RR Donnelley: Where Print Still Fits

Even in a digital world, the printer finds there is money in old media. The question is: For how long?

If the future of print media is dim, the outlook for the companies that actually press ink onto paper must be even darker. Newspapers are collapsing, magazines are losing advertisers, direct mail has morphed into spam, and even books may be threatened by portable electronic readers. Short-term trends—namely the economy's skid—only add to the sense of doom.

Quebecor World, which had been the world's biggest commercial printer as recently as 2003, lies in bankruptcy today.

Yet there is light at the top of the heap, where RR Donnelley & Sons (RRD) resides. Not that Donnelley has been printing money; the Chicago company lost $48.9 million last year, largely because of writedowns and higher acquisition-related interest costs, and its stock value has fallen by one-third since last summer. But industry analysts say Donnelley's geographic breadth, efficient operations, and strong balance sheet should enable the company to ride out a recession and snap up even more of its less fortunate rivals. As evidence, it gained market share in the first quarter—industry shipments declined 5%, yet Donnelley's slipped only 1%. The company, says Piyush Sharma, an analyst at Longbow Research in Cleveland, is "the chief beneficiary of industry distress."

Donnelley's biggest operational advantage comes from adding services upstream and downstream from the presses—becoming "sticky" to the customer, in the words of Matthew Troy, an analyst at Citigroup (C) Global Markets in New York. For instance, Donnelley not only prints magazines (including BusinessWeek) but sorts them by zip code and organizes them on pallets, sparing the U.S. Postal Service the tasks. In return, the Postal Service gives Donnelley a price break, which the company passes on to its customers. "This is what sets them apart from pure ink-on-paper commodity printers," Troy says.

Avoiding Publicity

There's probably no one in the U.S.—and, increasingly, everywhere else—who hasn't held a Donnelley product. The company, with 65,000 employees and 650 locations in 33 countries, handles roughly half of all the mail moved in the U.S. and a quarter of all the mail in the world. The top-secret printing and first-day delivery of Harry Potter books were Donnelley's handiwork. Cash register receipts, tags at office-supply stores, labels on overnight packages, financial prospectuses, bills from telephone companies, banks, and mutual funds—they're all courtesy of Donnelley.

For all that, the company is practically invisible. You rarely see Donnelley's name on anything or in the business press. And that's the way management likes it. "We live on behalf of our customers," says Donnelley Chief Executive Thomas Quinlan III in his downtown Chicago office. "The communications medium should not be out in front of our customers." Donnelley has no public relations staff, and Quinlan doesn't like to give interviews. "There's no reason for me to be above the horizon," the 45-year-old boss states simply.

Donnelley does loom large in one arena, however—mergers and acquisitions. The company has put together more than a dozen deals in the past few years, including a $2.8 billion takeover of Canada's Moore Wallace in 2004. That purchase allowed Donnelley to reclaim the No. 1 ranking in commercial printing from Quebecor. It also brought in new management: Moore Wallace CEO Mark Angelson became Donnelley's chief. He was succeeded in April, 2007, by Quinlan, another former Moore Wallace executive who had become Donnelley's chief financial officer in the interim.

Painful Writedowns

Donnelley kept spending in 2007, paying $2.1 billion altogether for Banta of Menasha, Wis., and three other printers. The additions helped push Donnelley's revenue up 24%, to a record $11.59 billion, in 2007.

"They are the most disciplined, financially savvy acquirers I've come across," says Troy. "They don't do deals that don't make sense." Quinlan says the compliment is deserved. "Our eyes have never gotten bigger than our stomachs," he says.

Management looks for three things in potential acquisitions, Quinlan says: What product or service can the new company bring to Donnelley's customer base? How much can the add-on company's costs be reduced? And how much printing capacity does it bring? "We treat the presses like airline seats," Quinlan says. "We need those presses to be running." In an industry where margins are low and returns are linked to utilization, analysts put Donnelley near the top—its gross margin has averaged 26.8% over the last five years.

Still, the purchases haven't always worked out. The company swung from a record profit of $405.3 million in 2006 to a loss last year, mainly due to $839 million in pretax writedowns from its purchases of Moore Wallace, document-processor Astron Group in 2005 for $954.5 million, and Office Tiger Holdings, a back-office outsourcing firm in Chennai, India, in 2006, for $248.8 million. "There was a vision that these would really take off," Quinlan says. "We haven't been able to meet those expectations." The company also shoulders $6.85 billion in debt, including $1.3 billion due in 2008. In interest alone, Donnelley owes $211.9 million this year.

Without a lift from takeovers, revenue and earnings growth are slowing. Add in the slowdown in the U.S. economy and the quickening pace at which print media are dying, and it's no wonder investors have turned sour on the company. Shares today fetch about $31, down from $45 last July and back to 2004 levels.

But most analysts contend the stock is undervalued and rate it a buy. In fact, with a net debt-to-capital ratio of 47%, Donnelley may be underleveraged, which means it could make more acquisitions, such as pieces of Quebecor, should they become available. "They could buy any printing company they want," contends Charles Strauzer, of CJS Securities in White Plains, N.Y. So is Donnelley in a buying mood today? "We are always acquisitive," responds Quinlan, circumspectly.