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Cenveo debt buyback may augur a sale

by Jamie Mason  |  Published October 26, 2012 at 9:06 AM
Cenveo Inc. has started buying back its 7.875% notes before they mature in 2013 as part of its mission to deleverage the printing and packaging company, which may be headed toward a sale.

Despite being part of an industry being ravaged by digitalization, the Stamford, Conn.-based commercial printer and maker of envelopes, business forms and labels has expressed confidence in its ability to buy back the $98.5 million in senior subordinated notes it still has outstanding from the $320 million it originally issued in 2004.

"Cenveo could be sold, but first the company needs to deleverage its balance sheet, which will get more companies interested in them," said senior analyst Rahul Gandhi at bond research firm CreditSights Inc.

During Cenveo's Aug. 9 second-quarter earnings call, the company's chairman and CEO, Robert G. Burton Sr., addressed the potential sale of the company. "We'll decide if we're going to sell the company, and by the way, we've had people knocking on the door for the last several years," he told listeners. "It's just been a price issue."

Minutes later, he was more committal, noting that a management buyout was possible, too. "We're going to sell this company, as we have other companies and made money for you the shareholders, or we are going to take it private, which appeals to us more and more every day," Burton said.

But Gandhi said Cenveo might not be headed for sale in 2013 unless it gets an offer management just can't refuse.

The buyer would likely be a strategic player, because while private equity firms reportedly have a lot of money sitting on the sidelines, such investors have been burned in the paper and printing industry in the past five years with companies such as NewPage Corp. and Quebecor World Inc., Gandhi said. "Historically, the paper sector hasn't been a profitable sector for PE firms," he added.

While it's difficult to confirm Burton's boast about interested suitors in the past, one thing's for sure: Cenveo has consistently worked to pay down debt as it tries to navigate a market increasingly moving away from paper. The company is expecting to reduce its debt-to-Ebitda multiple to 4.6 this year from more than 6 in 2010, and wants to reduce it to 4 next year, its executives said during the earnings call.

Documents filed with the Securities and Exchange Commission show that the company has gradually retired its 7.875% debt largely through open-market purchases since the beginning of 2011.

"After we retire these notes, we'll resume our practice of paying down another portion of our capital structure, including our term loan, second-lien notes, senior notes and convertible notes," Burton said on the earnings call.

He said he was "very confident" in Cenveo's plan to quickly address the remaining $98.5 million owed on its 7.875% notes using its free cash flow.

The 7.875% notes traded at 100.25 on Thursday, after selling for between 99.63 and 99.8 on Wednesday, according to the Trace system of the Financial Industry Regulatory Authority Inc., an independent regulator of securities firms.

According to Gandhi, the debt trading numbers show that the market believes the company will repay the notes at par.

"The company expects to continue to repurchase the 7.875% notes throughout the remainder of this year and into 2013," Cenveo said in SEC filings.

Cenveo generated $33 million in free cash flow in the second quarter, Burton said on the call. But Gandhi expects Cenveo to generate roughly $100 million in free cash flow in 2013, he said.

Outside of market purchases, Cenveo on June 5 did buy back $50 million of the 7.875% notes with the proceeds of a $65 million term loan added onto its existing senior secured credit agreement with Bank of America NA as the administrative agent.

Through the term loan add-on, Cenveo also amended its senior secured credit agreement, which delayed the tightening of bank covenants until the first quarter of 2013. The company's senior secured credit agreement includes a $170 million revolver and a $380 million term loan due 2016.

Cenveo owed $34.7 million on its revolver and $375.1 million on its term loan as of June 30, SEC filings said.

The company delayed a step-down covenant on its first-lien leverage ratio covenant to 2.25 from 2.5 until the first quarter of 2013. The step-down covenant requires the company to post lower leverage, according to Kim Noland, the director of high-yield research at Gimme Credit LLC.

