Case Deluxe Corporation

BA 280.2
Group 8: Quimpo, Villar, Yam
R. Ybanez
2 July 2015
Deluxes Restructuring
By all accounts, the restructuring can be considered a success as the company
posted growth in 2001 despite the shrinking market, and has outperformed
expectations on the firm. Additionally, share price is at an all-time high with market
share price vastly exceeding the book value. Despite skepticism on the firm and
industry in general, Deluxe has shown it can still continue to extract value and
generate revenues on the basis of its market leadership in the industry. On the topic
of their operating and investment strategies moving forward, one major thing that
stands out is their optimistic view of the market showing constant increases in sales
over the next 5 years. Their capital expenditures are also only enough to offset the
depreciation expense, which means the company is not looking to grow the
business beyond its current size. All of this is in congruence with the companys
statement that they only want to extract as much value as they can from the
industry before moving on, recognizing that the business will eventually be phased
out.
Sensitivity Analysis
Assumptions:
For the company to fall under a given rating, the most rather than all the
indices have to be satisfied since achieving all index targets are infeasible
with the current projections (Year 2002).
Short Term Debt ($151.40) and Existing Long Term Debt ($10.10) are fixed;
any additional financing is done through long term debt and existing retained
earnings.
Operating Income / Sales is a fixed amount.
Ratings for BB and B are immaterial due being considered non-investment
grade.
The following table below shows the maximum amount of long term debt that can
be borrowed in order to maintain the targeted rating (in US$ millions).
Rating

Addtl
Debt

AAA

150.00

AA

395.00

805.00

BBB

1,495.00

LT
$
$
$
$

The constraint that was most difficult to satisfy for the company was Total Debt /
Capital mainly driven by low equity book value (US$64 million); this was
because equity was fixed at a certain amount while long term debt was being
added. However, since the goal was to get a modal consensus of the rating rather
than to satisfy the rating requirements for every index, the binding constraint using
this assumption was EBITDA Interest Coverage; this was again due to the decision
to only acquire long term debt, hence the growth of the denominator in the ratio
was relatively high with increased financing.
Debt : Equity Ratio and WACC
At the maximum debt level under each rating, the computed Debt-to-Equity Ratios
(at equity book value) are as follows:
Rating
AAA
AA
A
BBB

D:E
Ratio
249%
631%
1270%
2344%

The high ratios are attributable due to the fact that the market / book ratio of the
stocks are 33.91x.
In computing for the WACC and assuming increments of 100 for the debt. The
lowest Cost of Capital was found at the debt rating of $1,400 with a WACC of 7.70%.
This is primarily driven by the much higher cost of equity compared to the cost of
debt, the company would therefore benefit from having a higher debt ratio
assuming they can utilize their additional capital. The table below shows
computations for the WACC.

Recommendations:

*WACC (blue) graph shows the cost of capital as borrowing is increased; WACC2
(yellow) graph shows the cost of capital when share repurchases are done with the
additional borrowing.
In order to achieve the lowest cost of capital, the group recommends that Deluxe
target a BBB rating by borrowing $1.4 billion in long term debt. At this rating, its
important to note that the firm will still be classified as investment grade. Borrowing
$1,400 to achieve the lowest cost of capital will give the firm a $95 million flexibility
level before they drop to the next rating. The debt to equity ratio at that level is
2196%, as stated earlier however, the high ratio is primarily due to the book value
of equity being highly undervalued; adjusted to market value, and the debt to
equity ratio is a much more manageable 65%.
The group questions how Deluxe could create value for shareholders given issuance
of US$1.4million debt. Ideally Deluxe should grow the business through capital
expenditures and higher sales projections. However, due to the current outlook of
the company, additional financing will more likely be used to: (1) pay dividends or
(2) further repurchase shares.
Under a dividend payout plan, the cost of capital will remain at 7.70% and equity
value can increase. Under the share repurchase plan, cost of capital will further
decrease to 6.50% driven by fewer outstanding stocks. The group recommends
share repurchase as this will increase stockholder value further and decrease cost of
debt without sacrificing the companys investment grade.

Appendix:
Required Debt Levels for Given Bond Rating