Largest RR Donnelley Bondholder, Chatham Asset Management, Threatens to Wage Proxy War
North America's largest commercial printer remains under attack. Chatham Asset Management — the Chatham, N.J.-based private investment firm that owns approximately 14.9% of the outstanding common stock and which is the largest bondholder of R.R. Donnelley & Sons (RRD) — made public a letter to RRD's board of directors demanding several initiatives in order to avoid a proxy contest.
It seeks RRD to appoint a new board chairman and add new directors, to terminate the company's poison pill, and to form a strategic review and finance committee. Chatham indicated the following initiatives must be implemented to stabilize RRD's share price and drive future value creation:
- A clear strategic review process focused on the identification and sale of non-core assets;
- Increased operational efficiency through improved margins from cost reduction;
- Improved capital allocation; and
- Better alignment of executive compensation with performance.
The full text of the letter dated Sept. 27, 2021, said:
Dear Members of the Board:
As you are aware, Chatham Asset Management, LLC (together with its affiliates, "we" or "Chatham") is the largest stockholder and bondholder of R.R. Donnelley & Sons Company ("RRD" or the "Company"), beneficially owning approximately 14.9% of the Company's outstanding common stock and 40.9% of the Company's outstanding bonds. We are disappointed that we find ourselves issuing another public letter to you, despite our significant recent efforts to work together to unlock value at RRD, including through a refreshment of the Board of Directors (the "Board").
Since our last public letter on September 1, 2021, we privately proposed that the Board be refreshed with the addition of two new directors, as recommended by Chatham, who have strategic, capital allocation and governance expertise. We also proposed that the Board appoint a new Chairman and that the existing Chairman, John C. Pope, who has been on the Board for 17 years and has overseen a decline in RRD's stock price of over 91% in that time, retire by next year's annual meeting. We further proposed that the Board immediately terminate its poison pill and form a new strategic review and finance committee at the Board level, to be chaired by one of Chatham's designees, focused on monetizing RRD's non-core assets, unlocking operational efficiencies and improving RRD's capital allocation.
Given the precipitous decline in RRD's stock price since July 2021, we were shocked that even after two weeks the Board neglected to give our proposal a substantive, or indeed any, response. Even for a board that has repeatedly failed to maximize stockholder value, its unwillingness to respond in a timely fashion to our legitimate concerns and reasonable proposals to address the Company's dismal performance, is inexcusable.
Despite our frustration with the Board's continued inaction, we remain convinced that there is meaningful value to be unlocked at RRD. We believe that through straightforward initiatives – including: (i) a clear strategic review process focused on the identification and sale of non-core assets and unencumbered real estate, (ii) increased operational efficiency through improved margins from cost reduction, (iii) improved capital allocation, and (iv) better alignment of executive compensation with performance – RRD's stock has the potential to increase to more than $13 per share, representing an increase of over $9 per share, or 210%, compared to RRD's share price as of market close on September 24, 2021.
In our view, a change in Board leadership, the addition of new directors, the immediate termination of the poison pill and the formation of a strategic review and finance committee can help unlock this value, and we urge the Board to constructively reengage with us to avoid facing a proxy fight in the near term.
Free Fall Destruction of Share Value
At the time of our public letter dated July 28, 2021, in which we urged the Board not to renew the Company's poison pill, RRD had an equity cap of $427 million. As of September 24, 2021, RRD's total equity cap was $319 million. In the space of 58 days, during which period the Board renewed the Company's poison pill over stockholder objections, the Board has overseen the dramatic destruction of approximately $108 million in stockholder value due to a 25% decrease in share price. Over this same period, the S&P 500 and Russell 2000 indices gained just over 1% each. Further, Quad/Graphics, Inc. (NYSE: QUAD, "Quad"), one of RRD's closest public comparable companies, has seen its share price increase more than 19%1 over this same period. Clearly, RRD is not simply a victim of market forces.
RRD is in Gross Need of a Clear and Decisive Strategic Vision
As a longstanding consolidator in the commercial print industry, RRD has acquired a large portfolio of businesses. We believe such a varied portfolio is no longer advantageous, however, given current industry dynamics and the leverage under which the Company operates. We also note that as of its most recent Annual Report, RRD reported owning or leasing 199 facilities globally, of which some 43% of the square footage was owned. The reported book value of owned real property is roughly $400 million, or 1 full turn of leverage.3 Sale-leasebacks or outright sales could provide meaningful proceeds to further deleverage the balance sheet, provide capital to return to stockholders in a prudent fashion, and continue to invest in the Company's growth. We urge the Board to form a new strategic review and finance committee to work aggressively to refocus the Company on its strategic business lines and explore ways to monetize RRD's portfolio of non-core businesses and/or unencumbered real estate assets.
