 26%, 27%, and 26% of total revenue in 2013, 2012, and 2011, respectively. CKP provides apparel retailers, brand owners, and manufacturers (much of this is source-tagging product where it’s manufactured) with a single source of apparel labeling products facilitated by web-based data management for on-demand printing (includes price tickets, graphic tags, care labels, and woven labels). This business also includes RFID labels. Apparel labels and tags are carriers for RFID to provide a seamless MAS solution.

     

    Retail Merchandising Solutions (“RMS”)

    The RMS segment includes hand-held labeling applicators and tags, promotional displays (supermarket displays or signage for in-store communication), and customer queuing systems. RMS, which is focused on European and Asian markets, represents approximately 7% of revenue.

     

     

    The Opportunity & Outlook

    RFID is emerging as the dominant product category across MAS and ALS segments and the appeal is the ROI it offers retailers. CKP helps retailers sell more merchandise. This is the key item to understand. They provide other services as well, but the bottom-line is they help retailers sell more merchandise and they are the only capable provider of a complete end-to-end RFID solution that allows retailers to sell more stuff. The returns are too attractive for retail CFO’s to ignore and broad adoption is not a question of “if” but a question of “when.” This brings me to the first of seven reasons I like CKP as a long; the attractive growth opportunity.

     

    1. Attractive Growth Opportunity
    CKP has a unique position and they are in the early innings of a multi-year growth period on increased adoption of RFID at retail. The ROI and statistics (stats available here and
    here) make this clear. The technology is now proven yet the stock remains depressed on what appears to be skepticism from the street that RFID will be adopted on a wide-scale. I think the slow rate of adoption is due to some unusual developments that will subside in 2015 and beyond.

     

    In 2013 and 2014 there were a host of security breaches at major retailers and these breaches prompted CTOs and IT departments to allocate dollars toward critical security infrastructure updates. This was emergency spending that stole dollars away from RFID and other supply chain management solutions that can enhance sales at an attractive ROI. But all this spending on security upgrades did was push projects like RFID initiatives out to the future. It doesn’t mean RFID initiatives aren’t still attractive projects. It would be foolish for retailers not to ultimately allocate budget dollars to these projects. The appeal of RFID is clear; retailers just had other more pressing items to address.

     

    As an example, consider the breach at a retailer like Target, which no doubt prompted other retailers who had not been victims of an attack to reallocate budget dollars to upgrade their own systems. In response to the breach, Target Chairman, President, and CEO Gregg Steinhafel issued an email statement saying,

     

    Target was certified as meeting the standard for the payment card industry (PCI) in September 2013. Nonetheless, we suffered a data breach. As a result, we are conducting an end-to-end review of our people, processes and technology to understand our opportunities to improve data security and are committed to learning from this experience. While we are still in the midst of an ongoing investigation, we have already taken significant steps, including beginning the overhaul of our information security structure and the acceleration of our transition to chip-enabled cards.” 

     

    According to their Q4 report to investors, Target spent $61mm through February 1st 2014 responding to the breach and later announced they would spend $100mm for registers and other technology that read the newest chip enabled credit cards.

     

    Publicly traded FireEye (“FEYE”), one of the companies benefiting from this upgrade activity is expected to report revenue of $625mm in 2015 compared to revenue of $424mm in 2014, up 47% yoy (and that’s not an easy yoy comp due to the Mandiant acquisition because Mandiant was acquired in December 30, 2013). FEYEs revenue growth demonstrates the recent rapid shift in spending on security initiatives that’s taken place, and I believe this spending has displaced spending on initiatives like RFID.

     

    ZBRA and CKP have both commented that budgets were squeezed this year and projects were delayed. Unlike CKP, Zebra sells some of the security related upgrades that were made in 2014 in response to the breaches, so this behavior didn’t really hurt them as much as it did CKP. CKPs lack of growth seems to have bred skepticism regarding the future of RFID but the fact is most retailers have inventory accuracy in the ~60% range, RFID can take that well into the ~90% range, and on average retailers have seen 1% sales improvements for every 2% improvement in inventory accuracy.  The ROI is undeniably attractive.

