Monday, October 3, 2016

Donnelley Financial Solutions: New RRD Spin, Asset-Light, Recurring Revenue

Donnelley Financial Solutions (DFIN) is one of two fresh spinoffs of RR Donnelley & Sons (RRD) that provides services to help create, manage and deliver financial communications to investors and regulators.  This means the unwanted paper annual reports and prospectuses you receive for equities, mutual funds and insurance products, much of that is printed by Donnelley Financial.  This is a slowly dying business that represents about 42% of DFIN's revenue, its declining low single digits annually, and being mostly held up by regulations that require funds to physically mail annual and semi-annual reports to investors.  The other half of Donnelley Financial's revenue is generated by software and cloud like solutions that assist companies in putting together filings and data rooms that are used as depositories for M&A and IPO transactions.  This is the growth side of the business and one where RRD had been actively acquiring technology and software companies to compete in an increasingly paperless world.

The company breaks out their lines of business into three segments, mostly by customer type:
  • Global Capital Markets: Clients consist of primarily publicly traded companies that are subject to the Securities Act of 1933 and the Securities Exchange Act of 1934 who need to make periodic regulatory and investor filings along with transactional filings when M&A, IPOs, bankruptcies or other large corporate actions happen.  About half of the revenue from this segment is recurring in nature, the other half is transactional and depends heavily on deal making activity in the financial markets.  Donnelley Financial did business with 422 S&P 500 firms in 2015 via this segment.
  • Global Investment Markets: Clients consist of mutual funds, hedge funds, insurance companies that use Donnelley Financial's products to create reports, prospectuses, fact sheets and other marketing materials.  Almost all of this segment is recurring in nature, although it may face broader secular headwinds as active management strategies continue to face challenges outperforming and the resulting outflows.
  • Language Solutions: DFIN's smallest segment provides translation services that adapt business content into different languages for specific countries.  This segment could be where future acquisitions are made as the market is highly fragmented.
Overall DFIN believes 62% of their revenue is derived from recurring sources and 38% from transactional deal related activity.  Some products that those in finance might recognize: EDGAR Online, EDGAR Pro, Venue, FundSuite Arc, Proxy Design, ActiveDisclosure.

RR Donnelley didn't run what is now DFIN as a separate business vertical prior to the spinoff making it difficult to see historical numbers or business trends.  Besides reading the Form 10-12, it might be helpful to go back and review Bowne & Co (BNE) which RR Donnelley bought back in 2010 for ~$460MM, significantly beefing up their financial communications business.  For cyclicality context, Bowne's revenue dropped about 20% from 2007's peak to 2009's trough.

Why do the spinoffs?
RR Donnelley split up into three companies which itself could create some market uncertainty (seems to have today at least) as investors digest the prospects for each separate business.  Donnelley Financial appears to be the best business of the three, but to complicate matters RRD CEO Thomas Quinlan jumped to what looks like the 'garbage barge' retail printing business (LSC Communications) and the remaining RRD will be maintaining a 19.25% interest in both spin-offs for up to a year which could result in exchange offers for fans of those transactions.
But overall, the spinoffs seem to be designed to separate the headwind facing business, LSC Communications, from the parent that has moved to a more value add business model.  Secondarily highlighting the high margin, low capital intensive financial communications business (DFIN) from the parent, which should lead to DFIN trading at a higher valuation.  Most of the legacy pensions, PP&E, and other old-economy like cash drags will be either going to LSC Communications or staying with RR Donnelley.

Daniel Leib, the old CFO of RRD, is now the CEO of DFIN.  He's been the CFO of RRD for many years and before that was their internal M&A and strategy lead.  I generally like when CFO's take over the head job, especially of a company like DFIN that is expected to generate a lot of free cash which management will need to allocate and DFIN's entire business model is based around financial statements and regulatory disclosures, Daniel Leib as a former CFO should be intimately aware of these challenges from a client prospective.  The board will be led by Chairman Richard Crandell, 77, he like the rest of the board don't appear to have much of a printing industry background, more technology and software, lending more credit to the strategy of shifting the company to software products.

Donnelley Financial will be substantially asset-light, they outsource much of the physical printing during peak times around proxy season, and have minimal capital expenditures ($20-30MM) as they shift their business to more software and cloud offerings.

New IPOs and deal making activity was a little muted during the first half of the year, particularly the first quarter, pushing down DFIN's numbers year over year.  I'm going to use a rough $200MM EBITDA number, below the current run rate to account for both some peak market activity risk and the inherent carve out risk of using proforma Form 10-12 numbers.  DFIN has approximately $600MM in net debt and 32.4 million shares outstanding (which includes the stake retained by RRD), at $24.50 per share, DFIN is trading at 7x EBITDA for a mostly recurring revenue stream, with strong margins and minimal cap ex requirements.  Seems too cheap to me.

Disclosure: I own shares of DFIN