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• Printing and publishing, of which commercial printing is the largest segment, ranks fifth among all manufacturing employers with 1.558 million employees.
  

• Printing and publishing has been and continues as fertile ground for entrepreneurship with 1,478 new companies, employing 10,856 persons, founded in 1999.
  

• Commercial printing is a major purchaser of capital equipment, with $3 billion in capital equipment expenditures.

• Commercial printing will purchase more than $18 billion in paper this year.
  

Commercial printing's profit leaders generate an average return on sales of 10.04% and an average return on equity of 24.75%. Our own analysis of the public printers with commercial printing operations indicates that they have generated sales growth since 1997 of 39.3%, are currently averaging EBITDA margins (return on sales) of 13.23%, and EBITDA growth since 1997 of 30.5%. Our analysis of the private commercial printers that we have represented over the past four years indicates even better results: sales growth since 1997 of 49.6%, with current average EBITDA margins of 14.51% and EBITDA growth since 1997 of 75.6%.

Private commercial printing company managers are developing a more balanced and professional approach to management. This management improvement portends even better performance as managers who formerly had a "printing craft" or operations orientation develop a marketing orientation that is accompanied by a much more advanced financial focus. Ten years ago the average private commercial printing company CEO could neither define nor understand EBITDA or EVA (Economic Value Added). Now they can.

The Commercial Printing Industry is Profitable
Commercial printing is price competitive – all fragmented industries tend to be. Its private companies, however, tend to have gross margins in the 25% to 30%+ range and EBITDA margins in the 15%+ range. Consolidated Graphics owns sixty-three commercial printing plants and regularly reports EBITDA margins of 15+% and gross margins of 30%. Although CGX has missed its earnings consensus three times, it has been by less than 10% of the Street's expectation and it continues to report good earnings and a healthy balance sheet. Its stock price is more a manifestation of the pain inflicted by Wall Street nowadays when any company fails to meet earnings expectations than of the condition of the commercial printing industry.

Printing Industries of America (PIA) reported that, for 1999, the industry's profit leaders averaged pre-tax income of 10.04% of sales. That percentage was up from 1996's 9.06%, 1997's 9.41%, and 1998's 9.80%. The PIA also reported that operating income as a percentage of gross assets for these profit leaders was 15.28% in 1999, up from 1996's 12.96%, 1997's 14.53%, and 1998's 14.55%.
Furthermore, commercial printers have been able to increase prices at a greater rate than their costs. For example, between 1988 and 1998, printing industry prices rose at an average rate of 3.7%, while costs rose 1.9%. The corresponding growth rates for 1998 - 2008 are projected to be 3.0% for prices and 2.4% for costs.

The Commercial Printing Industry is Growing
Commercial printing is growing. Shipments grew 16.59% between 1996 and 1999, while employment grew 17.84% during the same period. The PIA's annual market survey reports that first quarter 2000 sales growth was 7.3%, up from 1999's 6.6%. Other sources project commercial printing's growth from 1999 to 2000 to be 5.0% , and 5.2% to 5.7% .

Contrast this predicted growth with the growth of the Gross Domestic Product (GDP). Both The Survey of Professional Forecasters and The Livingston Survey, released on May 22, 2000 and June 16, 2000, respectively, by The Federal Reserve Bank of Philadelphia forecasted average annual real GDP growth for 2000 to be 4.9% over 1999.

America's for profit and not-for-profit sectors have not abandoned printing as a means of reaching their customers or constituents. Print buyers we have queried are projecting growing print budgets at 10% - 15% annually. They see no other existing media as a substitute for their printing materials. It appears that rather than "killing" printing, the Internet companies have become commercial printing's newest customers. Internet advertisers are buying printing to drive visitors to their web sites.

Commercial Printing is Technologically Advanced
The commercial printing segment is undergoing a revolutionary technology change to digital throughput. This began in the early eighties with Desktop publishing and it now embraces all departments in the manufacturing process. It is far from a smokestack industry and is, in fact, one of the most digitally efficient of all industries.

The commercial printing process at the leading commercial printers is a highly digitized process that includes:

• Electronic transfer of text and images from client to printer
  

• Electronic manipulation of text and images in preparation for printing

• Electronic transfer of text and images to film
  

• Electronic transfer of film to plate
  

• Electronic control of the printing press
  

• Electronic control of folding and binding equipment
  

• On-line billing
  

• On-line status control
  

Equipment and software suppliers are promising new productivity breakthroughs that will lead to even greater speed, productivity and profitability.

