American greeting

UVA-F-1693 Rev. Feb. 6, 2014

This case was prepared by Michael J. Schill, Associate Professor of Business Administration. Copyright  2013 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.

AMERICAN GREETINGS

This year American Greetings is demonstrating to naysayers that the greeting card space is not dead. The company has accelerated top-line [growth] through a combination of organic growth and acquisitions, and year-to-date revenues are trending well ahead of our forecast. However, the growth has come at a cost that is also far greater than we had anticipated…In Q3 marketing, spending increased by a surprising $10 million…The company also accelerated investment spending in the digital space to support the growth of recently launched cardstore.com. In addition, [American Greetings] has incurred…incremental expenses this year to roll out new doors in the dollar-store channel.

—Jeff Stein Managing Director, Northcoast Research

It was New Year’s Day 2012, and the weather was unseasonably warm in Cleveland, Ohio, headquarters for American Greetings Corporation (AG). But while temperatures were up, the same could not be said of AG’s share price, which had been cut in half over the previous several months to a year-end closing price of $12.51 (Exhibit 1).

At times of low equity valuation, AG management historically had turned to share

buybacks. With current valuation levels, management was considering going into the market with a $75 million repurchase program. The decision hinged on how the future of the enterprise was expected to play out. If the share price reasonably reflected bleak prospects for AG, management should preserve cash for future needs. If, on the other hand, AG stock was simply temporarily out of favor, the buyback plan presented a prudent defensive strategy. American Greetings

With $1.7 billion in revenue, AG was the second largest greeting card publisher in the United States. To meet the changing times, AG sold greeting cards as both paper products through traditional retail channels and electronic products through a number of company

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-2- UVA-F-1693 websites. In addition to gift cards, AG marketed gift wrap, candles, party goods, candles, and other giftware. To strengthen its business, the company owned and maintained the following major brands: American Greetings, Carlton Cards, Gibson, Recycled Paper Greetings, Papyrus, and DesignWare. AG owned the rights to a variety of popular characters, including Strawberry Shortcake, the Care Bears, Holly Hobbie, the Get Along Gang, and the Nickelodeon characters. The company was able to generate additional revenue by licensing the rights to these characters. Overall, management positioned AG as a leader in social expression products that assisted “consumers in enhancing their relationships to create happiness, laughter, and love.”1

The company had a long affiliation with the founding Sapirstein family. Shortly after immigrating to the United States in 1905, Jacob Sapirstein, a Polish entrepreneur, launched a business distributing German manufactured postcards in Cleveland with the help of his young family. Eventually the business leadership was passed on to Jacob’s oldest son, Irving Stone, then to Irving’s son-in-law, Morry Weiss. In 2003, Morry’s sons, Zev and Jeffrey Weiss, were appointed as CEO and president, respectively. Morry Weiss continued to serve as chairman.

Despite the strong family affiliation, AG was widely held in the public equity markets,

with more than 11,000 shareholders, including large positions by such institutional investors as the British investment fund MAM Investments (10.6% of AG shares) and U.S. funds Dimensional Fund Advisors (10.5%), BlackRock (7.9%), and LSV Asset Management (6.7%). Dividend payments to investors had been on an upward trend in recent years, rising from 12 cents per share in 2004 to 56 cents in 2010.

Exhibits 2 and 3 provide AG’s detailed financial statements. Since AG’s fiscal year

ended in February, the figures for 2011, for example, included results through February 2012, so remained estimates for the remaining two months. Greeting Cards

Two players, Hallmark and AG, dominated the U.S. greetings card industry. Hallmark, privately held by the Hall family, was the larger of the two, with total worldwide revenue at $4 billion. From its headquarters in Kansas City, Missouri, Hallmark had aggressively expanded its business internationally with operations in over 100 countries. Hallmark maintained licensing agreements with independent Hallmark Gold Crown retail stores that marketed Hallmark products and owned ancillary businesses such as Crayola (the crayon maker) and the Hallmark Channel cable network. Other card companies, such as Avanti Press, Blyth, CSS Industries, and Deluxe had found successful niches in the $6 billion U.S. greeting card market.

Mintel, the industry analyst firm, maintained that the overall greeting card market had

contracted by 9% since 2005 and that the contraction would continue (Exhibit 4). Mintel’s best- case scenario called for a 4% market decline over the next four years; its worst-case called for a

1 Company website.

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-3- UVA-F-1693 16% decline. The market contraction was thought to be driven by the substitution for greeting cards of other forms of social expression products, due to the ease of such alternative forms as smart phones, electronic social networking, and digital imaging, the last of which affected the traditional Christmas card market in particular. The rapid expansion of social media networks such as Facebook provided even stronger challenges to electronic cards. An industry survey found that the social media substitution was particularly acute in a younger demographic (Exhibit 5). Analysts expected the trend to continue as the ease of digital communication substituted for traditional forms of social expression.

