Saturday, 12 May 2012

ARC Document Services - Investment Analysis

Business Description

ARC Document Services' (ARC) primary business is providing document management services, document distribution and logistics, and print services to the architectural, engineering and construction industries. The company provides "blueprints," the drawings that are the universal "language" used in all aspects of the construction process, used by developers, architects, contractors, sub-contractors, suppliers etc. (up to 200 different types of trades are involved from start to finish on a large construction project, and many use these drawings).

Documents change constantly as a project progresses, and the changes must be tracked accurately, quickly and confidentially. The documents are generally larger than 11" by 17" and require specialized printing and finishing, and a deep understanding of construction work flows. Indeed, thousands of documents may be printed over the course of a single large project, a major feat of logistics and organization. ARC also houses company-owned equipment in customers' offices as part of their Facilities Management services, and in some cases customers outsource their entire printing and document management operation to ARC. In addition, ARC offers document management and printing services outside the construction industry, including to the retail, aerospace, entertainment, and health-care industries, mostly in the areas of advertising and promotion.

Competitive Position

ARC spent the last decade consolidating the industry and has established a dominant market position in a fragmented industry. Indeed, ARC has over 200 locations, eight times as many as their nearest rival. Most of ARC's stores are in the U.S., where they operate over 200 cities in 43 states. In addition, they have a presence in Canada, U.K., India and China.

Most competitors are privately owned, "mom-and-pop" shops that operate one or two locations, and generate less than $7 million in revenue per store. The prolonged economic slump, which has hit the commercial construction market particularly hard, has decimated many weaker players. Whereas in the past ARC trumped the competition by buying it, in recent years it has gained share as rivals have folded. The company may pay several thousand dollars to buy a customer list from a defunct competitor, rather than committing hundreds of thousands, or millions, of dollars to buy the entire business. Besides small, strategic "tuck-in" purchases, the company doesn't expect to make significant acquisitions in the future.

Scale gives them several competitive advantages: 1) A large geographical footprint that enables ARC to take on regional, national and global contracts that smaller competitors cannot; 2) As the industry moves to offer more digital services, ARC can spread research and development spending across many locations, but most competitors cannot (ARC has spent over $100 million in the past decade on technology innovation); 3) Economies of scale make ARC one of the lowest cost producers in the industry; 4) A large installed base of the company's equipment in customer offices ensures repeat business - "stickiness" - and studies show that such customers tend to use more services than they otherwise would.


The company enjoys high margins and a variable cost business model (55% of costs are variable), allowing it to produce significant free cash flows, even in a weak economy. In addition, maintenance capital expenditure requirements are modest, averaging about 1.6% of sales, or $7-10 million per year. Though ARC will invest a small amount of added capital to grow, overall capital expenditures should not exceed $15 million annually. The company believes it can double sales from the existing footprint - by adding a second and third shift - and doesn't expect to pursue a significant acquisition program in the future. This means that happy shareholders are likely to benefit from dividends and share buybacks in the future, though not until the company has further paid down debt.

                      2011 2010 2009 2008 2007 2006 2005 2004

Sales             423   442    502  701    688    592   494   444

EBITDA*       67     75      107   173    177    148   110   91

EBITDA Margin* 15.8% 16.9% 21.2% 24.7% 25.7% 25.0% 22.2% 20.5%

FCF** 34 45 90 118 93 91 60 55

*adjusted for unusual items

**defined here as operating cash flows, less capex


CEO "Suri" Suriyakumar has been with the company since 1989. He was President and COO from 1991 until 2001, when he became the CEO. The leadership team is experienced, having navigated through several business cycles and a range of economic, financial and political challenges. In addition, management owns 19% of the company, and are paid only modestly on an annual basis, aligning their incentives with shareholders'. The CEO is honest, energetic and capable. He has assessed the current tough market soberly, resized the business accordingly and has never pretended that a robust recovery was upon us. It must be admitted, though, that the company amassed too much leverage in the pursuit of acquisitions in the past.


The company can realistically hope to generate as much free cash flow at the top of the next cycle as it did at the top of the last one. After all, the US economy will likely have expanded by 15-20% overall, the company has taken significant market share from competitors, and it has expanded into adjacent, high-margin markets. Furthermore, at the top of the last cycle, the company had a very substantial debt load, with large related interest payments (around $25 million per year). However, within the next few years the company will likely pay down most or all of its debt, so interest payments will be negligible in a few years.

Assuming FCF peaks at around $120 million, and a multiple of 12x, the company's market value would stand at $1320/45 million shares = $32. Moreover, once debt is paid down, the company's FCF will be available for tuck-in acquisitions, dividends and buybacks, adding further value for shareholders. From today's $5-6 share price, the investment is a screaming, table-pounding buy.


ARC's markets typically lag behind the general economy by 12-18 months. Since this recovery is slower than most, it is possible that the company won't see a return to significant growth until 2013 or 2014. In the meantime, however, ARC is gaining market share, as smaller competitors close or are acquired, paying down debt, and investing in improvements to technologies. Having rationalized their store base in the past few years, the company has a much leaner cost structure, and will realize significant FCF as it returns to growth.


ARC has a significant amount of debt and high interest payments.

The company has grown mostly by acquisition in the past (140 locations since 1997). If further tuck-in opportunities do not arise, they may have trouble growing beyond past results.

Over 30% of sales are in a single state (California).

About 70% of sales are to commercial construction customers, which has been a weak market and may not pick up for some time.


Financial filings and presentations that can be found on the company's website:

There's ongoing commentary on ARC: Here is an update on the first quarter of 2012

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