US CREDIT-RR Donnelley's growth strategy raises concerns

By Dena Aubin

NEW YORK, Aug 12 (Reuters) - R.R. Donnelley's credit
spreads have tightened on signs of a healing economy, but
analysts say acquisitions could increase risks for the printing
giant's bondholders and weigh on its yield gap in future.

North America's largest commercial printer, R.R. Donnelley
(RRD.O) last week reported an 83 percent drop in quarterly
profit as demand slowed, though it said it expects sales to
grow modestly in the third quarter.

Helped by a broad credit market recovery, Donnelley's
five-year credit default swaps have tightened by over 150 basis
points over the past month to about 233 basis points, according
to data from Markit.

Its 6.125 percent notes due in 2017 have tightened by more
than 60 basis points month to date to 387 basis points over
Treasuries, according to MarketAxess.

Like other printers, Donnelley was hit hard by the
recession as customers cut printing jobs or moved more of their
business to the Internet. A glut of capacity has been another
huge problem for printers, keeping prices under pressure and
competition fierce.

Over-capacity is so great that the industry may not fully
recover even when the economy improves, Moody's Investors
Service said in April. It cited poor industry fundamentals as
one reason for Donnelley's Baa3 rating, one notch above junk.

In the years leading up to the credit crisis, the printing
industry went through massive consolidation, and that trend is
likely to continue as credit markets heal, with Donnelley as a
leading acquirer, analysts said.

"R.R. Donnelley is a major consolidator in the fairly
fragmented printing industry and you can rest assured that they
will continue with their acquisition spree once they can obtain
funding," said Sean Egan, managing director for Egan-Jones
Ratings Co in Haverford, Pennsylvania.

Donnelley has been buying up smaller companies for at least
a decade in a move to wring out costs and broaden its customer
offerings. In one of its latest bids, it offered earlier this
year to buy insolvent Canadian rival Quebecor World IQW.TO
but abandoned that deal after Quebecor's board rejected a
sweetened offer.

Dave Novosel, analyst at independent research service Gimme
Credit, said Donnelley may face continued pricing pressure from
smaller companies that are losing revenue and need to reduce
their prices to improve market share.

"It is one of the larger players in the industry and they
do a pretty good job of it; it's just that the industry itself
is suffering from the downturn in the economy," he said.

Donnelley's bid for Quebecor was not expected to jeopardize
its ratings, and future acquisitions will likely be structured
so that Donnelley could remain investment-grade, said Sam
Goodyear, analyst at independent research firm CreditSights.

"The real issue for bondholders is whether the benefits of
merger synergies can offset the secular demand decline that's
just crushing the company," he said.

Although acquisitions may not raise Donnelly's leverage
initially, they would increase Donnelley's exposure to an
industry that is losing commercial printing applications to the
Internet, he said.

For other related fixed-income quotations, stories and
guides to Reuters pages, please double click on the symbol:

U.S. corporate bond price quotations...NASDBONDS

U.S. credit default swap column........[CDV/]

U.S. credit default swap news..........[CDV]

European corporate bond market report..[EUB/]

European corporate bond market report..[EUB/]

Credit default swap guide..............CDSINDEX

Fixed income guide......BONDS

U.S. swap spreads report...............[SWP/]

U.S. Treasury market report............[US/]

U.S. Treasury outlook...[US/0]

U.S. municipal bond market report......[MUNI/]

(Editing by Andrew Hay)