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  • CBPX is currently trading at a significant discount to a peer group.
  • CBPX is positioned for strong FCF for at least the next three years.
  • CBPX has several strategic advantages that make it defensive in bad economic environments and offensive in good ones.

It's not often that I get to write a continuing coverage article down 5.3% after owning a stock for 80 days and still feel like I'm allowed to pound the table that the investment is still a great position to have on a big board. As a matter of fact only once prior in 2014 have I felt so bullish about a stock after being down every day since initiating coverage and executing a buy - the other case was Paycom (NYSE:PAYC) and that turned out OK for me so far. There are rare occasions where being early doesn't mean being wrong and I happen to think that I own one of those occasions with Continental Building Products, Inc. (NYSE:CBPX). Regardless of my current bullish sentiment it sure didn't feel good being down ~20% on the lows but I took that opportunity to average down in cost basis and average up in size. I also took that opportunity to refine my original thesis and I will present that thesis today.

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This article will make the case that CBPX is one of the most undervalued long-term positions available and that it is well positioned for growth on all durations and across multiple economic environments. This article will make the argument that CBPX is positioned defensively in slowing economic environments based on its current P/S to comparable company P/S for its sector and based on its actionable accretive M&A opportunities that would come available in such an environment. This article will make the argument that CBPX is positioned offensively in slow growth or quickly growing economic environments based on its state of the art operations, its many competitive advantages in the niche of its industry that it participates, and its ability to control pricing pressure. Finally, this article will make the argument that CBPX is undervalued by between 50%-66% based on its operating, technical, liquidity, and profitability metric performance when compared to a peer group.

A Brief History

80 days ago I made a 50% technical 50% fundamental purchase of a company that I thought, and still think, was the real McCoy. CBPX is a wallboard manufacturer (commonly referred to as drywall) that just recently underwent an acquisition by Lone Star, a private equity firm with $45 billion in aggregated capital commitments, and just finished a long-term transition from existing as an old, antiquated, sloppy operation to a cutting edge, efficient, agile enterprise. I was especially interested in the company in that the heavy lifting of the transition had been completed and that guided CAPEX for the next 36 months was going to be less than 3% of sales. For clarity, Lafarge (OTC:LFGEF) agreed to sell all of the assets comprising the predecessor of CBPX to Lone Star in late June 2013/early July 2013 with the actual transaction closing soon after.

What was this transition exactly? Well, in the most concise explanation possible, CBPX's predecessor Lafarge invested $550 million total into company plants and operations starting in 2002 in an effort to optimize the company's ability to compete in current and future environments. The investments were mostly to modernize plants, improve geographic footprint from a raw material to refined product flow perspective, and to make sure that CBPX would be producing 100% of wallboard from synthetic gypsum. All the strategic initiatives were executed beautifully. It is my belief that had Lafarge, who by the way is the largest cement maker in the world, not picked the worst timing in a century to get levered up and go M&A crazy (in late 2007) that Lafarge would still own CBPX.

Lafarge's efforts, which were based on an old industry model where the purchasing market had all the power to sway pricing pressure (remember this later on because this is extremely important), created an ability at CBPX to do two very important things that I very much like to own. CBPX has currently the ability to generate significant amounts of FCF and the ability to drive margins from increased efficiency. Those were essentially the two primary reasons I wanted in on this IPO and in at what looked like a great technical level.

The bull case didn't end there although fundamentally that for me would have been enough to dip my toes in the water. CBPX also has several industry specific tailwinds that should help drive share price appreciation:

  1. Industry Niche Consolidation: Over the last 20 years the US wallboard industry has consolidated from 13 major competitors in 1997 to just 7 currently, further concentrating market share and economies of scale for the surviving few. CBPX is the 6th largest provider in the US.
  2. A Pricing Pressure Pendulum Swing: this is a huge theme within my bull thesis and will drive quite a bit of the projections. Beginning in 2011 Eagle Materials (NYSE:EXP), the second biggest publically traded wallboard supplier, and the rest of the wallboard producers began announcing in the fall set price increases for the following calendar year. Starting that year wallboard prices rose 30% in 2012, 25% in 2013, and 20% in 2014 (stated).
  3. High Barriers to Entry: Because of the cost of Gypsum and that costs ratio to the weight of Gypsum, it only makes sense financially to source the raw material and produce the refined product in very close areas. If manufacturing facilities are not located in close proximity to end markets, transportation costs can completely eat away the profit spread for the end product unless higher prices are charged, which makes competing with companies who source and produce in the same areas a non-possibility. Existing players typically have these built in competitive advantages and have strangleholds on gypsum supply agreements. Smaller competitors either get squeezed on pricing or get squeezed on shipping. This has created a significant barrier to entry and a barrier to upward mobility.

