As use of checks shrinks, Shoreview-based Deluxe diversifies

Anyone who's paying bills online or found that their favorite store no longer accepts checks is aware of the challenges facing a company like Deluxe Corp.

For the past several years, Deluxe has been in a race against the continuing decline in paper checks, the company's primary business. It's a trend documented by a Federal Reserve survey that found printed checks' share of all noncash payments went from 45 percent in 2004 to 35 percent in 2007. Just 4 percent of consumers surveyed before last year's holiday season by the National Retail Federation said they planned to pay for purchases with checks, compared with more than 40 percent planning to use debit or checking cards.

Deluxe isn't taking its shrinking universe in stride though. Instead, it's diversifying. Through several acquisitions, Shoreview-based Deluxe has begun turning itself into a products and services provider for financial institutions and small businesses.

Checks still account for more than 60 percent of revenue, but in a presentation to analysts last month company officials said that share should shrink to about 45 percent in the next three to five years. Meanwhile, Deluxe's small-business services segment is expected to see its share of revenue rise from about7 percent to about 25 percent.

The segment still supplies printed checks but also provides payroll services, fraud protection, logo design and a variety of Web-based services for entrepreneurs and small companies.

"The company has found a niche and is trying to build itself into a one-stop solution for small-business owners," said Charles Strauzer, an analyst at CJS Securities in White Plains, N.Y.

Investors appear to believe Deluxe is on the right path. In the past 12 months the stock has risen more than 80 percent, outpacing the 57 percent gain in the Standard & Poor's 400 mid-cap index. The increase represents a gain of about $478 million in Deluxe's total market capitalization.

The momentum didn't end last week, after the company announced it had spent $98 million to acquire another check printer, Maryland-based Custom Direct Inc. Deluxe stock's closing price on Thursday hit a 52-week high of $20.79 a share.

Deluxe isn't widely followed, but two analysts -- Strauzer and Mike Hamilton of RBC Wealth Management in Minneapolis -- so far are maintaining their "buy" ratings on the stock, despite the recent runup.

Even though it's an investment in a declining business, Strauzer and Hamilton say that acquiring Custom Direct makes sense for Deluxe. "We believe Deluxe sees a rapid payback in making such a purchase," Hamilton wrote in research note last week. Deluxe has said Custom Direct will add about $60 million in revenue this year to the direct checks segment, which had sales of about $163 million in 2009.

Another analyst, John Kraft, who follows the company for D.A. Davidson & Co. in Great Falls, Mont., has kept his neutral rating since the Custom Direct deal was announced.

"While check printing consolidation transactions tend to make sense from a financial perspective ... we are less enthusiastic regarding the strategic implications," he wrote in a report.

The acquisition isn't expected to contribute to this year's bottom line because of transaction-related expenses, but it will generate about $15 million in cash flow. Deluxe has said it wants increase cash flow to pay down debt and fund future investments in its faster-growing small-business services and financial services segments.

The acquisition also solidifies Deluxe's position as a leader in checks that are marketed directly to consumers rather than through financial institutions. It's a higher-margin business because it eliminates the financial institution as the middleman.

Deluxe said last week it expects the Custom Direct deal to result in manufacturing efficiencies but has no immediate plans to close any facilities. Over the past decade, Deluxe has cut thousands of jobs and shut numerous facilities as it has grappled with its declining business. According to its 2009 10-K, it trimmed about 1,000 people from its U.S. workforce, ending last year with 5,592 employees nationwide.

Deluxe is scheduled to report its first-quarter results Thursday. In March the company said it expected earnings-per-share of 57 cents to 64 cents, compared with 56 cents a share for the period a year earlier. Analysts were somewhat more optimistic, with estimates ranging from 58 cents to 62 cents.

Both the company and analysts expect first-quarter revenue to be slightly lower than the $339.5 million reported last year. But the addition of Custom Direct should spark Deluxe revenue for all of 2010 to its first gain since 2006. Analysts are projecting revenue of about $1.36 billion to $1.4 billion, compared with $1.34 billion in 2009. Even though Deluxe has said Custom Direct won't contribute to earnings this year, Hamilton recently increased his 2010 per-share estimate by 5 cents to $2.55. That compares with $2.44 a share last year.

"We believe the combination of cost management and [Custom Direct] acquisition could lead to increases ... for the 2010/2011 years," he wrote.

Susan Feyder • 612-673-1723