The industry had responded to the substantive technological shift with important market

innovations. Both Hallmark and AG had created an extensive collection of electronic cards that made it easy for customers to send cards electronically. Card manufacturers maintained websites that allowed consumers to purchase paper greeting cards on the Internet via computer or smart phone and have the physical cards delivered directly to the recipient. Kiosks had been placed in retail stores that allowed customers to create custom cards. Distribution had expanded to build a substantive presence in the expanding dollar-store retail channel, where greeting cards were reported to be a top-selling item.

Despite the trends, large numbers of people continued to buy greeting cards. In a recent

survey, 52% of U.S. respondents had purchased a greeting card in the past three months. This figure was down from 59% who had responded affirmatively in 2006.2 Valuation

With an end-of-year close of $12.51 per share, AG’s PE ratio was at 6 times, its enterprise value to EBITDA ratio was at 3.5 times, and its market-to-book ratio was below 1. All of these valuation ratios were at the bottom of AG’s group of comparable companies. Exhibit 6 contains financial details and business descriptions for the AG-comparable group. AG’s management believed its valuation suggested an opportunity, but low levels also demonstrated substantial concern by the capital market regarding the prospects of the company. For example, equity analysts at Standard and Poor’s maintained a hold recommendation on the stock, claiming the following:

We see [AG’s 2012] sales increasing 2.5% to $1.73 billion…We see demand benefitting from increased promotional spending in a more stable economic environment as the company pursues growth within the discount distribution channel…acquisitions…[and] international sales...We expect margins to narrow…reflecting a shift in customer mix toward the discount channel, increasing marketing costs to spur demand, distribution expansion costs, and expenses related to plans to move AG’s headquarters building. While we believe channel migration will result in a permanent negative margin shift, we do not

2 Greeting Cards and E-Cards—U.S.: February 2011, Mintel report, February 2011.

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believe transition costs related to expanded distribution efforts will be a factor in the long term.3

Orly Seidman, a Value Line analyst, held a more optimistic view, expecting steady

margins and steady long-term growth: The company has been improving the product pipeline. Management should continue to follow consumer and societal trends to better brand its offerings. It has shifted its focus from its core segment to pursue noncard merchandise. Product innovation, stronger retail partnerships, and sell-diversified portfolio ought to drive customer interest in its goods. Technological enhancements will likely remain key to its long-term approach. Over the past few quarters, [AG] rolled out several complementary interactive products (i.e., mobile apps) and should continue to bolster its digital position.4

It was clear that there was substantial disagreement regarding the future growth trajectory

and operating margins for the company. Over the past several years, revenue growth had been near to below zero. In 2011, however, revenue growth was anticipated to be more than 7% (Exhibit 7). Similarly, operating margins, which had been abnormally low two to five years previously, had improved to 9% recently. The marginal tax rate for AG income was 39%.

A bullish view held that AG would be able to maintain operating margins at 9% and

achieve long-term ongoing revenue growth of 3%. A bearish view held that AG’s prospective revenue growth would be near zero into the future and that margins would continue to erode to a long-term rate of 5%. The expectation was that recent investments and ongoing electronic product substitution would generate some future working capital efficiency for AG, but there was little evidence that fixed asset turnover would improve. Property, plant, and equipment (PP&E) depreciation and capital expenditures had recently trended together at about $40 million per year. Exhibit 8 details the specific assumptions for the two scenarios.

Management understood that returns and growth were challenging to achieve in early

2012. Yields on U.S. Treasury bills and bonds were at historic lows of 0.1% and 2.8%, respectively (Exhibit 9). In such an environment, investors would richly reward returns of even small magnitudes.

3 American Greetings Corp., Standard & Poor’s stock report, December 27, 2011. 4 Orly Seidman, American Greetings, Value Line investment survey, November 11, 2011.

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-5- UVA-F-1693

Exhibit 1

AMERICAN GREETINGS American Greetings Share Price

(monthly close)

Data source: Yahoo! Finance.

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-6- UVA-F-1693

Exhibit 2

AMERICAN GREETINGS American Greetings Income Statement, December 20111

(in millions of dollars)

Data source: Company accounts; management and case writer estimates.

