Corporate Valuation

Final Project Report

on
Deluxe Corporation

Submitted to:
Rajesh Madhavan

Submitted by:

Submitted by: Group 4

Kajal Patil PGP09192
Margesh Patel PGP09216
Navneet Singh Rana PGP09207
Manohar Gupta PGP09157
Shreyans Jain PGP09237
Kirti Dang PGP09195
Tanu Kumari PGP09054

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Q1: Compute the Unused debt capacity at various rating
AAA AA A BBB BB B
Pretax cost of debt (Exhibit 9) 5.51% 5.52% 5.70% 6.33% 9.01% 11.97%
Required EBIT interest coverage (Exhibit 6) 23.4 13.3 6.3 3.9 2.2 1

Estimate of Maximum Debt Capacity

Normalized 5-Year EBIT (Exhibit 4) $359.4 $359.4 $359.4 $359.4 $359.4 $359.4
Maximum interest implied by rating $15.4 $27.0 $57.1 $92.2 $163.4 $359.4
Maximum total debt implied by rating $278.9 $489.6 $1,001.5 $1,455.8 $1,814.2 $3,003.9
Downside EBIT $200.0 $200.0 $200.0 $200.0 $200.0 $200.0
Maximum interest implied by rating $8.5 $15.0 $31.7 $51.3 $90.9 $200.0
Maximum total debt implied by rating $155.2 $272.5 $557.3 $810.1 $1,009.5 $1,671.5

Estimate of unused Debt Capacity

Book value of Deluxe's existing debt $161.5 $161.5 $161.5 $161.5 $161.5 $161.5
Maximum debt implied by rating $278.9 $489.6 $1,001.5 $1,455.8 $1,814.2 $3,003.9
unused debt capacity at current rating $117.4 $328.2 $840.1 $1,294.4 $1,652.8 $2,842.4
unused capacity until investment grate rating $-
is lost (atBBB) $1,176.9 $966.2 $454.3 $- $-358.4 1,548.1

Estimate of Capital Structure

Deluxe corporation market value of Equity $2,665.4 $2,665.4 $2,665.4 $2,665.4 $2,665.4 $2,665.4
Maximum debt implied by rating $278.9 $489.6 $1,001.5 $1,455.8 $1,814.2 $3,003.9
Total debt/equity implied by rating 10.46% 18.37% 37.58% 54.62% 68.07% 112.70%

EBIT/Total Debt %

Pretax cost of debt (Exhibit 9) 5.51% 5.52% 5.70% 6.33% 9.01% 11.97%
Required EBIT/Total Debt % (Exhibit 6) 214% 66% 42% 31% 20% 10%

Estimate of Maximum Debt Capacity

Normalized 5-Year EBIT (Exhibit 4) $359.4 $359.4 $359.4 $359.4 $359.4 $359.4
Maximum total debt implied by rating $167.8 $547.1 $851.7 $1,174.6 $1,824.5 $3,455.9
Downside EBIT $200.0 $200.0 $200.0 $200.0 $200.0 $200.0
Maximum total debt implied by rating $93.4 $304.4 $473.9 $653.6 $1,015.2 $1,923.1

Estimate of unused Debt Capacity

Book value of Deluxe's existing debt $161.5 $161.5 $161.5 $161.5 $161.5 $161.5
Maximum debt implied by rating $167.8 $547.1 $851.7 $1,174.6 $1,824.5 $3,455.9
unused debt capacity at current rating $6.3 $385.6 $690.2 $1,013.1 $1,663.0 $3,294.5
unused capacity until investment grate rating $-
is lost (atBBB) $1,006.8 $627.5 $322.9 $- $-649.9 2,281.4

Estimate of Capital Structure

Deluxe corporation market value of Equity $2,665.4 $2,665.4 $2,665.4 $2,665.4 $2,665.4 $2,665.4
Maximum debt implied by rating $167.8 $547.1 $851.7 $1,174.6 $1,824.5 $3,455.9
Total debt/equity implied by rating 6.30% 20.52% 31.95% 44.07% 68.45% 129.66%

