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  Chalk up another takeover in the Contra stable

BENJ GALLANDER and BEN STADELMANN

Thursday, November 21, 2003

This year is shaping up to be a sparkling one for our portfolio, and a string of takeovers has been a major reason why.

First Corel was bought out by Vector Capital, then Boise Cascade lunged at OfficeMax and Air France is in the process of flying off with KLM Royal Dutch Airlines. Now R. R. Donnelley & Sons is bidding for Moore Wallace. Four takeovers in such a short time frame is remarkable, though we saw equal tallies in 2001 and 1997, and enjoyed a record-high five takeovers in 1999.

Even with that track record, this year's takeover count has come as a big surprise, given the way our view on the "devil of overdiversification" has evolved. At one time, our portfolio often sported more than 30 stocks, but we reckoned that a roster of 15 to 25 would be easier to manage and would produce better results. Currently there are 19 in the lineup, leaving plenty of openings for some December tax-loss draft picks.

We first wrote about Moore, the business form and printing giant, in our inaugural Globe and Mail column almost four years ago. At that time, the stock was trading at around $8. Much has happened since then, and the return to favour of this downtrodden outfit has followed anything but a straight line. Spinning its wheels in an endless loop of restructuring, the enterprise finally began to right itself under the stewardship of Robert Burton.

Besides being an efficient manager, Burton also brought the former Canadian blue-chip into the orbit of American financial interests. Some of these funds ultimately helped Moore pull off a takeover of rival printer Wallace Computer Services.

All this garnered the attention of Donnelley, a printing behemoth with annual sales of about $4.75 billion (U.S.). Donnelley prints everything from TV Guide and Sports Illustrated to catalogues and bestsellers. Its direct-mail division makes entire forests quake in fear. You may not think the junk-mail business is hurting, but Donnelley's stock price has been depressed well below where it has spent most of the past eight years and is only now in recovery mode.

The merger creates North America's largest printer, knocking Quebecor from the podium. The prospects of this new conglomerate, which will be run by Burton's relatively recent replacement, Mark Angelson, look promising.

People on the Donnelley side are suggesting that the takeover will deliver an immediate boost to earnings after transaction costs are paid. They estimate annual savings at about $100 million in the first 12 to 24 months after the merger. Advertising is highly sensitive to the economy, so a sustained recovery is apt to drive profits from commercial printing sharply higher. This should help to cover the juicy dividend, currently $1.04 a share.

Making big deals is one thing, running a complex amalgam of three corporate cultures is another. Our original sell target of $27.75 for Moore translates to $33.63 for Donnelley, though after all the twists and turns, a recalibration will be in order. We will hold for now, believing on first blush that this complementary takeover will likely lead to a higher valuation for the combined entity.


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