Electronics For Imaging: Positioned Correctly For The Digital Printing Revolution

| About: Electronics for (EFII)
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Electronics for Imaging (NASDAQ:EFII) is a company primed for growth as the landscape for industrial and ceramic printing shifts. For years, printing was done through analog devices that used different presses for customization. That industry is changing to adopt a digital printing mechanism that does not use presses but digital customization features. The problem for years has been the detail of digital printing and its lack of performance in comparison to analog. EFII, though, is a premium product in this industry, and we believe its combination of value and growth are attractive. We see three main catalysts driving growth moving forward: the revolution of ceramic printing, the company's ability to supply a changing paradigm in advertising, as well as the company's LED cooling systems. These two initiatives are the key to the company.

Image courtesy of Smithers Pira

Most analysts like to focus in on the digital printing world for its ability to appeal to signage and advertisers. One interesting area that EFII is attacking is the ceramic tile industry. Last year, the company acquired a company called CretaPrint. CreatPrint was attractive because it was a digital ceramic printing company. The company's EFI CretaPrint C3 is the combination of technology and software from EFI with the ceramic printing of CreatPrint. The combination of the two has created an amazing product that can print ceramic tiles using a digital printing system. The company combines the tile printing with their Fiery software, which is the backbone of the company.

What is the opportunity here?

EFII has noted that only 25% of the ceramic tile business is currently printing digitally. At the same time, the tile industry is moving right now out of the Western world and into emerging markets like China, Mexico, Brazil, and Turkey. What that means is that there is first a transformation of the industry to digital while at the same time a lot of cyclical growth in new printers being purchased as this transition occurs. EFII sits right at the middle of that industry as one of the leaders in ceramic tile printing.

The potential is large. EFII believes that the industry can double in the next ten years for digital printing on ceramic tiles, and the industry is moving that direction. Dr. Ray Work of Work Associates, a digital printing consulting firm, noted that a strong shift from analog to digital in the industry is happening and the ceramic tile manufacturers can see their investment in a digital printer paid back in six months. Further, once they are working with EFII, the company can get access to the newest software and updates that will continue to improve their productivity.

The biggest benefit for ceramic tile, and why we believe that it will be a huge success for EFII is that with digital printing the ease of changing designs is a major benefit. Not only are the amount of design potentials infinite, but it takes a day to changeover on analog devices. The changeover from a digital printer can take minutes. The potential is huge here, and EFII is one of the only ways to gain exposure to this industry directly. Further, the barriers to entry are sizeable. The technology is unique as well as EFII bought a company with over 1700 clients already in CretaPrint.

The inkjet industry as a whole is a rapidly growing industry. In 2011, it was just over $33B in size. By 2017, it is expected to be over $67B according to Smithers Pira. One of the main reasons for this is mostly signage. The key to EFII is definitely signage, but we want to focus less on that growth since it's a widely understood area. Signage is over 50% (and the majority of EFII's current business) of the inkjet industry because of the ease of digital printers ability to change what it is printing as well as the cost of doing so is cheaper. It would not make as much sense for newspapers because of the sheer size of the project as well as less need to change printing each day.

What we want to focus on rather than the potential for signage and consumer-based marketing is the shift in advertising overall to showcase the potential for this industry. One of the reasons we are overly bullish on this side of the business is because the way advertisers and consumer companies can get to potential customers has changed. Electronics believes this side of the business can double in the next 3.5 years because old methods do not work as well. In the past, the easiest way to get to a consumer was through the TV. Commercials were highly effective at getting companies' brand and products to consumers. The changing shift of television with less commercial watching and less attention to commercials is a growing concern for companies.

For one, people are watching less TV per week. Just look at this chart below:

More people are switching to the Internet for news and entertainment as well as using digital devices more as well. 43M Americans are using on-demand services and that number has grown by 60% in the past year. Devices are constantly being made to make this easier, such as MyChoice, which will automatically flip a channel for a customer when a commercial comes onto the screen. Therefore, how can advertisers get in front of their audience more - signage. Marketers are a huge market for EFII and their inkjet revolution.

The suite of products offered by Electronics is unique as well, and they have built their software as an upgrade into a lot of other inkjet printers outside of the ones that are exclusively EFII's. The company compares their business of software (Fiery) to that of upgrading a car with a new sound system:

When you buy a Lexus you can get the built-in Toyota stereo system or you get the Bose system, it's not that they're Toyota or Bose to get one or the other, it's if you want the superior capability and it's like with Fiery like when you get the better sound but you also get better gas mileage because the Fiery actually drives more productivity out of the printing equipment because the process of the file is faster, get them into production quicker so you can get more clicks out of the actual equipment.

We believe that the revolution of technology in TV and internet is going to provide a great outlet for continued demand and growth in the largest component of EFII's business moving forward.

Lastly, we see a significant catalyst for EFII in their LED cooling software, which is a very unique offering. Since digital printing from EFII is about productivity, automation, and developing offerings that allow industrial printers and other printing companies to grow margins, one offering differentiates the company even further - cool cure technology.

The cool cure technology is a green printing solution that focuses in on power consumption and less hardware. The company has focused on developing an environmentally-friendly cooling technology as well as UV ink products that both appeal to consumers, and the company believes theses are places of growth for their business. The company's environmentally friendly ink has no volatile organic compounds, 50% natural monomers, are not considered hazardous waste, and contain organic substances that can be recycled.

We believe offering products like this that are not available on other competitors' models is a big win for the company and is one way they are differentiating themselves.

Moving forward, we are expecting continued growth that is very strong for the company around 10-15% per year in revenue through 2017. The company is well-positioned in the two prime areas of growth for the industry. Further, as the industry grows, the company's ink volumes will continue to expand that will drive home continued sales with a high margin. In the company's latest quarter, they saw inkjet volume up 26% year/year while their industrial inkjet revenue was only up 10%. The company is selling a lot of ink, which just goes to show you that the company's buying these products are producing at high levels and enjoying using their products.

Let's put all this information into a DCF analysis format to see just how much shares should be worth.

DCF Analysis

Operating income: We expect operating income to outpace revenue slightly as the company expands margins with software subscriptions on the rise as well as ink volumes. A conservative model would be to estimate CAGR of operating income around 12-14%. Those levels will actually likely push even higher into 2015-2017 as the industry is starting a strong cyclical growth with the macro global economy starting to show more green shoots. We can expect operating income, therefore, to be at the low-end around $60M by 2017.

Depreciation: This number should rise as the company does expect to continue to acquire more companies over the next several years. We would anticipate a similar rate of growth to revenue. We would expect depreciation around $45M by 2017.

Capital Expenditures: This number should jump up each year as we expect more acquisitions to occur over the next several years as well as the company has already shown an interest in share buybacks ($100M plan already launched and will take several more quarters to complete).

We will be using a cap rate of 5%, which is also a conservative level to discount the company.

When we use these figures in our DCF analysis, we come up with a price target of $41 for the next twelve months. That level is very conservative and uses a CAGR that is likely underestimating growth. Further, if the company can show consistent growth of 10-15% per year, we can expect the company to attract a more premium valuation than its current 17.3 P/E and 1.7 PEG ratio.


Moving forward from here, we are a big fan of Electronics for Imaging. We believe they are very well positioned to take advantage of a strong growth market, and that the company is set to produce very positive returns for investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no business relationship with any company whose stock is mentioned in this article. The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.