Finally, CBPX possessed and possesses company specific competitive advantages that help contribute to the new bull thesis.

Three Economic Scenarios

I believe that the combination of the industry tailwinds and company specific competitive advantages that I will outline make CBPX an excellent opportunity to own in any economic environment. I will break down three economic scenarios individually:

SCENARIO 1: Contracting Growth/No Growth (Recessionary Environment):

Competitive Advantages Leveraged in Environment: This obviously is our worst case scenario. Because of the ability for the industry in general to raise pricing regardless of economic backdrop (pricing was stated to rise 30% in 2012 during the fall of 2011 in the worst economic environment since the Great Recession); because CBPX has state of the art facilities - creating lower cost basis for production, lower margin needed to break even, faster completion and ship times, etc.; because CBPX has optimal logistical (read: supply and shipping) positioning for the markets it serves; and because of recent innovation at CBPX (54% of net sales in 2012 came from products developed in the last five years) - having unique or technologically advanced products is a value-add that can help win customers, I have modeled into CBPX share price an 8-10% potential decrease for a full 12 month cycle of this environment.

Explanation: Remember, consolidation in this industry is the norm and it happens for good reasons. Outside of the big boys owning the prime real estate and logistical structures that allow them to achieve lower cost basis' and lower margin break-evens, they also own all the benefits that come with having an economy of scale. The smaller players in this industry cannot handle the stress that the top-end companies can and during extended periods of non-productive economic environments end up being forced to M&A while they still can. The general market is smart enough to realize that these M&A activities, assuming a bidding war doesn't take place, are immediately accretive in normal or productive environments and price that into the equity. This provides a floor for equity pricing of sorts although depending on how severe the pullback the floor pricing level is fluid. Also, no-growth or slightly contracting growth (referring to net sales) environments the price increases will still move EBITDA margins and mill net sales prices higher, partially offsetting a lack of net sales. It is in this particular environment that the cream can rise to the top and take advantage of the blood in the street as well.

SCENARIO 2: Low Growth/Historically Average Growth (Recovery Environment):

Competitive Advantages Leveraged in Environment: This is the current environment. Again, the price of product increasing, the ability for CBPX to generate FCF as a result of having extremely low CAPEX, the ability to grow sales in a capacity that is still productive for long-term customer portfolio addition, the ability for CBPX to provide same day shipping - which is unique to CBPX as a result of its geographical positioning to major markets, and recent innovation at CBPX help allow the company to gain market share and put pressure on just below lateral competition. I have modeled into CBPX share price a 50-66% potential increase for a full 12 month cycle of this environment.

Explanation: It will be helpful to take a look at the income statement and the cash flow statement, and we will try to put this all into context, but most of the above is easily explainable. CBPX can deal with slower growth environments because of the factors we've already discussed in Scenario 1's Explanation portion but also because in this type of environment where all the purchasers of the product (namely Home Depot and Lowe's) want to keep inventory builds as small as possible and need to have new marquee products to bring customers into stores, CBPX can provide both. Same day shipping allows for greater inventory control for customers (read: greater cash flow control) and CBPX clearly can innovate (see stat above). Also, with the trailing years FCF historically going to paying down debt and lowering interest expense, the hypothetical years FCF would as well, CBPX needs less and less top-line to drive the bottom line. Even in a slow growth environment and especially in a recovery growth environment CBPX should see equity appreciation and it has - CBPX shares are up 14.2% on falling net income and top-line growth of 3.7% for 1H/14.

