Commentary & Analysis
FREE: Creo Takes the Next Step to $1 Billion: Creo Plates On the Way
By Gail Kailing with analysis from John Zarwan&
By WhatTheyThink Staff
Published: September 16, 2003
By Gail Kailing with analysis from John Zarwan September 16, 2003 -- Creo Inc. (NASDAQ: CREO; TSX: CRE) announced its intent to acquire a plate production facility in South Africa from First Graphics (Pty) Limited, for approximately US$11.25 million. As a key part of Creo's strategy to reach revenues of $1 billion by 2007, this acquisition expands Creo's current and future product suite and increases the competitiveness of its offerings. The plates will be shown at Graph Expo. During last May's quarterly call, Creo executives hinted at “low cost plate manufacturers coming to market with low cost thermal plates with superior performance and that will help Creo.” Today's announcement clarified that hint. Implications This initiative in effect doubles the size of Creo's market for consumables, prepress software, equipment and support. Printers spend an estimated $3 billion on printing plates and when you add the rest of Creo's addressable market of about $3 billion this results in a doubling to $6 billion. The digital plate market is expected to grow from about 147 million square meters this year to about 280 million square meters in 2007: a 17% CAGR. This is the fastest growing segment in the consumable market. Creo believes that a secure supply of competitive plates will increase the portion of sales that are sold as bundled solutions, especially to smaller printers. The Creo CTP plate is a high performance thermal plate, suitable for most commercial printing applications. And because Creo has the largest share of CTP installs and Creo's customers represent the largest market for digital plates, this strategy has great potential for long-term recurring revenue. Financial aspects Creo expects to see good operating leverage in consumables revenue because the systems are in place now to support the new business. There will be a small increase in inventory as the supply chain is built up, causing a small balance sheet impact. The company is likely to see some incremental 2004 capital investment relative to the plate manufacturing but overall capital expenditure spend will not show a big change from last year. In the long term, there will be some capital expenditures if, and when, Creo decides to ramp up capacity further. Creo has also learned from previous acquisitions and already has an implementation team at the plant that will relocate to South Africa to oversee the transition. The current general manager of the First Graphics plant has agreed to join Creo and will continue to manage the operation. Creo will take on about 150 full time and temporary employees when the transaction closes, but doesn't expect to build up a lot of staff or incur additional operational expense. The aggregate investment - $11.25 million cash – not a big acquisition for Creo and can be paid out of cash reserves. The company expects the investment to be accretive to earnings within two quarters with no significant downside in the short term. Facts from the conference call with analysts and WTT's call with Creo yesterday afternoon. • Though South Africa is not exactly central to distribution it was a perfect opportunity to acquire a new facility with dedicated labor that understands how to manufacture Creo plates. Creo has had a relationship with First Graphics for quite a while; they are the exclusive distributor of Creo products in South Africa and Creo is familiar with their operation and pleased with their performance. The cost of moving plates around the world can be offset by lower manufacturing costs. • Currently consumables make up about 10% of Creo's revenue and as part of the company's drive to $1 billion in 2007, they expect that to double over the next few years. The concept of “No Pre- and Post-Bake” resulting from the Creo emulsion is very significant in delivering a solution to smaller printers because they don't have the real estate or the money to invest in ovens. • The competition will be the same companies providing thermal plates that the company has today, however Creo believes that the new plates are outstanding and will be competitive. • The long-term production plan is to use a combination of Creo's own manufacturing capacity plus contracted manufacturing. There are some manufacturers world wide who are willing to manufacture very inexpensively for Creo, and in other areas Creo will have to do the manufacturing. Expect to see both. • There shouldn't be much impact on margins. The consumables business has margins that fall somewhat between the company's equipment and service business. As the business grows, gross margins will stay in that range. There will be improvements on equipment margins because Creo won't be subject to the same heavy discounting pressure that comes from not having a bundle. The consumables margin will provide great operating leverage. • Creo believes that they now have everything they need in support of their “trusted advisor” strategy for the offset printing industry. In gravure and flexo and other areas of digital printing, they still have a lot to do. Creo's primary involvement in digital printing is providing controllers to digital graphic engines. Don't expect to see any change in that strategy in the short to mid term. • This arrangement is very different from the existing bundling arrangements with third parties. Today Creo doesn't take the revenue of the plates into their income statement; they just take the mark-up from it. The transfer price Creo gets from its partners is high comparable to its own cost of manufacturing, so there will be a big economic impact on operations in the future, although that impact isn't expected to show until early next year. Don't expect to see an impact until after Q1 04, it will grow from there. • Creo says KPG is number one in marketshare, then Fuji and third Agfa. • Now that Creo has its own