DLX Valens Credit Analysis – Operational sustainability indicates that ratings agencies are overstating credit risk, while a lackluster recovery rate and material debt headwall signify that credit markets are understating credit risk

• Credit markets are materially understating credit risk with a CDS of 34bps relative to an Intrinsic CDS of 193bps. However, S&P is overstating fundamental credit risk with their BB rating, three notches lower than Valens’ IG4 (BBB) rating
• Incentives Dictate Behavior™ analysis highlights that DLX management’s compensation structure focuses management on improving margins and growth over time. However, it does not punish management for overspending on capex and acquisitions or taking on excess leverage, which could reduce cash flows available for handling debt obligations
• Earnings Call Forensics™ of the firm’s Q2 2017 earnings call (7/27) highlights that management is confident about the sustainability of lower brand awareness spending. However, they may lack confidence in their ability to drive marketing solutions and other services revenue growth at Direct Checks, and may be concerned about the potential for further declines in organic revenues
• Though credit markets appear overly complacent, equity markets expect Uniform ROA compression toward historically low levels. Considering the firm’s recent shift to a higher Uniform ROA business, and their historically stable profitability, these expectations may be too low and equity downside is likely limited