I had first heard of Valassis in 1993 when I worked at Procter & Gamble in the consumer research division. Valassis used to provide newspaper inserts with coupons and advertisements, ideal for brand advertising. At that time, it was "just another company" to me and I had not studied Valassis business fundamentals.
Earlier this year, I heard the news that Valassis was to buy Advo (AD). Valassis' stock price had fallen from $30.00 in May 2006 towards $13.00 in January. I had realized by then that Valassis was a strong contender in the newspaper insert industry and I had also seen Advo inserts in the mail. On studying their Annual Reports in detail, I realized that Advo would certainly complement Valassis Revenue, by adding a whole new revenue stream from the direct mail segment. In addition, Valassis operating cash flow of $116.189M looked attractive compared to its Market Capitalization of $636.77M, a multiple of about 6X. Its Return on Total Capital was 33.3%, 25.1% 28.9% in 2003, 2004 and 2005 respectively, but its profit margin was only 8.8% in 2005.
Okay, so this was not a totally incredibly fabulous business although its Return on Total Capital looked good. I took a step back and paused, wondering whether to buy Valassis. Then a Grahamian (I am a fan of Benjamin Graham, the father of Value Investing) thought occurred to me. Could this price of $13.00 be significantly below its intrinsic value?
Using a rough estimate with earnings and operating cash flow, I concluded that Valassis was undervalued at $13.00 per share. If Earnings were indeed 1.99 per share in 2005 and operating cash flow came to about $116M, I was essentially buying Valassis shares at a multiple of about 6X. Valassis Debt: Shareholder Equity in 2005 was $256M:$103M, which didn’t look too daunting. I bought shares at $13.30 and waited for a few months.
To my delight, the market had realized the value of Valassis and within 4 months the stock price has climbed beyond $19.00, providing me with an unrealized gain of 40%. I expect Valassis to climb even further beyond $19.00. Even a conservative multiple of 8X (19/2.00) using just Valassis 2005 earnings as a conservative proxy is too conservative for Valassis after it has Advo providing revenue and earnings growth in its portfolio for the future.
This was another example of how shares get beaten down in times of uncertainty, only to recover in due course.
Disclosure: Author is long VCI
VCI 1-yr chart