     

    While it’s difficult to quantify the exact impact retailers response to security breaches had on the uptake of RFID, it’s too much of a coincidence that CKP saw deals get pushed out while retailers ramped spending on security.

     

    On the 3Q’14 earnings call, George Babich, the CEO of CKP explained a few times the lack of business is not due to losing deals to competitors but simply deals being pushed out:

     

    We don't know exactly what will be the catalyst for those retailers to pull the trigger. And as I've said many, many, many times since I've gotten involved with Checkpoint, this is a very lumpy business and -- that we would strive to improve upon those elements of the business that we can control, being margins and mix and pricing and cost and SG&A, cash, working capital and so on. So we need to work through the tough economic times and I believe we will. These retailers aren't choosing to go with another solution, with a competitor of ours. It's just -- it's a little bit of just hitting the pause button. And as you know, Jeff, every year, retailers line up in the first half of the year, these projects, and they're ready to pull the trigger if they have a good year once you get to the mid-year point. But at mid-year, if it's not looking as good for them as they had hoped, they can easily just give us a call and postpone. So that's pretty much what we're facing right now.”

     

    I said last quarter, after our 3, 4 months with outside consultants, that we were pretty confident that we are a significant player in the RFID space with respect to Merchandise Visibility. We offer end-to-end solutions, as you know, including a rapidly growing RFID label business. Those markets are expected to grow double digits for the next 5 to 10 years actually, so it's -- they're very strong markets. But there is, obviously going to be more competition, but we have done very well in the pilots that we're in. We feel very extremely confident about our solution. And the only thing that I would say has happened is retailers have slowed a little bit on their pace of adoption, just slowed a little bit. And it's -- I think it's a temporary thing because the ROI is clearly there. But I would not -- again, I would not attribute to any of the revenue guidance that we gave to additional competition or us losing business to competition, that's just not the case.”

     

     

    2. CKP is Misunderstood

    The street seems to have a couple of other knocks on CKP that I disagree with.

     

    First, the street seems to believe reduced brick and mortar retail growth (new stores) and reductions in retail selling square footage (fewer big box operators, goodbye Sears?) are headwinds for CKP and their products and solutions. But RFID at retail is a supply chain solution with a large and arguably untapped TAM. CKP doesn’t need retail expansion to succeed, they need CFO’s to act rationally and adopt a high ROI initiative of implementing an RFID solution. CKPs products are good for their customers and CKPs success selling will be based primarily on their ability to penetrate the market, not grow on the heels of retail expansion. The business opportunity is misunderstood and there are enormous white space opportunities. For example, spoilage at grocery is a billion dollar problem and while CKPs solutions exist at European grocers, the U.S. is essentially untouched.

     

    Second, the depressed multiple could also be due to their exposure to Europe, about 42% of their business. This is a concern that has always been out there. It’s not new but its’ possible folks have been and will continue to be managing their books to reduce regional exposure to Europe. The European retail market hasn't exactly been a strong market lately. So, yes, contract wins abroad could come at a slow pace, but (i) CKP isn’t laying out herculean guidance, and (ii) CKP helps retailers sell more stuff; it’s a product that helps companies grow earnings and it’s a worthwhile investment. Some might argue it’s somewhat recession resistant.

     

    Regarding item number one, guidance, CFO Jeff Richard and CEO George Babich have been demonstrating through guidance they are conservative when it comes to forecasting, and they have been fairly clear guidance doesn’t bake in any big successes, just little battles on continued cost savings, pricing optimization, etc.

     

    They have realized enormous cost savings over the past couple years through a lean six sigma based restructuring initiative and another SG&A cost savings initiative and this success is apparent in the numbers. Revenue has declined from ~$690mm in 2012 to $673mm on general weakness in the retail environment (fewer sales mean fewer items to tag and less interest in retailers making capex investments) but gross profit has increased from ~$270mm to ~$280mm and EBITDA has increased from ~$39mm to ~$71mm.

