Description
OVERVIEW
Imagistics (IGI) is a direct sales, service and marketing organization that offers fax machines, copiers and multi-functional devices to enterprises in the US (97% of revenue) and in the UK. As of December 3, 2001 the company began its life as a stand-alone company after being spun off from Pitney Bowes (PBI) in a tax- free dividend to existing PBI shareholders.
The company has an installed base of over 320,000 fax machines and copiers under current rental or service agreements. It employs 2,500 sales and service representatives who operate out of 150 locations.
INVESTMENT THESIS
Imagistics presents both a near term trading opportunity and is an attractive longer-term investment. The trading opportunity is a result of a dramatic drop in share price since the company’s public debut caused by existing PBI shareholders simultaneously unloading their positions on the market. PBI shareholders are income oriented large cap managers. IGI simply does not qualify for investment as it offers no dividend and has an equity market capitalization under $200 million.
After trading as high as $15.50, shares can currently be purchased for $10.10 or approximately 70% of book value and have traded as low as $8.60.
As a longer term investment, the company (on a normalized basis) is nicely profitable and well-capitalized. I believe it can grow top line in the 2-3% range (exclusive of acquisitions) and bottom line at higher rates over the next 3-5 years. The business generates decent returns on capital and solid cash flow. Finally, management has a history at PBI (Imagistics CEO is the former COO of PBI) of supporting shareholder friendly uses of free cash (a large share buy back program has been underway at PBI for at least 5 years).
CUSTOMERS/COMPETITORS
The document imaging solutions industry is very competitive and is undergoing change as software, network and Internet based solutions impact the once thoroughly dominant positions of copiers and fax machines in the office. Nonetheless, there is little reason to expect that fax machines and copiers will disappear as both are critical pieces of office equipment.
Competitors come to market in numerous ways. Hardware manufacturers offer their products through direct sales and territory based independent distributors. Big box retailers (like Staples) also offer products through their retail stores and office products distribution channels to small and mid-sized enterprises. Software and Internet based solutions providers come to market largely through value added resellers and direct sales.
As a result of the broadening range of document imaging hardware and software, many competitors with an investment in direct selling have shifted from a product to a solutions based selling strategy. Feeding into this trend are the outsourced solutions providers like PBI’s Management Services Division and Xerox Business Services. Both have become significant customers for manufacturers and distributors like IGI.
In this environment IGI stands out as a well capitalized “private label” distributor of hardware solutions. Its closest competitors are IKON, and Danka. Each competitor sources equipment largely from Japanese manufacturers and offers sales, rentals and service. Both are significantly less well capitalized than IGI as shown below.
Company Debt/(Debt + Equity)
Imagistic (IGI) 35%
Ikon (IKN) 70%
Danka (DANKY) 88%
GATX (GMT) 81%
United Rentals (URI) 63%
As a result of its financing, IGI is in a unique position to grow through acquisitions and organically by adding finance assets. Given Danka’s heavy debt load, it is possible that further asset sales (PBI purchased the outsourced services business a few months ago) may be pursued.
IGI POSITION IN THE MARKET
IGI targets large corporate enterprises (major accounts) with rental and lease solutions on the fax side of its business. On the copier side the company has historically focused on product sales and service and targeted mid-sized and small enterprises (commercial accounts). Over the years the company has made numerous small acquisitions of regional/local distributors to better serve commercial accounts. Future fill-in acquisitions are a possibility.
The strategy going forward is to shift its business mix in the copier segment away from sales/service towards rental/lease. The desired result is a steady and predictable revenue stream and customer “lock-in”. The later is particularly important considering the changes taking place in the market for document imaging solutions.
With the advent of email and fax server software, some industry consultants expect fax page volumes to grow less rapidly than page volumes over software and network based fax alternatives. Some impact is being felt by IGI as fax rental revenues increased by only 1% year on year for the nine months ending 9/30/01.
In a flat net new equipment placement environment free cash flow should improve as fewer new fax machines will need to be purchased but the existing portfolio will continue to generate cash flow.