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To reiterate, this is hardly a raging bull income statement. 3% top-line growth for the 1H paired with COGS increases of 9.5% don't exactly make the income statement read a reason to pop champagne. Now, most of the negative in the income statement (COGS, Interest Expense, and Other Expense) is one-time in nature or several standard deviations outside of trend line norms:



Natural Gas which helps comprise inputs such as paper, gypsum, and other raw materials that represented 69% of manufacturing cash costs for the six months ended June 30, 2014 being up to multi-year highs prior to falling 19% over the last 90 days. This type of spike for a commodity, even natural gas, is unusual and several standard deviations above the normal growth curve and has since reverted to the mean. Look for COGS totals to decrease and to decrease as a percentage of revenue. This should help with operating, EBITDA, and profit margins.


Included a one-time write-off addition of $6.9 million of original issue discount and deferred financing fees associated with the early repayment of the Second Lien Credit Agreement on February 10, 2014


Included $5.1 million in one-time increases due to the $3.1 million prepayment premium for the repayment of the Second Lien Credit Agreement and $2.0 million for the payment of termination fees to affiliates of Lone Star in connection with the termination of CBPX's assets advisory agreement

Speaking specifically to shipping costs and energy costs, what I mean when referencing the COGS increase as one time in nature (the severity of the COGS increase) is that statistical theory tells us that these type of COGS line increases that are several standard deviations above the normal growth curve shouldn't be seen again after a reversion to the mean - inputs such as paper, gypsum, natural gas, and other raw materials, represented 69% of manufacturing cash costs for the six months ended June 30, 2014 and these contributors to COGS don't typically accelerate in pricing as fast as was evidenced in 1H/14. Again, the majority of the COGS bump was caused by natural gas skyrocketing in price but that has since fallen ~19% over the last 90 days and should contribute far less during 2H/14.

That said, the fact largely remains that this is going to be typical (minus the one-timers) of what the income statement should look like in this environment, a very slow growth income statement that reflects small developments that you're going to have to look for at deeper than surface level. An additional fact is that all the market cares about during this scenario is growing the top-line (read: market share) and that the margins expand - they did and I'll show that soon. This deflated, whimpering income statement has been worth 14.2% upside. Can you imagine what a Peak Environment scenario could be worth? Before you move on take a look at that green highlighted box, CBPX grew its Mill Net Sales Price over the 1H and that my friends isn't going back down anytime soon. Factor that into your models of projected top-line growth during better economic backdrops and let me know how that turns out in the comments section.

The cash flow statement is another pillar to my bull thesis. The ability to generate FCF at CBPX is essentially the "cure-all" for the less than ideal environments:

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Again, this will be a simple read. Even with an artificially weak net income number (CBPX had a one-time Other Expense of $5.2MM due to the prepayment premium of $3.1MM for the repayment of the Second Lien Credit Agreement and the payment of termination fees to affiliates of Lone Star; and a one-time $6.9MM expense relating to the write-off of original issue discount and deferred financing fees associated with the early repayment of the Second Lien Credit Agreement) the company still had positive Operating Cash Flow and FCF of $10.97 million (I take the Net Cash from Investments number into my CAPEX number because additions to this section still matter even though they aren't considered CAPEX traditionally). CBPX uses its FCF historically to pay down debt and lowered debt decreases interest expense. Less interest expense, also lowered interest rates can be had by meeting specific leverage ratios found in the lenders' covenants, means less top-line needed to drive bottom line, and we all like the sound of that. The point is that CBPX can improve fundamentals in this environment and if COGS line items like energy come down (they have) CBPX can move fundamentals in a big way.

Before moving to our third scenario, a quick look at Debt which has been much improved over the last six months. This really is one of the most compelling reasons to get bullish this name long term:

SCENARIO 3: Above Historical Average Growth/High Growth (Expansion/Peak Environment):

Competitive Advantages Leveraged in Environment: All of the above. I have chosen not to model for this type of environment until a later date when real time economic developments indicate we are closer to this reality.

