Greater Pricing Power: The Not-So-Secret Secret Behind the Quad-LSC Deal
Wall Street analysts hate Quad/Graphics’ proposed purchase of fellow mega-printer LSC Communications because they don’t understand the deal. Publishers hate the deal because they do understand it.
“Investors do not like the deal despite promised synergies, amidst added leverage, integration risks and lower margins reported by LSC,” writes a SeekingAlpha commentator known as The Value Investor. Those “promised synergies” total $135 million annually, which is 1.7% of the companies’ combined net revenues.
Quad’s stock price dropped 15% the day of the announcement, but has inched up a bit since then.
Wall Street goofed by listening only to what Quad and LSC are saying about the deal. Publishers are worried about something Quad and LSC aren’t talking about. Here’s a hint about this not-so-secret secret to the deal: Phones were reportedly ringing off the hook at smaller publication printers after the two printing giants revealed their plan on Halloween.
Quad’s and LSC’s extensive regulatory filings and their elaborate presentation to investors make no mention of the proposed deal’s impact on their pricing power. So Wall Street isn’t factoring product pricing into its valuation models.
Magazine and catalog publishers have other thoughts. Many fear that Quad would have them over a barrel because LSC is currently the only viable competitor for some segments of the publication-printing business and one of only a few competitors in much larger segments of the business. (My recent article “How the Quad-LSC Deal Will Impact Publishers” explores seven implications of the proposed deal for publishers.)
“The impact of decreasing demand for printed materials and significant overcapacity in the highly competitive commercial printing industry creates downward pricing pressures,” Quad said in its most recent quarterly earnings statement. LSC has made similar comments. Over the past couple of decades, prices for publication printing have dropped about 1 or 2 percentage points annually (not adjusted for inflation), according to printing companies’ statements.
The Quad-LSC tie-up would clearly reverse that trend, especially for large- and even medium-sized publishers that would see greatly reduced competition for their business. Together, Quad and LSC bring in about $4 billion in annual net revenue from printing and shipping magazines, catalogs, and inserts in the U.S.
Let’s assume that publishers’ worst nightmares are overwrought and that the combined Quad-LSC is only able to improve the trend by about 5 percentage points annually – from the current decline, say, of about 1.5% to an increase of 3.5%, which is barely above the current rate of inflation. (Five points is my guesstimated average; it would be higher for large print orders and perhaps negligible for some niche titles.)
Those 5 percentage points would mean another $200 million in annual net revenue – more than those synergies Quad and LSC are playing up. And that’s not a one-time gain: Quad would presumably be able to continue ratcheting up prices, instead of the current practice of trimming them just to maintain market share. Assuming those 5-point gains last for just five years would add about $700 million to the estimated value of the combined company. (For you math geeks: I assumed a 7.5% average cost of capital and that the real value of the gains would decline 5% annually because of market shrinkage.)
But you won’t hear Quad and LSC officials talking about such gains. Doing so would play into the hands of those who oppose the Quad-LSC nuptials on the grounds that it would stifle competition. No organization has come out publicly against the deal, yet, but I’d be shocked if none did.
Joel Quadracci, Quad’s CEO, claims that the deal would not stifle competition because “our real competition is other channels” – a reference primarily to digital media that are eroding the publication-printing business.
Quadracci has a point. I think the combined company would move cautiously on pricing so as not to push customers further toward digital media – and also because Quadracci’s vision to provide a wider range of services to its print customers. But I can’t imagine it continuing to reduce prices, or even to undershoot inflation, in the sizable segments of the market where most or all of the competition currently comes from LSC.