1 Fiscal year ends February of subsequent year.

2008 2009 2010 2011E (Feb 2009) (Feb 2010) (Feb 2011) (Feb 2012)

Total American Greetings Figures Total Revenue 1,691 1,636 1,593 1,677 Material, Labor, and Other Pruduction Costs 810 713 682 743 Selling, Distribution, and Marketing Expenses 619 508 478 526 Administrative and General Expenses 226 276 261 258 Goodwill and Other Intangible Asset Impairments 290 0 0 0 Other Operating Expenses 1 0 3 (6) Operating Income (253) 139 175 157 Net Interest and Other Nonoperating Expenses 22 18 19 28 Income Before Income Tax Expense (275) 121 156 129 Income Tax Expense (47) 39 69 47 Net Income (228) 82 87 82

Earnings Per Share (Basic) (4.89) 2.07 2.18 2.22 Dividends per Share 0.60 0.36 0.56 0.60

By Business Unit Operating Segment Net Sales North American Social Expression Products 1,095 1,235 1,191 1,215 International Social Expression Products 271 254 262 344 Retail Operations 179 12 AG Interactive 83 80 78 68

Operating Segment Earnings North American Social Expression Products 70 236 218 148 International Social Expression Products (78) 17 20 20 Retail Operations (19) (35) AG Interactive (162) 11 14 14

Total Revenue by Product Category Everyday Greeting Cards 704 764 753 823 Seasonal Greeting Cards 357 369 377 408 Gift Packaging 240 221 223 239 Other Revenue 44 38 32 32 All Other Products 345 244 207 176

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Exhibit 3

AMERICAN GREETINGS American Greetings Balance Sheet6

(in millions of dollars)

Data source: Company accounts; management and case writer estimates.

6 Fiscal year ends February of subsequent year.

2009 2010 2011E (Feb 2010) (Feb 2011) (Feb 2012)

Cash and Cash Equivalents 138 216 172 Trade Accounts Receivable 136 120 130 Inventories 164 180 190 Prepaid Expenses 148 128 131 Other Current Assets 94 72 54 Total Current Assets 679 716 677

Net Property, Plant, and Equipment and Other Assets 850 832 859 Total Assets 1,529 1,547 1,536

Debt Due within One Year 1 0 0 Accounts Payable 95 87 87 Other Current Liabilities 272 245 255 Current Liabilities 369 332 343

Long-Term Debt 329 233 235 Other Liabilities 196 219 206 Shareholders’ Equity 636 763 752 Total Liabilities and Shareholders’ Equity 1,529 1,547 1,536

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Exhibit 4

AMERICAN GREETINGS Total U.S. Greeting Cards Sales (Actual and Forecast)

Data source: Mintel, based on U.S. Census Bureau, Economic Census.

Sales at current prices in millions of dollars % annual change

2005 6,537 2006 6,420 -1.8 2007 6,285 -2.1 2008 6,266 -0.3 2009 6,149 -1.9 2010 5,935 -3.5 2011 (est.) 5,838 -1.6 2012 (est.) 5,711 -2.2 2013 (est.) 5,596 -2.0 2014 (est.) 5,478 -2.1 2015 (est.) 5,359 -2.2

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-9- UVA-F-1693

Exhibit 5

AMERICAN GREETINGS Feelings About e-Cards: Usage Change among 2,000 Respondents, October 2010

Data source: Mintel.

By Age Category All 18-24 25-34 35-44 45-54 55-64 65+

In the last year, I have sent more e-cards than I used to. 22% 17% 26% 20% 22% 21% 24%

In the last year, I have sent fewer e-cards than I used to because I send greetings over social networking sites such as Facebook.

20% 26% 27% 21% 19% 15% 13%

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-10- UVA-F-1693

Exhibit 6

AMERICAN GREETINGS Comparable Firms, End of 2011

(in millions of dollars except share price)

Data source: Yahoo! Finance, Standard & Poor’s, Mergent.

Share Price Shares

Outstanding Total Cash Total Debt Enterprise

Value Revenue EBITDA EBITDA Multiple*

American Greetings 12.51 38.3 86 235 714 1,660 204 3.5 Blyth 56.80 8.2 182 101 568 984 48 11.7 Consolidated Graphics 48.28 10.2 7 197 692 1,050 122 5.6 CSS Industries 19.92 9.7 10 0 194 453 30 6.5 Deluxe 22.76 50.9 31 742 1,901 1,420 359 5.3 Hallmark NA NA NA NA NA 4,100 NA NA Lancaster Colony 69.34 27.3 162 0 1,890 1,090 156 12.2 Meredith 32.65 44.8 26 250 1,712 1,350 240 7.1 Scholastic 29.97 31.1 114 215 1,145 1,950 189 6.0

ROA ROE Beta Bond

Rating**

American Greetings 7% 11% 1.63 BB+ Blyth 4% 9% 1.60 B Consolidated Graphics 5% 10% 1.45 BB CSS Industries 4% 2% 1.36 Deluxe 13% 55% 1.85 B Hallmark NA NA NA Lancaster Colony 14% 19% 0.42 Meredith 7% 15% 1.75 BB Scholastic 6% 8% 1.04 BB-

* EBITDA miltiple is defined as Enterprise Value divided by EBITDA ** The ratings for Cons. Graphics and Meredith are estimated by case writer.