Explanation: It's in these types of environments that the fat cats get fat and store a little bit away for the lean times. In this particular environment, a company like CBPX, which generates FCF in size in the above environment, would be able to pay down significant portions of debt and fully leverage its state of the art facilities at scale. This would further create an economy of scale and even further drive margins. If CBPX can have one or two years of this type of environment prior to 2019, the company can put a huge dent into the need to refinance much of the current $383 million of principal payments due at the beginning of the 2019 - this will get refinanced regardless as CBPX cannot possibly meet that type of debt obligation at once but it would be nice to not have to carry over a larger balance of principal debt. What would CBPX do with its new found liquidity and lowered leverage profile? Prospect for M&A opportunities that are sure to be there during the next no growth/contracting growth environment. The best case scenario for CBPX and for the rest of the large players in this niche is that the business cycle follow normal cyclical patters for similar durations. Nothing would benefit CBPX more than two years of this environment followed by two years of environment 1. Think of the possibilities.

Valuation Analysis and Potential Upside

Ok, it's time for me to justify my limited downside and high ceiling upside modeling. I used three companies to perform comparable company analysis on CBPX. I believe that the two other companies used are of acceptable correlation and have provided an acceptable backdrop with which to base comparisons. I have also compiled up to date data as of recent Q2 (Q1/15 in the case of EXP) announcements that should be the most up to date public data from non-paid sources.

Operating Metrics:

First, I wanted to take a deep look at operating metrics:













(13.4)%, (3.8)%,1.2%













1 EXP's figure listed represents the final two quarters of its fiscal year - Q4/14 & Q1/15.

2 Figure is net of subtraction of $27MM one-time gain on the deconsolidation of subsidiaries and consolidated joint ventures. This gain is unusual and non-recurring. I have removed it for relevancy and correlation purposes.

3 Significant adjustments made to Net Income number include: subtraction (net addition) of one-time Other Expense of $5.2MM due to the prepayment premium of $3.1MM for the repayment of the Second Lien Credit Agreement and the payment of termination fees to affiliates of Lone Star; and subtraction (net addition) of one-time $6.9MM expense relating to the write-off of original issue discount and deferred financing fees associated with the early repayment of the Second Lien Credit Agreement. These expenses are non-recurring and unusual. I have removed them for relevancy and correlation purposes.

4 No adjustments have been made for one-time or non-recurring items. This may decrease the accuracy of this number in relevance and correlation to company norms.

I've listed the valuation here to make obvious the spread between the three companies. I've also listed total revenues to indicate the overall market share of the niche although CBPX is by far the most dependent on wallboard sales and the other producers both use wallboard as a supplemental driver - which may drive down correlation a bit, but of the public players, these were the two closest in correlation. That said, the most important information to be had from this table's research is the two columns furthest to the right.

First, profit margin - which is top-line that makes it all the way to the bottom line, distinguishes (even with the concessions made for CBPX) the significant effect that increases in COGS has on CBPX compared to peers. You can see a significant drop from 7.9% at FY13 to 4.2% during 1H/14. This 370 basis point drop reveals a major area for CBPX to get more efficient and I believe having Lone Star as new owner will help create this efficiency. Lone Star has its hands in many sectors across many expertises and I'm certain they are seeing what we are seeing. Energy and shipping costs cannot cause these types of swings going forward. Also, it is worth noting that the price of natural gas is down roughly 19% over the last 90 days and if this lower mean holds over the course of the next few months there could be a built in operating income surprise coming. Do these swings matter? Of course. Is this something the market is overly concerned about? As discussed in analysis of the income statement, I don't think it does at this stage of maturation. All told, the fact that CBPX is able to historically capture roughly half the profit margin of the niche leader EXP while even at current size and state able to drive 42% of total sales shows that the potential is there for CBPX. Everything is created from the top-line, and the top-line being 42% the size of EXP's while current CBPX valuation is 13% of EXP's is our first indication of a mispricing. More on this later.

One last note before moving on to the next section, the question could be asked as to why Lone Star, if able to create a more efficient CBPX, hasn't been able to consistently press margins higher and why hasn't the new ownership been able to make larger changes on the front-end? The question has two answers. The first is that Lone Star has created a more efficient machine, as evidenced by the growth in profit margin from FY12-FY13 - remember, Lone Star only had control over operations for 2H/13, and as should be evidenced during 2H/14, was able to move profit margins with the short amount of time that the company had to implement the changes it could see from a surface level analysis of the company. Lone Star hasn't had a time sample of control long enough to clearly illustrate what I'm saying will happen outside of what it was able to do for 2H/13 profit margin growth and what it will be able to do for 2H/14 profit margin growth. Lone Star, in my opinion, will get the shipping costs and the COGS increases caused by complete absence of natural gas hedging under control. It is my opinion this has already happened, now that Lone Star understands the size and scope of the problem, and will be reflected in Q3 numbers. Also, please keep in mind the size of the operations at CBPX. It will probably be another few quarters before Lone Star has the opportunity to really get a complete feel for the changes that need to be made and that can cost effectively be made in the immediate term. Just give Lone Star time and look for that COGS line and profit margin improvement in Q3.