As just one example, we believe that RRD's foreign operations must be reassessed, specifically its China-based Asia Printing and Packaging business. We believe if this segment were sold for the $800 million rumored last December,4 proceeds from the divestiture of this business could be applied to pay down RRD's outstanding debt and could lead to a material price per share increase. Applying proceeds from this sale to repaying a portion of RRD's debt, even assuming that upwards of 40% of the gross sale amount are used to pay related taxes and fees, could lead to annual interest savings of over $25 million. These interest savings alone could easily fund a reinstated annual dividend of $0.34 per share, which implies a price per share of $13.60 at a dividend yield of 2.5%.5
Together with the other operational improvements highlighted below, RRD should still be able to generate free cash flow sufficient to continue to invest in RRD's core strategic product lines and continue to deleverage the Company. The above actions could also permit the Company to return capital to stockholders in a prudent and sustainable manner, whether through restoring the dividend or undertaking strategic share repurchases. Further, aggressive deleveraging through divesting non-core businesses and exiting geographies could provide RRD the flexibility to pursue highly synergistic acquisitions to support its growth businesses such as packaging, labels, and supply chain management.
RRD Can Unlock Significant Value By Improving Margins Through a Reduction in Costs
Given the state of the Company's performance, we believe that one of the foremost goals of RRD and its management should be to constantly strive to achieve further operational and portfolio efficiencies. While we acknowledge the year-on-year improvements in RRD's full-year 2020 adjusted EBITDA margins of roughly 150 basis points on an as-reported basis, we also note that a significant portion of this improvement was driven by the divestiture of the Company's unprofitable logistics business line.6
We believe significant opportunities exist to reduce operating costs which will further improve RRD's margins. We calculate, holding all else equal, that an adjusted EBITDA margin improvement of approximately 100 basis points could lead to a material increase in equity value to over $12.00 per share. Although we can only assess RRD and its peers through monitoring publicly available financial statements, we believe this target is achievable. We note, for instance, that although RRD has been able to reduce its selling, general, and administrative (SG&A) margins by some 50 basis points since 2016, its peer set,7 on average, has achieved over 110 basis points in margin improvement in that time. We believe this represents a clear opportunity to improve operational efficiency, and indeed that there are likely more opportunities to be found.
RRD is in Gross Need of Revisions to its Executive Compensation to Better Align Management's Compensation with Actual Performance
Unfortunately, the fact that such dramatic value destruction should go unaddressed at the Company only emphasizes what we believe is the complete misalignment of incentives between RRD's leadership and its public stakeholders. For example, in 2020, a year in which many public companies were beset by the pressures of the COVID-19 pandemic, RRD's shares declined 43%. Despite this unprecedented decline, Daniel L. Knotts, the Chief Executive Officer, was rewarded with a 7.7% increase in his total compensation, including a 44% increase in cash incentive-based payments in the context of an organic pro forma top line decline of 9%, and a 3.5% decline in pro forma adjusted EBITDA.8 Even if one were to consider only the CEO's non-adjusted "Actual Compensation" as disclosed in the Company's proxy statement for its 2021 annual meeting of stockholders (the "2021 Proxy"), it still reveals an extraordinary year-on-year increase of 30.7%.9 For the sake of comparison, consider that under the same time period, Quad's share price declined 18%, while the total compensation for Quad's CEO decreased by 46%, including a base salary reduction of 50% for 4 months.10
We are therefore forced to ask the distressing question: Have the Board and management hitherto accepted—or worse, welcomed—operational decay and stockholder value destruction while enriching themselves? Is it possible that management appreciates the share price devaluation at fiscal year-end, so that they may purchase shares they know are undervalued? By the Company's own admission in its statement regarding the poison pill's renewal, it agrees with Chatham that its equity is undervalued. We believe, therefore, that the Company's equity incentive program must be reevaluated given current levels. Going forward, we propose that equity incentives be awarded in the form of out-of-the-money options, rather than time-vesting stock units. This action will help assuage any fears of a misalignment between the interests of Company leadership and investors and will further incentivize aggressive action from Company leadership to address RRD's undervalued equity.
The Path Forward for RRD
We continue to be supportive of RRD as a company and believe it could once again generate great value under a refreshed Board. Our present exasperation is due to a situation that we believe the market recognizes, yet one that eludes Company leadership: To wit, the Board and management have done little to address the massive value destruction in both the long and short-term, content to simply collect their unconscionable compensation and entrench themselves.
As we have repeatedly noted, even undertaking a minimum of our suggested actions should have a material positive impact on RRD's equity value. Since many of our concerns have heretofore gone unheeded, we believe the only reasonable path forward is to enhance the Board with two additional directors who possess strong corporate governance and capital allocation expertise to refocus the Company's strategy, streamline the Company's operating cost structure, improve its capital allocation policies, and better communicate to the market the Company's value proposition.
