Share Sleuth: Grafenia and the mother of all risks

Last month's full-year results from Grafenia, make for difficult reading for shareholders. Its printing franchise is losing franchisees, some to its own initiatives, as its small business customers adopt cheap online print services.

Losing franchisees

Revenues from the Share Sleuth portfolio member fell 6%, but revenues from Grafenia's franchise network fell 32%, and overall adjusted profit fell 13%. The numbers aren't entirely bad. If sustained, the company remains profitable enough to be a reasonable investment on an accounting and cash basis, and its bank balance was positive and stable at the year end. But it's easy to imagine scenarios in which that doesn't remain the case.

Grafenia has two main assets, a centralised printing hub in Manchester, and proprietary software that manages all aspects of print from template driven design to ordering.

It packages these with marketing services into franchises that gives print shops and graphic designers access to low cost print and a system that enables them to manage their print operations more effectively including the option of template driven design. Principally it derives revenue from print sales, but it also earns about 5% of revenue from franchise and software licence income.

Software as a service

In recent years, Grafenia's attempted to counteract the shrinking franchise network by developing its in-house software into a platform than can run the operations of any printer, marketing company, or graphic designer requiring printing services, providing them with a print ordering, management system and web store, W3P, without the other franchise elements. Optionally, customers can source print from Grafenia through W3P.

In 2014, its first year of sales, W3P earned Grafenia £0.61m in printing revenue and license fees but at the cost of 72 franchisees that converted to becoming software customers alone.

Templatecloud, a source of editable design templates, can also be licensed by other printers. It earned revenues of £0.16m, up from 0.1m in 2013.

BrandDemand, introduced in 2011, extends the software platform to corporate customers. It earned Grafenia £0.62m up from £0.58m in 2013.

In 2014 Grafenia introduced, a less functional version of W3P through which graphic designers and other professionals can buy print, without having to bear the cost of licensing the software.

In comparison to overall revenues of more than £19m and capital investment running at over £1m a year principally related to the new software services, these initiatives have yet to prove their worth.

Selling online

One investment that may have was the acquisition of a Dutch online printer in 2010. The brands Grafenia acquired earned revenues of more than £7m in 2014, most of Grafenia's online revenue, which in total grew 8% and for the first time surpassed the traditional channel.

The company is trying to replicate its success selling direct to business abroad in the UK and Ireland with and but between them they earn less than £1m.

Online print is very competitive, which may imply that despite growth in online revenue, profit and cash flow principally still come from the franchise network.

Experimental approach

Now that Grafenia has tried just about every method of extracting profit from its printing hub and software, founder and chief executive Tony Rafferty says it will focus on those that give it the greatest economic return.

Maybe this experimental approach is the only way to cope with the rapidly changing business of print but it's difficult to evaluate these small early stage projects, and although each new venture promises an alternative to the shrinking franchise they also create problems. Selling software as a service won't plug the gap if most of the customers are downgrading from franchises. Selling print direct online, might upset the remaining franchisees, still probably Grafenia's most profitable customers.

Unsurprisingly, perhaps, the current share price of 20p values the enterprise at less than £12m or seven times adjusted 2014 earnings. The earnings yield is an enticing 14%. Set against that very attractive market valuation is the palpable risk that in the bewildering mix of oddly-named brands and services Grafenia's created, it has yet to find the seed of long-term profitability.

Extinction, the mother of all risks

There's another risk, the mother of all risks. You can read it in the principal risks and uncertainties listed in the annual report. Small businesses might give up on print as a source of advertising altogether:

...With the advent of online advertising, coupled with the proliferation of the use of Smartphones and Tablets, we cannot be certain that the demand for printing as a promotional media will be maintained at anything like its current levels. Were the demand for print, at a macro level, to be significantly reduced this would affect the viability of the Group in its current form.

Perhaps that's why the company's latest experiment, Nettl looks a bit like a step backwards. Grafenia bills Nettl as a cross-media refresh of the franchise that will allow franchisees to manage not just print, but graphic design and web development projects.

In embracing franchising Grafenia may be hoping to ape its profitable past, and in embracing web development, it may be trying to secure the future. But in the short-term at least investors will still be wondering if Nettl is the idea that will stick.

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