The copier business seems to have more potential for growth as a result of IGI’s low level of penetration and its shift from sales/service to rental/lease. The opportunities for cross-selling at the major account level seems bright. Rental revenues on this business increased 9% year on year for the nine months ending 9/30/01.
HISTORICAL FINANCIALS (see Form 10 for further detail)
--Nine Months 9/30--
Income Statement Pro Forma
Highlights
1998 1999 2000 CAGR 2000 2001 % Change
Revenue 589.7 626.5 642.8 4.4% 482.1 467.3 (3.1%)
CORev 212.1 231.6 274.7 13.8% 203.2 212.6 4.6%
SS&A 213.7 232.6 252.8 8.8% 187.8 222.7 18.6%
EBIT 163.9 162.3 115.3 (16.1%) 91.1 32.0 (64.9%)
NI 94.7 91.9 62.8 (18.6%) 50.1 14.3 (71.5%)
GM 64.0% 63.0% 57.3% 57.9% 54.5%
SS&A 36.2% 37.1% 39.3% 39.0% 47.7%
EBIT 27.8% 25.9% 17.9% 18.9% 6.8%
Pro Forma
Balance Sheet Highlights 1999 2000 2001
Cash 4.1 3.1 38.9
Working Capital 198.0 218.0 196.8
PP&E 13.7 15.6 22.0
Rental Equipment 134.8 141.3 133.6
LTD/Due PB 80.9 107.9 155.0
Equity 305.3 315.2 280.0
Total Assets 449.8 505.5 525.2
Debt/(Debt + Equity) 35.6%
Net Income 14.7% 9.8% 3.1%
Asset Turn 1.39 1.27 0.90
Leverage 1.47 1.60 1.88
ROE 30.1% 19.9% 5.2%
--Nine Months 9/30--
Cash Flow Highlights 1998 1999 2000 2000 2001
Cash From Operations 108.9 108.0 114.5 96.6 99.5
CAPEX (78.6) (98.8) (89.2) (70.5) (57.8)
Free Cash Flow 30.2 9.2 25.3 26.1 41.7
D/A 58.4 67.2 73.8 54.5 57.6
1998-2000 Review
-Total dollar growth in revenues was about evenly split between sales and rental revenues, though the growth in rental revenue (7%) outpaced sales (4%) and support (-1%).
- EBIT margins declined over the period due to a combination of lower gross margins and increased selling, service and administration.
- The portfolio of rental assets grew during the period to $141 million.
YTD 2001
- Total revenue declined with particular weakness in sales (-6%) and service (-8%). Rental revenue increased 3%.
- EBIT margins declined further on weaker gross margin and a dramatic, seemingly one time, increase in SS&A. I assume the company, in advance of its spin-off, aggressively priced it’s offering to minimize revenue loss in a very difficulty environment for office equipment. Additionally, SS&A spending was likely drawn forward to prepare the company for leveraged results when the environment improves.
VALUATION
I see no reason why this company wouldn’t resume its top line growth and experience a return to 15-20% EBIT margins in the next 12-18 months. Additionally, given the high returns on capital (both relative and absolute) available to this business it is hard to see why IGI wouldn’t trade at a multiple to book value rather than the current 30% discount.
Here’s how the competitors trade.
P/E P/B
Ikon 87.7 1.1
Danka NE 1.1
Both businesses have inferior capitalization and weaker financial performance than IGI.
On top of a return to historical performance levels, IGI will have ample opportunity to make acquisitions, grow finance assets or return cash to shareholders should growth opportunities be in short supply. Given management’s history as stewards of capital, I trust that these decisions will be made in the best interest of shareholders.
CONCLUSION
The market has yet to discover Imagistics. After the selling is done and sober minds run the roost, I expect the company to trade at least at book, offering shareholders a 30% return from here. Longer term the prospects are even brighter given the strong balance sheet relative to competitors.
Catalyst
Analyst coverage and improvement in operating performance.