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Exhibit 6 (continued)

Comparable Firms

Blyth Global marketer of candles, gourmet foods, weight management

products, holiday cards, photo albums, and houseware products

Consolidated Graphics

Provides commercial printing services in North America, including brochures, shareholder communications, trading cards, calendars, catalogs, and greeting cards

CSS Industries Designs, produces, and sells social expression products in North America, including greeting cards, gift wrapping, Valentine cards, Halloween costumes, and stationery

Deluxe Provides printed products to financial institutions and small businesses worldwide, including forms, checks, envelopes, and greeting cards

Lancaster Colony Manufactures and markets specialty foods, glassware, and candles in the United States

Meredith Licenses brands and publishes magazines (e.g., Better Homes and Gardens, Ladies’ Home Journal, FamilyFun) in the United States

Scholastic Publishes and distributes children’s books and other media in the United States

Data source: Case writer descriptions.

T h i s d o c u m e n t i s a u t h o r i z e d f o r u s e b y S u h a n P a t e l , f r o m 1 / 7 / 2 0 1 8 t o 4 / 7 / 2 0 1 8 , i n t h e c o u r s e : M B A 7 2 9 4 : A d v a n c e d F i n a n c i a l A n a l y s i s - J o h n B i s h 2 0 1 8 , W i l m i n g t o n U n i v e r s i t y .

A n y u n a u t h o r i z e d u s e o r r e p r o d u c t i o n o f t h i s d o c u m e n t i s s t r i c t l y p r o h i b i t e d * .

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Exhibit 7

AMERICAN GREETINGS American Greetings Operating Performance

Note: Fiscal year ends February of subsequent year. Data source: Company financial statements.

2005 2006 2007 2008 2009 2010 2011 Revenue Growth 0% -7% -1% -5% -3% -2% 7% Operating Margin 8% 2% 5% -1% 6% 9% 9%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

2005 2006 2007 2008 2009 2010 2011

Revenue growth Operating margin

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Exhibit 8 AMERICAN GREETINGS

Financial Forecast Assumptions

Note: The ratios are defined in the following manner: Revenue Growth is the annual percentage change in total revenue, Operating Margin is operating income divided by total revenue, Net Working Capital Turnover is total revenue divided by net working capital where net working capital is current assets less current liabilities, Fixed Asset Turnover is total revenue divided by net PP&E and other assets. Data source: Case writer estimates.

Actual *********** Forecast *********** 2011 2012 2013 2014 2015

Bullish Scenario Revenue Growth 5.3% 1.0% 1.5% 2.0% 2.5% Operating Margin 9.4% 9.0% 9.0% 9.0% 9.0% Net Working Capital Turnover 5.02 6.00 6.50 7.00 7.50 Fixed Asset Turnover 1.95 1.95 1.95 1.95 1.95

Bearish Scenario Revenue Growth 5.3% 0.0% 0.0% 0.0% 0.0% Operating Margin 9.4% 8.0% 7.0% 6.0% 5.0% Net Working Capital Turnover 5.02 6.00 6.50 7.00 7.50 Fixed Asset Turnover 1.95 1.95 1.95 1.95 1.95

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-14- UVA-F-1693

Exhibit 9

AMERICAN GREETINGS Capital Market Data

Data source: Bloomberg, Value Line Investment Survey, and case writer estimates.

Yield 30-Day Treasury Bill 0.1% 10-Year Treasury Bond 2.8%

10-Year Corporate Bonds of Industrial Companies AAA 2.8% AA 2.9% A+ 3.2% A 3.3% A- 3.5% BBB+ 3.8% BBB 4.1% BBB- 4.6% BB+ 5.8% BB 6.5% BB- 6.5% B+ 6.8% B 8.4% B- 9.0%

Historical Market Risk Premium Equity Market Index Less Government Debt 5.5%

5-Year Forecast U.S. Real GDP Annual Growth Rate 3.3% U.S. GDP Annual Deflator Rate 1.8% Consumer Price Index Annual Rate 2.2%

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