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13 Jan 2006
MOODY'S LOWERS DELUXE CORP.'S RATINGS (SR UNSECURED TO Baa3 from Baa1); OUTLOOK IS NEGATIVE
Approximately $1 Billion of Long-Term Debt Securities Affected
New York, January 13, 2006 -- Moody's Investors Services downgraded Deluxe Corporation's ("Deluxe")
senior unsecured ratings to Baa3 from Baa1 and commercial paper rating
to Prime-3 from Prime-2, concluding the review for
possible downgrade initiated on November 7, 2005. The downgrade
results from increased business risk and deterioration in the revenue
base because a loss of volume and market share are intensifying pricing
pressures in the company's check printing business. Moody's recognizes
the company's plans to offset these pressures by growing its small business
services (SBS) segment but perceives execution risk in an unproved business
model. In Moody's opinion, these operating risks will challenge
management's ability to reduce leverage from the high levels it achieved
over the past five years. The rating outlook is negative.
Ratings affected include:
Senior unsecured notes -- to Baa3 from Baa1
Senior unsecured shelf -- to (P)Baa3 from (P)Baa1
MTN program -- to Baa3 from Baa1
Commercial paper -- to Prime-3 from Prime-2
Consolidation among financial institutions and the erosion of printed
check unit volumes due to the ongoing shift in financial transactions
to electronic from paper-based formats is increasing the business
risk in the check-printing industry and putting severe downward
pressure on revenues and earnings in Deluxe's financial services
(FS; 32% of revenues) and direct check (DC; 15%
of revenues) segments. Moody's is concerned that the decline in
physical check demand (unit volumes are currently contracting by 4-5%
per year) will continue and ultimately accelerate erosion of the revenue
base. Declining check usage and financial institution consolidation
also create significant downward pressure on check product prices.
Deluxe is attempting to counteract these pressures by focusing on its
SBS segment (53% of revenues) -- a strategy shift that prompted
the June 2004 acquisition of New England Business Service (NEBS) to broaden
the SBS product line.
The SBS segment has lower margins than Deluxe's FS and direct check
segments and presents operating challenges due to the print-based
product line and significant churn in the customer base. Business
checks are the largest product in the SBS segment and are vulnerable to
the same demand pressures facing the FS and DC segments, although
to date the pace of decline in business check usage (1-2%
per year) has been slower than that of consumer checks. Other SBS
product offerings, which include business forms, packaging,
promotional products, envelopes, labels and tags, and
greeting cards, are commodity-like with usage tied to the
small businesses economy. Customer acquisition costs are considerable
given the churn in the SBS client base resulting from a high percentage
of firms that do not become repeat customers after the first order,
which is characteristic of direct marketing companies, the high
rate of small business failures (averaging approximately 10% per
year), and the tendency of small businesses to shift to electronic
from certain paper-based products as they grow.
Moody's rating anticipates that management will continue to focus
on debt reduction in 2006 and 2007 in an effort to lower the company's
high leverage (debt-to-EBITDA was 3.0x for LTM ended
September 30, 2005 incorporating operating leases, pensions,
and Moody's other standard adjustments). However, Deluxe's
financial profile has become more aggressive at a time when business risks
are increasing. Total debt has risen considerably over the last
five years to fund acquisitions and share repurchases. The rating
agency is concerned that the heightened level of business risk will limit
the company's ability to reduce debt-to-EBITDA leverage
and could lead to further strategic leveraging transactions over the intermediate
The ratings are supported by the company's leading market position in
core businesses, good cash flow capabilities and adequate liquidity.
In the SBS segment, Deluxe can leverage its relationships with financial
institutions to provide a more cost-effective means of acquiring
new customers than is available to competitors, which rely more
heavily on direct and relationship marketing. SBS customer leads
also increase the value of the financial institution relationship to Deluxe,
affording some flexibility to price aggressively in the FS segment.
The expanded small business product line resulting from the NEBS acquisition
positions Deluxe to increase wallet share and improve customer retention
by becoming more of a one-stop supplier for all client printed
material needs. This should benefit customer retention over time.
Integration of NEBS is also yielding cost synergies through plant rationalization,
headcount reductions, and from increased manufacturing scale economies
and buying clout.
Integration of NEBS into resource planning and order capture systems and
investment in additional sales staff will allow for more coordinated product
offerings in the SBS segment and a shift to a more proactive sales approach
based on the specific product, distribution channel and order frequency
needs of various customer segments.
Deluxe's low cost status in the check printing industry should sustain
the company's leading market position. The company continues to
rationalize its plant footprint and non-union employee base to
keep pace with lower unit volumes and benefits from its greater buying
clout than competitors with paper suppliers. Moody's believes
Deluxe will utilize the cash flow from its check-printing businesses
to invest in its SBS segment growth initiatives and reduce debt.
Moody's does not anticipate the company's strategic,
operating and capital structure plans will change in the near term under
the interim CEO. Moody's will evaluate any changes to the
company's plans that a permanent CEO might implement once the search
process is completed.
The negative rating outlook reflects the potential for additional erosion
of the revenue base and resulting elevated level of event risk.
Moody's expects that Deluxe's strategy will allow for modest growth in
the SBS segment but that price and volume declines in check printing will
continue to pressure consolidated revenue. Moody's believes cash
flow is likely to benefit in 2006 from smaller outlays on contract acquisition
payments, capital expenditures and accrued liability paydowns relative
to 2005. Moody's anticipates that Deluxe can maintain debt-to-EBITDA
in a 2.75-3.25x range in the near term by utilizing
free cash flow to reduce debt and that debt-to-free cash
flow will decline from its current high level (18x for LTM September 30,
2005) to an 8.0-10.0x range.
Debt-to-EBITDA exceeding 3.25x or debt-to-free
cash flow exceeding 10.0x due to earnings deterioration or a leveraging
event could negatively affect the ratings.
Renewed revenue growth, margin stability and debt reduction that
leads to sustainable debt-to-EBITDA and debt-to-free
cash flow in a range of 2.75-3.25x and 8.0-10.0x,
respectively, could favorably affect the rating or outlook.
Deluxe Corporation, headquartered in St. Paul, MN,
provides checks and related products to consumers and small businesses
through financial institutions, direct marketing, and retail
John E. Puchalla
Corporate Finance Group
Moody's Investors Service
Corporate Finance Group
Moody's Investors Service
No Related Data.
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