Liquidity and Profitability Metrics:

Next, I wanted to make sure the Liquidity and Profitability comparisons checked out.


































1 EXP's figure listed represents the final two quarters of its fiscal year - Q4/14 & Q1/15.

2 Calculated by adding Depreciation & Amortization to Operating Income

3 EXP's figures reflect last three fiscal years

4 Figure presented for CBPX Full Year 2013 is Pro Forma with reductions to debt made to reflect use of $151.4MM of IPO proceeds and additions to debt of $13.5MM to reflect CBPX's use of its revolving credit facility.

5 FCF annualized by doubling FCF as of 1H/14. For EXP FCF was doubled from totals from Q4/14 & Q1/15

6 USG had negative FCF for 1H/14 in the amount of $38MM and negative annualized FCF of $76MM

7 Significant adjustments made to Net Income number include: subtraction (net addition) of one-time Other Expense of $5.2MM due to the prepayment premium of $3.1MM for the repayment of the Second Lien Credit Agreement and the payment of termination fees to affiliates of Lone Star; and subtraction (net addition) of one-time $6.9MM expense relating to the write-off of original issue discount and deferred financing fees associated with the early repayment of the Second Lien Credit Agreement. These expenses are non-recurring and unusual. I have removed them for relevancy and correlation purposes.

8 As of most recent quarter

Again, the similarities to EXP are amazing. 1H/14 EBITDA margins showed significant contraction of spread (CBPX's move was to the top-side while EXP's remained largely flat at healthy rates) between CBPX and EXP while illustrating a clear difference between industry leaders and an industry laggard; CBPX showed a much better performance when compared to USG from a historical EBITDA margin and average EBITDA margin standpoint - I would like to reiterate I am bullish EBITDA margin growth for CBPX including as early as Q3; CBPX showed a comparable long-term debt to FCF ratio - indicating the company can service its debt (and remember, this is improving by the quarter); and showed an impressive current ratio. All of these liquidity and profitability measures again underline that CBPX is an up and coming company that should be valued closer from a multiple standpoint to EXP than USG, even at its current maturation.

Technical Metrics:

Price is truth, right? What's a comprehensive analysis without the technicals.












$1.47B,$4.09B, $4.13B


















1 P/S uses last two quarters revenue rather than 12 month trailing sales for purposes of increased relevancy and correlation. The figure has been annualized by doubling the current pace of revenue from the last two quarters. This may decrease the accuracy of this P/S calculation.

2 Closing prices used were taken from the final close of the calendar year for USG and from the final close of the fiscal year ended March 31st for EXP. All final closing prices have been adjusted for splits and dividends.

3 At calendar or fiscal year end

I think this table is pretty self-explanatory and I lean heavily on it for my final valuation analysis so I'll just let the next section take us home.

Final Calculations:

I believe CBPX can continue to build intrinsic value each quarter as it, at the very least, reduces its leverage profile and continues to demonstrate the ability to generate FCF. I also believe that as capacity utilization rates continue to increase from the low sixty percent range closer to the historic mean of between eighty and eighty five percent that EBITDA margins will continue to increase and that the pricing power pendulum that has greatly swung to the side of the suppliers will move further in this side's favor. Without reiterating the total of the points made in the body of the article, all told I am very bullish CBPX and in general this niche of the basic materials industry as I think there are multiple tailwinds that will provide ample upside movement for publically traded equities, in this case CBPX stock.

Method: P/S Comp Company

In many of the Operating Metric and Liquidity and Profitability Metric comparisons provided in the tables above, CBPX has been able to halve the performance of the industry leader EXP or has been able to match performance directly.

