Billionaire David Einhorn's Investor Letter: Short Pitney Bowes

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Why billionaire David Einhorn hates Pitney Bowes (NYSE: PBI)

 It turns out that Einhorn's Greenlight Capital hedge fund underperformed in 2012, putting in a 7.9% return for full year 2012, compared to the S&P 500's 2012 return of over 13%.

 However, since its inception in 1996, Greenlight has managed to return an annualized 19.4% net of fees (check out Greenlight's long portfolio,) so when he speaks, investors tend to listen. Hence, why I'm curious about his distaste for Pitney Bowes. In his 2012 letter to shareholders, Einhorn had this to say about Pitney:

 Our three year old thesis that Pitney Bowes was a “melting ice cube” due to secular declining U.S. mail volumes played out. The company has been in a perpetual restructuring mode and reported a series of disappointing quarters. In addition, the viability of the dividend came into question. We covered the short position with a nice gain.

 Although Einhorn covered his short position with a "nice gain,” I believe the stock still has room to fall. The price of sending mail with a first-class stamp is up to $0.46 after a $0.01 increase last month and will likely continue to rise. Overall, the prices for mailing and shipping services will increase by 4% on average due to the recent rate hikes. These hikes come as the U.S. Postal Service continues to struggle, and embarks on possible insolvency.

 A large part of Pitney's revenues are overexposed to the United States Postal Service. As a result, it requires a robust and operating USPS infrastructure, but this infrastructure has been dwindling. The USPS had to borrow $15 billion from the U.S. Treasury in 2012, but even that wasn't enough for the agency. Things have gotten aggressively worse, with USPS defaulting on two payments in 2012 to fund future postal retirees' health benefits. The USPS is again cutting hours, slicing jobs and closing locations, all of which does not bode well for Pitney.

 The industry is narrowing

 The fundamental industry changes are numerous, from technological changes to developments in customer preferences. Ironically, Pitney changed the mailing industry with its technology. Pitney was an innovative and growing company, until technology caught up to it. Now the company is seeing immense pressure due to a fundamental change in how content is delivered and business is transacted. One big player in changing the way bills are paid is eBay's online payment company PayPal. Per eMarketer, the U.S. retail ecommerce sales industry will grow from $224 billion in 2012 to $361 billion in 2016.

 Other big names suffering from the decline in physical mail circulation include magazine and newspaper publishers. The New York Times (NYSE: NYT) has seen its stock pushed down almost 50% the last five years, and has not paid a dividend in over four years. Analysts' also expect The New York Times to see a negative 6% annual growth rate in earnings for the next five years.

As far as other major publishers, it appears one of the best ways to survive is to spin off publishing businesses and focus on entertainment.  Take News Corp (NASDAQ: NWSA), where recent quarterly results showed that its publishing segment contributed only $53 million of the company's $1.58 billion operating profit, will spin off its publishing business later this year. Another notable media company. 

Time Warner (NYSE: TWX)is also exploring the sale of its entire magazine portfolio. This would include dumping such titles as Time, Sports Illustrated and People. The sale of Time Inc. and the suite of magazines could fetch Time Warner as much as $2 billion to $3.5 billion. Thanks to their media businesses, News Corp and Time Warner have weathered the demand decline for print much better than The New York Times. News Corp is up over 40% the last five years, and Time Warner is up 13%. 

 Back to Pitney 

Pitney's customers have been reducing budgets, which includes spending on postage, and are seeking cost efficient ways to lower office supply costs. All of these pressures have put steady downward pressure on Pitney's revenues, with a steady downtrend for the last six years:


Questionable dividend 

I also question Pitney's insanely high 11% dividend yield. With declining revenues and cash flow, it's hard to see how the company will be able to continue paying out such a high dividend. Based on analysts' earnings estimates, if it maintains its current dividend yield with no dividend growth, it would be paying out over 85% of earnings by 2014:
<table> <tbody> <tr> <td colspan="1" rowspan="1"> </td> <td colspan="1" rowspan="1"><strong>2012</strong></td> <td colspan="1" rowspan="1"><strong>2013E</strong></td> <td colspan="1" rowspan="1"><strong>2014E</strong></td> </tr> <tr> <td colspan="1" rowspan="1">Earnings Per Share</td> <td colspan="1" rowspan="1">2.18</td> <td colspan="1" rowspan="1">1.91</td> <td colspan="1" rowspan="1">1.75</td> </tr> <tr> <td colspan="1" rowspan="1">Dividends Per Share</td> <td colspan="1" rowspan="1">1.5</td> <td colspan="1" rowspan="1">1.5</td> <td colspan="1" rowspan="1">1.5</td> </tr> <tr> <td colspan="1" rowspan="1">Pro Forma Payout</td> <td colspan="1" rowspan="1">69%</td> <td colspan="1" rowspan="1">79%</td> <td colspan="1" rowspan="1">86%</td> </tr> </tbody> </table>
 Notice that earnings are expected to be in steady decline, thanks to various restructuring costs over the next few years. More worrisome is that earnings have been greater than free cash flow in four out of the last five quarters, implying that the actual dividend payout on free cash flow is already close to 100%. The dichotomy between Pitney's free cash flow and dividend payment has been strengthening the past few years, and it appears a dividend cut is the only plausible ramification. 

Don't be fooled

Pitney's growth is limited, and so is its limited financial flexibility, due to a high dividend payout. Although David Einhorn (see Einhorn's newest picks) has already exited his short position, I think the stock could easily see more downside, and in the least I would not be a buyer. 

See what else I  found in Einhorn's letter: Part 1 (saviors of 2012), Part 2 (big bets for 2013), Part 3: (Marvell Technology) Part 4 (Computer Sciences), Part 5 (short iron ore.)

mhargra has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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