In assigning a rating on new debt issued by Harland Clarke to cover the purchase of Valassis, Moody’s made an assessment of a business that is primarily dependent on check printing and mail advertising. Its comments suggests that Wall Street sees both the transaction and advertising mail businesses as profitable but in a secular decline. More importantly for holders of bonds due in 2021, Moody’s expects the secular decline in both checks and mail advertising to accelerate towards the end of the decade.
Harland Clarke’s B2 Corporate Family Rating reflects Moody’s ongoing concern that the combined business model is subject to secular decline in both its check printing and Valassis’ printed based advertising model. While the decline in checks has moderated recently we expect the business to remain in secular decline due to new and evolving payment alternatives. Additionally, legacy Valassis has pressure from the secular demand shift of advertisers’ marketing spend and distribution to Internet-based / digital media channels, as well as the ensuing pricing pressure on traditional print-based media. We anticipate secular pressures to be moderate in the near term as there will be demand for both products for an extended period of time, but the pressures have the potential to increase over time. The ratings also reflect the company’s pro forma leverage of 4.3x for the twelve months ended September 30, 2013 (including the impact of the Valassis acquisition and Moody’s standard adjustments) which has improved from 4.9x at the end of 2012 driven by the improvement in its check business and wind down of the GlobalScholar business. Pressure on revenues in its Scantron segment due to the maturity of its form products and the history of sponsor friendly and related party transactions is also reflected in the rating.
Harland Clarke has a good track record of mitigating volume declines with price increases and costs savings, but we remain concerned these efforts will not be sufficient to prevent top line erosion if check volume declines should accelerate in the future. The acquisition of Valassis will enable Harland Clarke to diversify its business lines and expand its customer base to over 15,000 Valassis’ clients within the grocery and drug, retail, consumer packaged goods and restaurants industry segments, for which the company provides advertising and media delivery campaigns via its Shared Mail, Neighborhood Targeted, Freestanding Inserts and International, Digital Media & Services businesses. Moody’s considers client spend to be cyclical but believes the consumer value-oriented nature of the product offerings (including promotions and coupons) somewhat dampens the cyclicality since advertisers often reallocate marketing budgets to this type of advertising during economic downturns. We do expect Harland Clarke to achieve meaningful operational cost synergies as a result of the acquisition over the next two years and believe there are opportunities for operational improvement and modest revenue synergies. The ratings are also supported by the company’s strong cash flow generation from its portfolio of businesses, EBITDA margins in the low 20% range, and the 10% debt amortization requirement on the term loan B-2 and 2.5% requirement on the B-3 which accelerates debt repayment.
The combination of profitability but a secular decline explains why This combination explains why mail related businesses, other than the largest printers, Quad Graphics and R.R. Donnelly are attractive only