     

     

     

    More recently CFO Jeff Richard has discussed their efforts to restructure the sales force compensation system. Salesmen are now paid based on the profitability of business they book and not just the revenue they book. This will take time to flow through the business but I’d expect margin expansion in 2015 as much of 2014’s business was booked under this new system. And 2015 revenue should come with much more attractive margins as well, especially compared to the margins the business has historically generated.

     

    So if the pace of wins in Europe is slower than the street expected, that is one thing, but the stock is cheap on what seem to be reasonable expectations from management and the street (consensus is for only 2.6% revenue growth next year and a 9% increase in EBITDA).

     

    Then there is item number two, the product being arguably somewhat recession resistant. In periods of weakness, CKP has said they see retailers try to squeeze out more margin, and this typically means initiatives like improving shrink management and optimizing their supply chain and inventory controls. So while it’s only natural for retailers to cut back or delay capital projects, the RFID solution is an ROI based C-suite sale that involves CEO George Babich and CFO Jeff Richard when the deals reach a certain size. Jeff Richard is well versed in six-sigma lingo and is uniquely qualified to pitch a product that cuts costs and increases top-line and George Babich is a former retailer himself from his days at Pep Boys where he was President and CFO. Their ability to sell is proven.

     

    Under George and Jeff’s leadership CKP has won a contract from Tesco Express Stores (“TSCO”) to implement a global EAS program to improve on-shelf availability of products and the consumer shopping experience and more recently they penetrated the formerly unprotected market of dollar stores by winning Family Dollar (“FDO”). Zara was also an impressive win because Sensormatic has historically dominated retail. RFID is a smart investment for retailers and CKPs management team is the right team to sell it.

     

     

    3. Market Share Gains Reveal a Competitive Advantage

    CKP is the only company with an end-to-end solution making it an easier sale to CFO’s, which is largely what RFID has become; a CFO sale. CKP’s Tesco contract was won from their largest competitor, Sensormatic, and CKP has continued to take share from Sensormatic, even winning apparel business in the U.S., a market that has historically been dominated by Sensormatic because of their initial advantage years ago in gate width. These share gains and the progress they have made penetrating new markets like the dollar stores demonstrate the advantage they have over their peers by being a one-stop-shop provider of inventory management solutions.

     

     

    4. Margin Expansion Underway & Consensus Appears Conservative

    The old CKP management team mismanaged the business. The sales team wasn’t compensated properly, their supply chain wasn’t optimized, and there was a tremendous amount of fat to be cut in terms of excess costs, an issue demonstrated by the success current management has had at increasing margins on shrinking revenue. Significant improvements have been made, costs have come out, and the headcount has been reduced. Management eliminated 2,400 employees in 2013 alone and expects SG&A savings currently running at $12-15mm in 2014 to reach $15-20mm annualized for 2015. In the 3Q’14 press release management also laid out expectations for incremental savings of $2mm by the end of 3Q’15. These savings are expected to come from a Profit Enhancement Plan driven by additional strategic headcount reductions and streamlining manufacturing processes.

     

    For a company with consensus 2014 EBITDA of about ~$74mm, incremental savings of $5 to $7mm is material; an increase of ~6-10% yoy. If results are better than flat, investors should see an increase in EBITDA exceeding this 6-10% range, so not a whole lot needs to happen for CKP to produce a significant increase in year-over-year EBITDA. With a rationalized cost structure, any top-line growth from any one of the 20 pilots currently outstanding should drive EBITDA well beyond the $80mm consensus expectation.

     

     

    5. Recurring Revenue

    Roughly 55% of the business is recurring revenue from tag sales generated off of the installed base of systems and CKP rarely ever loses customers.  Tags and label sales fluctuate in response to the natural vicissitudes of retail sales but they fluctuate within a fairly steady band. This makes for a relatively steady earnings stream and I think investors have overlooked the quality of CKP’s business model. Companies with attractive growth prospects and substantial recurring revenue rarely trade at mid-single-digit EBITDA multiples. This is an underappreciated earnings stream that alone deserves a double digit multiple and outside of a SOTP should drive a blended multiple to at least 9x EBITDA.