Cenveo also increased the pricing on its senior secured debt -- the term loan and the revolver -- by 0.375%, allowed the company to repay its 7.875% notes before they mature on Dec. 1, 2013, and provides the company with a reprieve of up to $65 million against its cash flow sweep that would have been payable in the first quarter of next year, Cenveo said on the earnings call.

The company used the remaining proceeds of the $65 million add-on loan -- some $15 million -- along with its cash flow to pay down $30.9 million of its revolving credit facility due 2014.

While the company has projected it will be able to repurchase the outstanding 7.875% notes, "the situation is tight, which is why one rating agency put the company on negative watch and the other lowered its liquidity rating," Noland said.

Standard & Poor's said the company may not have enough liquidity to buy back its 7.875% senior unsecured notes by June 1, 2013. If the company fails to repurchase the notes by that date, its revolving credit facility and term loan maturities would be accelerated to Sept. 2, 2013.

S&P said in an Oct. 2 report that it expects the company's leverage to remain high and its liquidity to remain limited over the next year. S&P also said it believes "discretionary cash flow will be insufficient" to pay down the 7.875% senior unsecured notes by June. The rating agency estimated that Cenveo would report $40 million to $70 million in positive discretionary cash flow in 2012.

An S&P analyst wouldn't comment beyond the report.

According to Noland, "the problem with operations and why one can't be sure of their stability is that Cenveo has lost business due to both a cyclical and a secular decline in the use of printed materials and envelopes."

Still, she believes Cenveo can slide by. "While Ebitda has been stable for the last couple of quarters, revenue continues to decline and at some point, there are no more costs to wring out. Nevertheless, the economy has improved a bit and the secular decline is fairly slow," she said. "So I think they could meet this 2013 liquidity hurdle if operations stay stable."

Once they have repaid the 7.875% subordinated debt, "they can breathe a sigh of relief, since they don't have a debt maturing until 2016 and 2017," Gandhi said.

While its debt issues will become more manageable if it can get beyond 2013, Cenveo's business prospects may become less so. The printing industry isn't doing very well, with troubles on both the supply side and the end market, Gandhi explained.

Indeed, in the second quarter of 2012, Cenveo had $438.9 million in net sales, a decrease from $469.9 million in the second quarter of 2011, because of lower sales in the print and envelope product lines. Cenveo had $894.5 million in net sales and a $22.5 million loss from its operations for the first six months of 2012.

The printing sector is very fragmented, with most of the market being run by mom-and-pop printers around the country. Larger printers, such as R.R. Donnelley & Sons Co. and Quad/Graphics Inc., have made multiple acquisitions each year, rolling up small printers to add to their revenue nationally but incurring integration costs and the wrath of the lending community when leverage is high. At the same time, the end market is gravitating to more digital products, Gandhi said.

On the bright side, Cenveo has shifted its focus more on direct marketing, which is going to help the company because direct mail is still a relatively effective marketing tool compared to newspaper and weekly magazine advertising, he noted.

And Cenveo's capital structure does sharply improve, at least when it comes to maturities being further out. The company has $86.25 million in 7% senior exchangeable notes due May 15, 2017. Some $225 million in 11.5% senior notes aren't due until May 15, 2017, and $400 million outstanding on its 8.875% senior second-lien notes don't mature until 2018. U.S. Bank NA is the indenture trustee on the 7% notes and 11.5% notes.

(Unfortunately, Cenveo's stock, which trades on the New York Stock Exchange under the symbol CVO, hasn't traded above $3 since April 5. On Wednesday, it closed at $2.04.)

Cenveo president Robert G. Burton Jr. couldn't be reached for comment, but Noland, who noted that the company executives continue to buy stock, said, "Management is very upbeat and supportive, which could be indicative of better news to come."

Tags: Bank of America NA | Cenveo Inc. | NewPage Corp. | Quad/Graphics Inc. | Quebecor World Inc. | R.R. Donnelley & Sons Co. | Robert G. Burton Jr. | Robert G. Burton Sr. | SEC | Securities and Exchange Commission

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