You wouldn’t think it from the share price, but this company, which operates photobooths and makes photo-processing equipment, is in bid talks. In June, rumours surfaced that Arcapita, a Bahrain investment fund, had made an approach. A day later, the firm confirmed that it was “conducting a strategic review which may or may not lead to an offer”.
Share tip: Photo-Me International (PHTM)
At the time, the shares had drifted to lows of around 85p-90p. In late 2005, they had been as high as 130p a share, but in its interim results last December, PMI warned of problems with product delivery and in some of its key markets for photo-processing equipment, meaning it would miss broker forecasts of £45m-£50m profit for the current year. On news of the talks the share price jumped back up to 115p, and in the following weeks there was heavy volume as large investors built stakes. All in all, 12 investors now hold around 73% of the shares, including chief executive Serge Crasnianski with 19%.
They all know the attraction. PMI has a stupendous cash-generating business in the 35,000 photobooths and other equipment that it operates mostly in the UK, France, and Japan. Up until 2004 it used its annual gross cash inflow of around £60m to pay down what had been large borrowings only two years before. Now it has been redeploying it to build up its minilab manufacturing stocks and a new arm – digital printing kiosks sited on its existing photobooth estate.
A new owner could divert that cash inflow to repay whatever loans it takes on to buy the company.
But the cash-cow photobooths are only the means for a bidder to buy. The real opportunity they see is the delay in PMI’s plans to reap the benefit of its strong position in the minilab market. Minilabs are machines costing up to £120,000 that print your photos in high-street shops and, increasingly, in supermarkets too. This market is ready to explode when all the world’s 160,000 analogue machines (which print from film) are replaced by the digital versions needed as photographers switch to digital cameras.
So, why has PMI put itself up for sale? Probably because it hasn’t been able to capitalise on this business as quickly as it would like, and perhaps because Crasnianski wants value for his 19% stake earlier than the stockmarket seems willing to give it to him.
Crasnianski is the inventor of PMI’s minilabs. In the early 1990s, despite competition from giants such as Fuji, PMI’s analogue developing machines managed to gain a 10% share of the global market. In the last five years, the firm has developed a range of digital machines that have won rows of industry awards. Five years ago, Kodak selected PMI’s machines to equip its worldwide print shop network. But before that programme got under way, Kodak’s traditional film and printing paper market all but evaporated in favour of digital. Kodak has now exited from everything to do with consumer photography, including installing minilabs.
That put a hole in PMI’s order book – but it won’t last long. Although Kodak’s woes may hurt PMI in the short term, they point to an attractive long term. Kodak has been wrong-footed by faster-than-expected growth in the digital photography market. Digital cameras now offer quality approaching that of traditional film at an affordable price. As a result, after only five years digital photo- printing volumes now equal those of film and by 2010 are set almost to replace it. That makes it essential for the high-street photo printers to replace their analogue machines in order to defend their markets against supermarket chains moving into digital photo-printing.
But other factors associated with the move to digital have also temporarily held back demand. There have been ‘print wars’; some retail chains have not yet fully depreciated their old minilabs; and buyers have been holding off for third-generation machines (of which PMI’s DKS3 is only now going into volume production). More significantly for PMI, firms that rely on traditional film, such as Kodak, but lack PMI’s photobooth income, such as Agfa and Konica, have been exiting the minilab market and selling off their stock. So the market has temporarily gone flat.
PMI published its 2005/2006 results in July, which confirmed that the minilab market is still slow, but its photobooths business is improving. And it seems to have acquired a partial replacement minilab customer for Kodak, with an initial order last year from the 5,400-store US pharmacy chain CVS. When up and running, PMI’s minilab business should make treble last year’s £11m profit – against £19m from the photobooths.
That would give earnings per share of around 10p, and double that in cash flow.
It may not happen imminently, which perhaps explains why bid talks have gone on for so long. While this suggests they must be serious, it has also induced lethargy in the shares. But the institutions familiar with the story have filled up and the few brokers who understand PMI (and are allowed under the takeover rules to comment) are still recommending buys up to 130p. Even if a bid doesn’t materialise, the shares look cheap on a two-year view, while the charts indicate limited downside. If a bid arrives, there’s a short-term profit to be had.
Recommendation: BUY below 100p
John Cornford is a City analyst