     

    There really aren’t any good comps to CKP, but in thinking about businesses with recurring revenue derived from a large installed base, the auto dealerships are an example that comes to mind. Companies like Asbury Automotive, Group 1 Automotive, and Lithia Motors report ~30-40% of their gross profit dollars coming from parts and service business, business generated off of the maintenance relationships on the installed base of cars they have sold.

     

    In theory, this model of selling a product and clipping coupons on servicing that product later is not all that different from the model CKP runs. CKP is just selling a different product. What stands out in stark contrast to the auto dealerships, though, is the retention rate of the customers’ business after the sale of the initial product. When CKP sells a system, the tag sale business associated with the system doesn’t churn off at anywhere close to the churn rates the dealerships see. Dealerships see anywhere between 35-60% retention five years down the road after selling a car, whereas CKP tends to continue to provide all the tags the customer needs (the wide margin among dealerships is due to luxury car dealerships generating much higher retention of parts and service business than low-end cars, see the GPI write-up from 7/30/13 by VIC member PGTenny for background).

     

    CKP’s business model has a more resilient recurring revenue stream associated with its installed base of products yet it trades at a mid-single-digit EBITDA Multiple, half the 12-13x EBITDA multiples being paid for dealership companies with arguably comparable business models.

     

     

    6. Management is Conservative

    Recently Europe and Asia have been weak and deteriorating markets for CKP and they had a potentially significant customer delay a contract last quarter. Normally, an unexpectedly weak market and a contract delay would force a company to revise their earnings guidance downward but CKP presented the news last quarter and didn’t have to update earnings guidance.  They maintained EBITDA guidance of $70mm to $80mm for the year and only reduced top-line expectations.

     

    The management team at CKP has under promised and over delivered on nearly every goal they have laid out (mostly savings related goals) and their track record of conservative earnings guidance is not only refreshing it provides some comfort that current expectations are likely to be beaten.

     

     

    7. CKP Is Cheap and an Acquisition Target

    The stock is trading for 6.4x the high end of their 2014 EBITDA guidance compared to a historical multiple of ~8.4x over the last seven years yet they are more profitable and they are on the verge of what will likely be substantial top-line growth and continued margin improvement. More importantly, CKP is essentially the only publicly traded pure-play on the RFID upgrade cycle and likely a very attractive acquisition candidate to Private Equity or one of their larger competitors like 3M, Avery Dennison, Roper, or Zebra (although Zebra is probably three years away at minimum considering their recent acquisition).

     

     

    Valuation

    At 9x $83mm in 2015 EBITDA plus FCF of $40-50mm I arrive at a ~$20 target. I think that is where the stock should be trading today. By year-end 2015 I think we will be looking at forward EBITDA approaching $100mm and at 9x $100mm plus incremental FCF the stock would be trading for ~$25.

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    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Customer wins & buyback

    One or two significant customer wins could really drive numbers. If management decided to establish a repurchase program and buyback stock at today’s price level, this would juice the returns investors realize from this multi-year RFID upgrade cycle in its infancy.

     

    Divest non-core RMS division: Checkpoint also has one division that doesn’t really fit the business and this could be monetized.  The segment is called RMS and it’s a handheld reader business that at ~1x sales might fetch $50mm or so.  They explain the problem is this resides in Germany.  Most of the cash is abroad as well so repatriation is an issue. But with the ever changing landscape in Washington, perhaps we get a tax holiday that allows this value to be realized.

     

    Management Sells the Company

    Both the CEO and CFO sold their prior companies and as a pure-play RFID solution provider they could be a great fit for 3M, Avery, Roper, or Zebra (but again, Zebra probably 3 years away considering their recent acquisition).

    Messages


    Subjectnew technology
    Entry01/08/2015 10:33 PM
    Membersocratesplus

    thanks for writeup.  have you been following new technology developments in the area, such as http://www.thinfilm.no/products/kovio-eas-electronic-article-surveillance/

    do you think this constitutes a risk to ckp? if not why not? thanks


    SubjectRe: Re: Apologies in advance if this is a stupid question... what do the online retailers use in ter
    Entry04/07/2015 08:19 PM
    Memberhkup881

    how do you feel about the trends relative to your expectations?

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