Pitney Bowes' (NYSE:PBI) short interest has declined markedly over the past year but is still over 10% of the float as of May 30th. Despite the bashing that shorts have taken, their arguments largely rehash the same theses that have been proven wrong every quarter since Q2 2013.
Specifically, the shorts claim:
· Growth of digital commerce will be unable to offset physical mail declines
· Cost cutting has played out
· Revenue and cash flow are in terminal decline.
Several short sellers also question PBI's balance sheet and outdated debt ratings to claim the company is being threatened with junk status. Some particularly desperate shorts even go so far as to not so subtly accuse the company of using accounting changes to make results look artificially elevated.
These items are all either factually wrong or presented out of context. Pitney Bowes is still in the early innings of an impressive turnaround under an experienced leader who has a clear game plan. He has delivered great things for investors over his first 18 months (punishing the shorts in the process) and he can deliver more.
We'll start with the first item:
Digital commerce can offset physical mail declines
One only has to look at the Q2 report to see that e-commerce grew 27% year over year offsetting declines in SMB solutions (mail equipment) and Enterprise Solutions (production mail and presort) for overall company revenue growth of 1%. Moreover, the SMB's revenue declines were largely due to a change in the way they sell as part of a new "go-to market" strategy. Management was very clear on the Q2 conference call that revenue improved throughout the quarter and they expect the segment to return to its first quarter sales trend, which suggests down 2%, from the down 4% revenue decline in q2. The enterprise declines were related to some one-time production mail sales in q2 '13 that didn't recur this year. Management was clear that the underlying business is otherwise stable as indicated by presort sales (half of Enterprise Sales) growing 4%.
Management was also very clear in the investor day presentation that they see digital commerce solutions growing to 30-35% of sales in the future. At 27% growth rate and 22% of sales as of Q2, the company could hit that target by sometime in 2016.
Cost cutting is not over yet
Bears claiming cost cutting is over are just wrong. Sure a lot of low hanging fruit has been grabbed over the past 18 months. You would expect any CEO worth his salt to do that. But management is clear there is still more to go. The new go-to market sales strategy in SMB should lead to cost cuts in selling costs. A unified ERP system certainly should lead to further cost cuts at the corporate level at the very least. These guys definitely aren't spending $30mm this year on ERP without some high expected benefit.
Moreover, the EBIT margins are still low in digital commerce. This is a function of specializing software sales people. There is upfront cost with hiring and training these people but the benefits should appear within a year. Lautenbach came from IBM. He knows what software EBIT margins should be.
Cash flow and revenue are NOT in terminal decline
A core flaw in many short theses on PBI is one that is easily debunked. Cash flows are down from 2008 but 2008 should not be the starting point. Argue what you will about the decline of physical mail in this country. It is very hard to argue that there wasn't more mail activity around 2005. And what was free cash flow then? About the same as company guidance of $475-$575mm for 2014. Cash flow was temporarily elevated around 2008 because so many companies went out of business. Consequently, finance receivables declined and cash flow increased. Now that fewer companies are going out of business, cash flow is returning to where it was historically. You can read the 10ks from the period to see this yourself or look at the 2013 investor day where management guides people through what happened over the past 10 years.
As for revenue growth, PBI management just upgraded revenue guidance, to 1% to 3% growth from -1% to 2% growth on the Q2 earnings release.
Balance sheet stability
This argument has been put to bed for over a year yet the bears try to scare people in pretty lame terms. Some point out that Fitch rated the 10 year paper the company just offered at BBB-, the lowest investment status. So? S&P and Moody's, the ratings agencies that really matter, have the company rated BBB stable and Baa2 stable and those are ratings on the company from December 2012, right when Lautenbach took over and started restructuring. PBI is probably due for an upgrade over the next year.
Moreover, PBI got that 10 year deal done at just over 4.625% and it's trading over par now-that's solidly in investment grade land. So the ratings argument means nothing beyond the agencies are behind the curve. This company is nowhere near junk levels. Look where its bonds and credit derivatives are trading. Not to mention that close to $2bln of the debt on the balance sheet is offset by finance receivables. True corporate debt net of cash is very low.
At the end of the day, it should all come down to valuation. Yes, PBI has climbed a lot in the past 12 months. That doesn't make it overpriced now. It was at a 20% free cash flow yield one year ago. Now it's around a 10% free cash flow yield using the $525mm midpoint of cash flow guidance. That's still much cheaper than the S&P. Of course, if the company were shrinking in terms of revenue, perhaps one could argue that that's an appropriate lower valuation. However, as mentioned above, management improved revenue guidance pointing to revenue growth and just upgraded the bottom of the range of earnings to where the company is still at a meaningful discount to the market earnings multiple.
Lastly, PBI has not employed any accounting gimmicks to make its results look "artificially elevated". PBI is just a company that has had sorely needed restructuring. Lautenbach has sold underperforming or poor return businesses. He then redefined the three business categories. Doing so was not an effort to obfuscate the business. If anything the moves made it easier to understand. The company also shows year over year comparisons of the business lines as they are currently structured. The results are the results. The digital commerce business is now growing double digits again. Management hasn't done any acquisitions and discusses currency effects. Therefore most growth basically has to be organic.
To sum up, you can look at PBI very simply as 2 legacy cash cows supporting a nicely growing new business line. The core mail cash cows taken together are fairly stable and provide a solid base for the overall enterprise. The digital commerce growth engine is fairly quickly getting to the critical mass where it can drive revenue and earnings for the total enterprise.
Given how much pain the shorts have experienced based on poorly founded or just plain incorrect analysis of this company over the past 12 months, it's pretty surprising that anyone would keep trying to scare people with many of the same old arguments that have been proven wrong every quarter. That is not to say that PBI can't have a hiccup going forward. Any company can. But the scare tactics of steep revenue declines, "terminal" decline of cash flows and risk to the balance sheet are just plain wrong. This management team has done a great job with this company, but it's still early innings. They have some great products in quickly growing industries and dominant, high margin market shares in low to no growth industries. One can argue what the right multiple is for that combination of growth and cash flow. An above market free cash flow yield seems cheap though.
Disclosure: The author is long PBI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.