The leading printers recognize the importance of electronics in their business. The larger commercial printers are either developing or buying digital capabilities. We track printing industry acquisitions in The Compass Report. We note that, in 1998 and 1999, eleven acquisitions announced by printing companies were software companies. Three of Bowne & Co.'s five announced acquisitions in 1998 were software companies.

The "Demise Reporters" are Focusing Only on Certain Public Printers
We believe that only Wall Street analysts and disappointed investors are reporting the demise of the printing industry. These "demise reporters" have said that:

"Commercial printing is dying. It is a mature business that is being killed by either the Internet or digital printing." One analyst has been quoted as saying, "Commercial printing will be dead in four years."

"Commercial printing is a no-growth business. It is growing slower than the GDP."

"Commercial printing is intensely price competitive and its companies experience poor margins."

Our analysis, set forth above, is that none of the statements quoted above are true. Then why are we hearing such negativism about the industry?

We believe that Wall Street's perception that commercial printing has a "black eye" has resulted entirely from the misadventures of a handful of public companies – the so-called consolidators. One company, Master Graphics, (MASR – NASDAQ de-listed) is in Chapter 11 bankruptcy. It acquired some twenty commercial printing companies between 1997 and 1999 before its losses led to loan defaults and forced lenders to seek relief. From the outset, the leadership of this company was consumed with building critical mass at any price and then failed to manage what had been acquired.

The two most active consolidators, Consolidated Graphics and Mail-Well, have been punished severely for missing earnings expectations and, consequently, carry price to earning (P/E) ratios well below those carried by other public printers, such as Wallace and Quebecor, which are perceived by Wall Street as operators, not as consolidators. Whereas at the end of October 2000 CGX was trading at a P/E of 4.39 and MWL at 4.24, Quebecor carried a P/E multiple of 27.79 and Wallace a P/E multiple of 27.61.

Compass believes that some consolidators' troubles have been caused not by fundamental problems in the industry but by issues connected with integrating acquired businesses. These are management issues, however, and similar to those in any consolidation play where large public company cultures are attempting to assimilate small privately held entrepreneurial cultures. There is almost always a performance lapse among the acquired companies while managers learn that public markets are now measuring them. This change in management philosophy never takes among some independent thinkers who now have fat bank accounts from the sale of their companies. In these cases, defections occur and even more time is required to bring the target company up to the buyer's expectation for performance.

Commercial Printing Has Entered Phase II
If undisciplined "acquisitions for growth's sake" consolidation activity was Phase I, Consolidated Graphics, Mail-Well and Quebecor World have all taken direct action to move their corporate development activity into what we are calling "Phase II – Integration and Profitization." One new entrant into the printing industry, Kelmscott Communications, a San Francisco–based private company backed by J. P. Morgan, First Union and Duff Ackerman, is well into this "Phase II" and has embarked on its acquisition programs armed with well-defined integration plans. Kelmscott's pursuit of growth, guided and financed as it is by steely-eyed investors, speaks volumes about the future performance and the desirability of the commercial printing segment.

In reaction to Wall Street's rejection of their earlier business model, CGX and MWL have responded with well-defined programs to improve internal growth. These endeavors are rooted in cross-selling to existing accounts, targeted national account development, aggressive sales management and strategic print job deployment for improved plant utilization. These companies are moving from acquisition driven roll-up cultures to customer driven marketing cultures. While we believe they will resume buying companies during the next 12-18 months, we also believe that as the sales initiatives are activated at the plant level they will yield double digit internal growth. The new internal growth coupled with renewed external growth should result in sales and earnings growth north of 25%. As they move into Phase II and 25% growth, their P/E multiples should move more toward 8.8 to 16.1.

As we see P/E multiples and stock prices improve, we will also see a restoration of buying activity – this time with a more selective and disciplined approach.

Is There a Phase III?
We believe that "Phase III - The Profit Growth Era", will begin by 2003. Equilibrium between printers and their customers will be achieved and the public companies will enjoy gross margins ranging from 35% to 40% and EBITDA margins approaching 20%. During this phase up to eight consolidators will aggressively, but selectively, pursue strategic targets at multiples that will probably be significantly lower than the prices paid during 1997 – 1998.

Compass Capital Partners, Ltd. is the leading investment banker for the printing industry. They are located in Radnor, Pennsylvania and headed by Harris M. DeWese, chairman and Gabriel Nagy, president. Mr. Nagy can be reached at NagyG@ComCapLtd.com Compass Capital Partners represents only sellers and buyers of printing companies. Since 1996, Compass Capital has completed 55 transactions involving printing revenues exceeding $1.7 billion.

Compass Capital Partners, Ltd.
259 N. Radnor-Chester Road
Radnor, PA 19087
(610) 293-0210

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