plates, what makes Creo any different than Agfa or Fuji? Creo says they are “not burdened with a declining legacy consumables business (film and conventional plates). We are very focused on the full digital implementation with a very coherent product portfolio (all thermal, high resolution, common technology over entire installed base). We have a proven ability to deliver leading edge workflow. Our equipment is better. We have an unmatched range of proofing systems.” • Why will does this announcement encourage the industry to move to thermal plates? Creo says “Creo entering the plate market will make it a more competitive market, especially for smaller printers. Other vendors won't be able to foist that visible stuff on the small printers, so even Agfa and Fuji will sell more thermal to smaller printers. Creo will sell more, therefore more thermal.” What does this mean for the industry? - Commentary by John Zarwan Creo’s announcement continues their strategic goal of increasing their consumables business and gives them another weapon to compete, particularly with Agfa and Fuji but also with Screen and Heidelberg. Creo has decided that CTP systems and plates are one business, and that they cannot be in the equipment business alone. Although the initial reaction to the announcement is positive, with little apparent downside for Creo or its customers, the move will surely have consequences that may cause problems. Issues for Creo Creo believes that they have been at a competitive disadvantage by not being able to “bundle” plates with CTP systems and workflow. Their alliance with Lastra (Western) and Spectratech was an attempt to address this. With their own facility and label, Creo will now be able to compete with a more “level” playing field. However, getting involved in the plate business has a number of implications for Creo: 1. Logistics and ordering. Although Creo has clearly planned for this and done its homework, delivering plates to thousands of customers around the world will be quite different from meeting the needs of the 150 hand-picked beta-test sites. Creo will, of course, pick up the burden of inventory and receivables, which are now handled by dealers. Another potentially large problem is order size. Creo may find the economics of taking orders for and delivering plates and chemistry in one or two carton lots to be more difficult than anticipated. 2. Quality control. The Creo plate will, no doubt, be a good plate. Creo would not risk their reputation otherwise. But it will be manufactured under contract by a variety of suppliers. Creo will have to insure that their PTP plates are consistent and reliable. Purchasing a manufacturing facility will aid them in their efforts, as will instituting statistical process control. Creo will have to devote significant resources to monitor and inspect their suppliers regularly. The plates will most likely not be completely interchangeable. Major plate manufacturers have experienced problems from time to time in insuring consistency from plant to plant. This will be an even bigger potential issue for a contract manufacture. Customers will have to be careful that the plates they receive are manufactured in the same plant. 3. Market strategy. Creo has been very aggressive with plate pricing in their “bundle” deals. One can expect that their own plates will, at the very least, not cost any more than those of their current “partners”. Creo will likely target smaller printers and geographical areas where they have relatively lower market share with their new plate offering. As a bundling strategy becomes more important to Creo’s success, however, they begin to look more like Agfa and Fuji. Creo currently competes based on perceived differences in product and workflow. As a plate supplier, though, the element of choice of a plate with Creo – and other – systems becomes more theoretical and less practical. Implications for Competitors All major Creo competitors offer their own plates or have a close alliance with a plate manufacturer. Creo has historically supported and qualified plates from any manufacturer that meets their specifications. Plate manufacturers are, at the end of the day, mostly indifferent regarding what equipment images their plate. Most are in the equipment business only to sell plates. Creo will be less likely to invite and welcome third-party plate suppliers into a sale, and visa versa. One can expect Creo’s competitors to do whatever is necessary to counter-act Creo’s new strategy. If Creo continues to use low plate prices to sell equipment, the major suppliers can, if they choose to, meet that threat head-on. If Creo uses a more traditional tactic of using plate prices to subsidize equipment sales (There’s a reason Gillette doesn’t sell $100 razors.), then things don’t change much. Implications for Customers Switching costs for changing plates are high, so we don’t expect many existing customers to change their current plate supplier unless the price differential is compelling or they are already dissatisfied and contemplating changing plates. As Creo will be supply limited, at least initially, and the primary targets are new equipment customers, this should not be a problem. The situation for prospective customers, the ones Creo hopes to reach, is somewhat different. One of the key advantages Creo had was their independence from any particular plate supplier, even when they were closely allied with KPG. Even today, Creo states that only about 20% of their orders are bundled with plates. The industry may look at Creo differently now that they have total package. Creo, of course, expects market reaction to be positive. If Creo’s strategy is to keep plate prices low, prospective customers will benefit as the overall price level falls. On the other hand, Creo may push their plate bundle; or, in an effort to be profitable, pricing may not be as aggressive as anticipated. In that case, customer choice will decrease. Reach at firstname.lastname@example.org and contact John at email@example.com.