Lexmark Can Reach $32 On Restructuring, Perceptive Software And MPS

Lexmark International (NYSE:LXK) is exiting the inkjet hardware division and is restructuring its business to concentrate on laser printers, managed printing services and Perceptive software. Inkjet printers are usually sold at a loss and the loss is made up on sale of peripherals such as ink cartridges. With counterfeit cartridges easily available and users re-filling old cartridges, this business model has not worked out too well in recent years.

We estimate that the average price of an inkjet printer (non-AIO) is ~$27 and this is before the retailer’s margin is added. The price average price of a cartridge on the other hand is ~$30. EBITDA margins of the division are low and dropping, and we expect Lexmark’s focus on laser printers, Perceptive Software and Managed Printing Services to drive the company in the future. We expect Perceptive Software to be the highest growth opportunity for Lexmark and we expect the MPS business line to grow and provide a steady source of income as these contracts are long term in nature and will make up for the drop in inkjet printer sales as corporations transition to a Printing-as-a-Service model.

See our full analysis on Lexmark

Lexmark Is The Undisputed Leader In  Managed Print Services

Lexmark has been recognized as the leader in MPS from industry analysts; Gartner, IDC and UK based Quocirca. MPS is a way for the company to increase margins as the hardware market is highly commoditized. We estimate margins for hardware to be around 17% and remain the same until the end of our forecast period. MPS provides cost efficiency for the customers. Security and cost efficiency are the biggest drivers for enterprises to shift to MPS followed closely by a reduction in carbon foot print and operational efficiency.

MPS currently contributes to a small portion of the revenues, but is set to grow as it focuses its business on the service aspect. Lexmark has recently bagged a 5-year $21 million contract from the Federal Aviation Administration (FAA), which will make it the sole provider of printing solutions. It has also won contracts from the USDA and Anehuser-Busch to provide MPS. Currently the largest division for Lexmark is Laser Printers and Cartridges which constitute 73 percent of our current Trefis price estimate.

Perceptive Software Services

Perceptive Software is an Enterprise Content Management provider and a Business Process Managment solutions provider. It is used to bring paper invoices, bills and other non electronic invoices into the electronic mainstream for more efficient processing. We estimate the margins of this business to be in the range of 25 percent and estimate that this would be the margins for MPS as well. Perceptive Software is the main service offering of Lexmark and constitutes 10 percent of the current Trefis price estimate. Perceptive software revenues have been growing rapidly and we expect it to grow at nearly 20% y-o-y. We estimate that revenues will reach $285 million at the end of our forecast period. If Perceptive Software services growth doubles to $570 million in the same period, we expect 13 percent upside to the current Trefis Price estimate. The ECM and BPM market has witnessed rapid growth over the past few years and we expect the market to continue growing rapidly in the future at a compound rate of 12% annually reaching $8 billion in 2014.

Higher Margins on Software Business

Software businesses usually have higher margins than hardware business as they are generally free from component costs. Perceptive Software has an estimated EBITDA margin of ~22% in 2012-2013, which is much higher than Lexmark’s printer business. We expect the division’s margin to increase going forward as Perceptive Software related merger synergies will help reduce costs. We assume a discount rate of ~9% and a tax rate of ~20% in our calculations.

Restructuring To Save Costs

Restructuring is expected to save on inkjet related infrastructure costs, research and development costs, supply chain and other support function costs. Lexmark’s Philippines inkjet supplies manufacturing facility will also be shut down, by the end of 2015.  It expects to eliminate ~1,700 jobs worldwide, including 1,100 manufacturing positions. It will also look to sell the company’s inkjet-related technology. The restructuring is expected to generate $85 million savings in 2013, increasing to $95 million beginning in 2015. The pre-tax cost for the restructuring is expected to be $160 million, with a $110 million outflow in 2012, $30 million incurred in 2013, and $20 million spread over 2014 and 2015. The cash flow impact of the restructuring is expected to be $75 million, with $40 million impacting 2012, $30 million impacting 2013, and the remaining $5 million impacting 2014 and 2015. Lexmark also announced an additional $100 million of share repurchases in the third and fourth quarter of 2012.

Based on the arguments stated above, we believe that Lexmark is worth $31.73.

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