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Q2: Compute the WACC for the respective rating and the value of the company at the best rating
AAA AA A BBB BB B
cost fo debt (pretax) 5.47% 5.50% 5.70% 6.30% 9.00% 12.00%
cost of equity 10.3% 10.4% 10.5% 10.6% 12.0% 14.3%

Approach based on Hudson Bancorp

Estimates of Equity costs
Tax rate @38%
After-tax cost of debt 3.4% 3.4% 3.5% 3.9% 5.6% 7.4%
cost of equity 10.3% 10.4% 10.5% 10.6% 12.0% 14.3%
Debt/capital (Exhibit 6) 5.0% 35.9% 42.6% 47.0% 57.7% 75.1%
Weight of debt (implied by coverage ratio) 9.5% 15.5% 27.3% 35.3% 40.5% 53.0%

WACC (using Hudson's estimates - Interest

coverage) 9.60% 9.27% 8.60% 8.24% 9.40% 10.64%
WACC (using book weighs) 9.91% 7.86% 7.53% 7.45% 8.30% 9.14%

Alternative approach based on CAPM

and Levered Beta
cost of debt (pretax) 5.51% 5.52% 5.70% 6.33% 9.01% 11.97%
Unlevered beta 0.82 0.82 0.82 0.82 0.82 0.82
Debt/equity (Market) 10.5% 18.4% 37.6% 54.6% 68.1% 112.7%
Levered beta 0.87 0.91 1.01 1.10 1.16 1.39
cost of equity (rf=0.0530, MP=0.054) 10.0% 10.2% 10.8% 11.2% 11.6% 12.8%

After-tax cost of debt 3.4% 3.4% 3.5% 3.9% 5.6% 7.4%

Cost of equity 10.0% 10.2% 10.8% 11.2% 11.6% 12.8%
Debt/capital book value Exhibit 6 5.0% 35.9% 42.6% 47.0% 57.7% 75.1%
Weight of debt (implied by coverage ratio) 9.5% 15.5% 27.3% 35.3% 40.5% 53.0%

WACC (using market weights - Interest

coverage) 9.38% 9.17% 8.78% 8.64% 9.16% 9.97%
WACC (using book weighs) 9.68% 7.78% 7.68% 7.78% 8.12% 8.78%

EBIT/Total Debt %
cost of debt (pretax) 5.51% 5.52% 5.70% 6.33% 9.01% 11.97%
Unlevered beta 0.82 0.82 0.82 0.82 0.82 0.82
Debt/equity (Market) 6.30% 20.52% 31.95% 44.07% 68.45% 129.66%
Levered beta 0.85 0.92 0.98 1.04 1.17 1.48
cost of equity (rf=0.0530, MP=0.054) 9.9% 10.3% 10.6% 10.9% 11.6% 13.3%

After-tax cost of debt 3.4% 3.4% 3.5% 3.9% 5.6% 7.4%

Cost of equity 9.9% 10.3% 10.6% 10.9% 11.6% 13.3%
Weight of debt (EBIT/Total Debt) 6.3% 20.5% 32.0% 44.1% 68.5% 129.7%

WACC (using market weights - EBIT/Total

Debt) 9.49% 8.88% 8.34% 7.84% 7.48% 5.71%

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 AAA AA A BBB BB B
WACC (using Hudson's estimates - Interest coverage) 9.60% 9.27% 8.60% 8.24% 9.40% 10.64%
WACC (using market weights - Interest coverage) 9.38% 9.17% 8.78% 8.64% 9.16% 9.97%
WACC (using market weights - EBIT/Total Debt) 9.49% 8.88% 8.34% 7.84% 7.48% 5.71%
Cost of Debt (Based on future assumptions, yield) 5.51% 5.52% 5.70% 6.33% 9.01% 11.97%
Cost of Equity (Hudson Estimate) 10.25% 10.35% 10.50% 10.60% 12.00% 14.25%

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Q3: Analyze the situation qualitatively and recommend any future action

What is the nature of Deluxe Corporation’s (Deluxe) business? Describe the firm’s 
strategy and the risks the firm faces as a result of its strategy.

The nature of the Deluxe Corporation’s business is paper check printing.

In the late 1990’s, the firm’s strategy was to reduce expenses. They did this by divesting 20 non-
core businesses, closing 49 plants, reducing its labor force by 8,000 employees, outsource IT and
focus on improving manufacturing efficiencies.