To reiterate from most important to least important, CBPX has achieved a most recent full year profit margin of 7.9% to EXP's 13.8% - a figure that would have been much improved had natural gas not experienced historic price increases during the winter of 2013; CBPX has been able to produce 42% 1H/14 revenue when compared to EXP's production even at what I consider to be very early stages of efficiency and refined maturation - for clarity, CBPX is a mature operation from an infrastructure and client portfolio standpoint but I believe new ownership will make company altering strides in optimizing supply, transportation, hedging, and innovation that will greatly expand EBITDA margins and every other meaningful operations metric; CBPX has trend line visibility to meet and beat (read: demonstrate a lower value) a comparison multiple of long-term debt to FCF (annualized) when compared to EXP; and while not able to show the consistency of trend line growth that EXP has been able to show CBPX's 1H/14 EBITDA margin has shown a spread contraction from 970 basis points during FY13 (Fiscal Full Year 2014 for EXP) to 350 basis points - a spread I expect to continue to contract into year end and into the balance of 2015.

That said, with the niche leader in this sector commanding an "annualized current" P/S of 5.6X and a three year average P/S of 4.5X and a comparable company that is dealing with a laundry list of problems, USG, commanding a relative P/S to CBPX's I feel there is significant reason to believe CBPX is trading at a discount to its peers. I believe CBPX should and will soon trade at an "annualized current" P/S of 2.7-3.0X. This is a conservative modeling that could very easily stretch to the mid-three's if market beta, overall housing and remodel demand, or commercial construction demand accelerates. Using comp company methodology I am placing a fair value, using today's information, at between ~$1.023 billion - ~$1.136 billion. This would imply between 50-66% upside to today's share price or share price value of between $23.19-$25.66. Again, I could still make a compelling argument that the above valuation leaves the company under fair value based on the premium that I believe the high visibility of EBITDA margin expansion and the high visibility of a reduction in leverage profile deserve but in an attempt to avoid allegations of sensationalism I will leave this crude valuation in place. I myself would be very happy to see CBPX trade more closely to a multiple of 3X and believe it will.

Where's the trade?

If you made it thus far, I want to sincerely thank you for reading. That said, I truly believe CBPX is an excellent risk adjusted long position that offers a ton of upside potential. Specifically, the amount outlined above.

I also think if the markets want to get frothy that this entire niche could see a big multiple expansion that is impossible to model in at these points.

I have liked CBPX for the last almost three months and have nothing to show for it outside of a lot of wasted ink and some scratch calculations done on a notepad but I really think the stock is about to turn the corner on some real growth. I mean, it's up big for a basic materials company for those that were lucky enough to get IPO shares but I'm talking the kind of growth EXP saw from 2012-2013. These names, because of all the factors mentioned above, can really run the table if the markets and the company can both get hot. I think that's closer to reality than not for CBPX.

I like the fact that outside of end-of-the-world scenarios like late 2008/early 2009 that the market generally moves the major public players in this space higher on all durations, even USG. Take a look at a 5 year chart of USG and EXP, both are sitting at 45 degree angles to the right despite USG's struggles. The general market understands that the industry factors (consolidation, barrier to entry, etc.) make the few companies left in this niche of the basic materials sectors more and more valuable each year regardless of the temporary economic environment. Eventually, when the economic cycles flips to scenario two or to scenario three, the market understands drywall is necessary to build and it can only be purchased from so many companies. The market front runs this and prices this in. I would compare the steady, priced-in share price growth to the way that the general consumer prices market prices in inflation, but even inflation has years of flat growth whereas drywall, since the big boys took the power to price back from the market, doesn't. I think the biggest reasons why there is so much value not being priced into CBPX at this point is that the company is in fact young, it did just go public, we are currently in the middle of a bull market where much sexier choices of investments are available, many don't understand that Lafarge wasn't dumping CBPX but that Lafarge shareholders were demanding debt reductions, and that many just don't understand how attractive a space this really is. Basic materials, when done right, has overwhelming core-potential possibility because of the uniqueness of the business models that exist in the greater space. I think CBPX is that next big basic materials company and I only think its relevance in the general space will grow.

I am long the stock and am reiterating my buy recommendation for anybody needing a basic materials company or a steady return provider.

I look forward to providing continuing coverage in the future. Good luck to all.

Source: Continental Building Products: A Multi-Year Bull Run Story
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