We urge the Board to recognize the need for immediate change at the Company and engage with us in a more constructive and meaningful manner to preserve and maximize stockholder value. We have no desire to engage in a distracting and expensive proxy contest to replace directors on the Board or vote down the poison pill at a special or annual meeting, but we will do whatever is necessary to protect stockholder interests.
Anthony R. Melchiorre
1 All historical share prices based on closing prices per Bloomberg historical price data. Share value change calculated from July 28, 2021, to September 24, 2021.
2 As measured from September 30, 2016, to September 24, 2021.
3 Book value of owned land and buildings is as of RRD's most recent 10-Q, filed August 4, 2021, for the period ended June 30, 2021.
4 See "R.R. Donnelley Is Said to Seek $800M in Asian Asset Disposal," Bloomberg News, December 16, 2020.
5 The weighted average dividend yield of RRD's peers, as identified in the Company's 2021 Proxy (as defined herein), is 2.3%. We have calculated the dividend yield based on 2019 financial results, as many companies reduced or suspended their dividends in 2020 in response to the COVID-19 pandemic.
6 Pro forma the divestiture of the logistics business, full year 2020 adjusted EBITDA margins improved some 80 basis points year-over-year.
7 The peer set is comprised of RRD's compensation peer group as identified in its 2021 Proxy.
8 CEO compensation per the 2021 Proxy. Results of operations based on RRD public disclosures, and account for the full disposition of RRD's logistics business line, which was completed in the fourth quarter of 2020. On an as-reported basis, revenues declined 24.1%, and adjusted EBITDA declined 7.6% between 2019 and 2020.
9 According to the 2021 Proxy, "Actual Compensation" is comprised of: "2020 base salary, 2020 actual AIP payment, paid in March 2021, and: (i) the value realized upon vesting of RSU awards as of December 31, 2020 and (ii) the value of the 2018-2020 PSU awards based on the final performance factor of 99.4% and stock price of $2.26 as of December 31, 2021."
10 Per Quad/Graphic's proxy statement for its 2021 annual general meeting of stockholders.
RRD Issues Public Response to Chatham
In response, RR Donnelley issued the following public statement on Sept. 28 to its stakeholders:
RRD is an industry leading marketing and business communications company with a well-defined strategy focused on creating long-term stakeholder value. Through the focused execution of its three strategic priorities – to strengthen core performance, drive revenue growth through higher value offerings, and improve financial flexibility – RRD is well positioned for the future.
As described in its August 2, 2021 press release, RRD has delivered solid results over the last two years and through Friday, September 24, 2021, has delivered 67.8% in total stockholder return vs. pre-COVID period (assumes February 20, 2020) and has outperformed the average return of Russell 3,000 companies, which delivered a total stockholder return of 37.0% during the same period.
Since the spin in 2016, RRD has made strategic investments to drive profitable growth, divested non-core businesses, and proactively improved its balance sheet. In 2020, the Company expanded its technology solutions portfolio and introduced new products that enable its clients to simplify complexity, reduce costs, and enhance the effectiveness of their communications.
The Company also invested to increase production capacity in its core growth businesses, including labels and packaging, where RRD has delivered sales growth in each of the last five quarters, including double-digit organic sales growth in the second quarter of 2021. In addition, at the end of 2020, RRD reported its lowest gross and net leverage levels since the spin.
RRD benefits from a strong and diverse Board that provides effective oversight and guidance on the execution of the Company’s strategy in addition to regular evaluations of the Company’s portfolio and other strategic opportunities. The RRD Board and management engage regularly with stockholders, including Chatham Asset Management LLC (“Chatham”), to understand their perspectives and discuss the Company’s strategy and prospects. The RRD Board is composed of seven highly qualified directors, six of whom are independent and of which four were appointed in the last five years including one that was appointed in February of 2021. The directors bring a wide range of experiences and skills that bring diversity of thought and perspectives to the boardroom.
In addition, the Board expects to evaluate additional board candidates in the near term in an effort to execute smooth transitions upon upcoming retirements. The Board has informed Chatham that they would consider all qualified candidates Chatham wanted to put forward.
The Board regularly reviews the Company’s strategic priorities and opportunities to maximize value, and is unified in its commitment to serving the best interest of all RRD stakeholders. Relatedly, the Board will continue to review potential divestitures of additional non-core assets on terms favorable to the Company as part of its continuing strategic review of the RRD portfolio.
Both the Board and management are confident in RRD’s strategic direction and in its ability to deliver significant, sustainable value creation for each of its stakeholders.
It appears the ongoing war between major bondholder/shareholder Chatham Asset Management and North American mega-printer RRD is far from over. Ultimately, the shareholders may decide which side prevails. But, in the meantime, it appears Chatham will continue to apply public, and behind-the-scenes, pressure to achieve its financial objectives.