Grafenia (GRA): From ink to online

Grafenia (LON:GRA) is a company which caught me a little by surprise. It's not often I see companies I have never seen before in any capacity pop up on my screeners (a problem with screeners, you might rightly suggest), but I certainly hadn't heard of Grafenia, and the metrics were  interesting. They're predominantly a printing services group who are diversifying - and focusing more and more resources and attention - into 'software as a service' solutions for other printers and related businesses. This is something they have a bit of expertise with, since they've run a franchised network for a number of years. Digging into their annual reports quite quickly explained my perplexity - Grafenia, for all their snazzy new name and business segments, used to be known as Printing.com. And Printing.com is a company I had heard of!

What's in a name, then, and what's happening at Grafenia?

Out with the old..

The old Printing.com was basically a part-run, part-franchised printing group. Working mainly with small companies, they do the sort of stuff you'd expect any business printer to do - flyers, business cards, posters and so on; all the usual jazz. In 2010 they bought a Dutch company in a similar vein; in this case, the company owned three websites and then subcontracted printing. Essentially, in one way or another, Printing.com was involved in most stages of print management; they did some printing, they did some selling and they franchised out the selling. Simple enough - when you're running a capital intensive business like a printer, you really want to be maximising your capacity utilisation and working your assets as hard as possible, since that represents the easiest way of keeping returns competitive. Having lots of channels strikes me as the easiest way of doing this.

Over their time as Printing.com, they had an excellent track record of payouts  - there's a great cumulative return graph you can find in their annual reports (found here). They made good, steady profits and management earned themselves at least a small green tick by distributing most of it to shareholders. It's since then that's been the real question mark, though, and the name change is only really a signpost for a fundamentally changing business. The graph in the top right shows the problem - all measures of profit are declining as revenue increases. Clearly, margins are being squeezed, and the underlying cause looks likely to be the continuing shift to online sales and away from their shops or the franchised model. The amount of competition in the online market place is pretty fierce; you can literally just Google 'business cards' and see the swathe of different results that come up. It looks as if, on top of competition in the normal sense, there are a number of online shopfronts essentially competing to sub-contract to printers and skim off some profit on the top. The golden age certainly appears to be over.

 .. in with the new

Hence, Grafenia are trying to stay relevant. There are really two options when you think your old business model is starting to crumble; you either try to wrap things up in a way which maximises cash flow and return it to shareholders, or you invest your cashflows from the old business into trying to stay relevant. Grafenia chose the second option. Clearly, this is a higher risk/reward strategy; but there are some reasons for having at least a little faith in management.

Their chosen way to stay in the game is by developing software for use in the print industry - mostly for use by printers with their clients, but also through another system for graphic designers and small businesses directly. The value in this approach is twofold; they both represent revenue streams in themselves (via upfront and ongoing fees for using the software, or commission) but should also drive some sales to Grafenia's traditional printing business. Grafenia also note that they developed this software at least in part by using systems and assets that were already in place within the business. This is obviously a more attractive and more cohesive business model transition than is undertaken by some companies when they realise things aren't looking too rosy.

And where does it leave us?

I think it's probably fair to split the business up into two chunks - the software bit and the legacy printing segments. The software section, for me, is extremely difficult to value; it's consumed millions in cashflow and contributed only £0.67m in revenues in the first half of this year. They don't split operating costs off by segment so we can't get any intuition into the profit figures there, but it seems likely to still be making a fairly substantial loss. Arguably, that's to be expected in the growth stage. The long term viability of the software is really the key here, and it's not one I have any particular insight into. I can only go with what the figures tell me, and at this very early stage, the figures tell me very little.

It's not all doom and gloom, though. The stated profit figures are dragged down by amortisation charges I'd rather exclude, and management say further capex isn't required in the print business, so the group is extremely cash generative on an operating level. You might also suggest that the recession has seen marketing spend squeezed rather tightly, and that post-recession we might note that the decline in the print business doesn't look quite so bad after all - the old secular vs. cyclical story.

The cash is getting consumed by the software though, so a sum-of-parts isn't really appropriate here. Faith in management is key. Tony Rafferty has been around a long time and, given what I mentioned earlier about returns, gets more confidence from me than lots of managers who produce both poor returns and dodgy capital allocation decisions. The past doesn't predict the future, though, and I know so little about the service that they're providing now that I feel a little uncomfortable predicting results in any direction.