Currently (2000’s), the Deluxe Corporation (DC) strategy has been to spin-off technology related
subsidiaries. They spun-off eFunds and iDLX Technology Partners thru an initial public offering
(IPO). Management believe there was more value in these companies are separate entities, and
that these companies did not have valuable synergies.

The current strategy is very risky. iDLX Technology Partners offered technology related
consulting services to financial service companies while eFunds offered electronic payment
products and services. The CEO admits that the paper check business is dying, but spun-off a
company that seems to be replacing it in eFunds. People were shifting from writing checks to
using credit cards, debit cards and using electronic payment services over the internet, so a
major risk that just occurred is DC just lost a huge growth company, and that company they just
spun-off can come back and take market share from the paper check industry in the form of
electronic payments. If the CEO is correct in predicting the demise of the paper check business,
then it is likely that electronic payments would be the business the kill the paper check industry.
Another risk is they lost diversification by spinning-off these two companies, especially losing the
consulting service company; iDLX. The consulting service company could have provided a very
different business than the payment business they were in.

What are management’s motivations and key objectives in setting the firm’s
financial policy?

Management’s key objective is to focus on its core business. By spinning-off eFunds and iDLX, DC
can concentrate on its core business - which the CEO strongly feels still has growth opportunities.
The core business is very profitable, and he states that can generate good revenue and profits
from it over the next five years, and does not want to abandon a good business too early. After
the spin-off, the company is repositioned as a pure-play check printing company. Since this is
what their investors wanted, after the news of the spin-off, the stock rose. DC then used cash for
company share buybacks. The share repurchase plan authorizes the purchase of up to 19% of
total shares outstanding, this will increase the value of the stock to its shareholders. However,
the dividends will remain constant.

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 What financing requirements are foreseen for Deluxe in the coming years?

There are foreseen financing requirements for DC in the next couple years, they include
additional financing for working capital, capital asset purchases, possible corporate acquisitions,
repayment of short-term debt, interest payments on long-term debt, dividend payments to
shareholders and possible stock buybacks depending on the state of the stock.

Is Deluxe’s current level of debt is appropriate?

No, I do not think that the current level of debt for DC is appropriate.  Just based on the foreseen 
financing that is due in the coming years, they do not have enough with their $161.5 million.  They 
need additional funding.  I also think that for this business to not just sustain the next five years, but to 
prosper after that time frame they will need to acquire their competition’s business, since it is likely 
their competition will go under before DC.  This will take aggressive marketing, and strong sales.  
Based on their expenses, they may not have the resources to do so.  

But based on the current state of the business, they could expect to be acquired by a electronic payment
type of company like they had spun­off in eFunds.  A company like this will want to tap into an 
established customer base, and they will be able to get a company like DC at a discount over the next 
couple years.  

Recommendations concerning
a. Target bond rating.
DC needs to position itself to obtain a AAA rating.  Anything less can start a downward spiral for the 
company.  If the shareholders start to sell, this company may not rebound since it is in a dying 
industry.  Once it drops out of the premium ratings, the company will be an acquisition target by 
growing electronic payment companies.  

b. Level of flexibility.
Flexibility is the amount of debt DC can take on before you lose the investment­grade bond rating.  
Based on the financial analysis, the BB level is where the cost jumps the most.  There is a 26% 
increase in costs from a level BBB rating to a level BB.

c. Mix of debt and equity.
DC is targeting an aggressive share buyback plan.  They are increasing their equity in the company by 
reducing shares.  But because of the future of the company, they will also need to take on debt.  Based 
on the financial analysis, they are better off taking on debt.  Debt is cheaper for DC.  Cost of debt 

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ranges between 5.47% to 12%, and that does not even include the 37.5% tax shield.  Cost of equity is 
more expensive, it ranges from 10.25% to 14.25%, and there is no tax shield.  

d. Other? 
Today is six years after the case, and DC is still in business.  The stock (DLX) has been very volatile.  
It looks like the CEO was correct, after five years, the revenue growth has stopped, and turned 
negative.  The financials are starting to weaken, and the company has turned to diversifying its 
business to stay around.