Lexmark Printer Business To Suffer In H2 2015 Despite Growth In MPS

Lexmark International (NYSE:LXK) has been focusing on building its end-to-end solutions company with emphasis on Electronic Content Management (ECM) and Business Process Management (BPM). However, its printer hardware and supplies business generates most of the cash, and makes up 83% of its estimated value. Due to the secular downtrend in the printer hardware market, its printer business has suffered with stagnant perfromance. Furthermore, intense price competition from OEMs and cheap supplies from independent suppliers, who offer re-manufactured (and, in some cases, counterfeit) cartridges and refills at lower prices, has affected its printer and supplies revenues. We believe that these trends will continue in second half of 2015 and the company will continue to report a decline in printer revenues. Additionally, Managed Printer Services (MPS), which form 22% of printer business, might not be able to offset the decline in overall revenues. In this note, we explore these factors in detail.

See our full analysis on Lexmark

Players Competing On Price

According to IDC, the worldwide hardcopy peripherals market shipment declined by 6% in Q2 2015. ^[1] The trend indicates that demand for both inkjet and laser printers faltered in Q2, as was the case in Q1. However, the decline in demand for laser printer in both Multi-Function printer (MFP) and single function format was steeper than the industry.  While the single function laser printer market declined by 14.4% year over year in the second quarter, MFP shipments decreased by 6.6%.

In order to compensate for the fall in printer units, and to increase their market share, many hardware manufacturers, especially Japanese manufacturers, have cut the prices on their printers. This was reflected in the Q2 numbers reported by IDC.  IDC reported “Epson outperformed all other vendors for the second quarter in a row, with continuous success in the inkjet segment. Most of Epson’s growth came from the United States and Asia/Pacific (excluding Japan)(APeJ).”  ((Worldwide Hardcopy Peripherals Market Declines Nearly 6% in the Second Quarter of 2015, August 24 2015, www.idc.com)) Most of the Japanese OEMs have their manufacturing units in China, and this gives them the leverage to under cut competition on price.

Lexmark’s manufacturing operations for laser printer supplies are located in Boulder, Colorado; Juarez, Mexico; Zary, Poland; and Shenzhen, China. According to Lekmark’s 10-K fillings, most of its laser printer cartridges are assembled by a combination of in-house and third-party contract manufacturing, and the manufacturing control center for laser printer supplies is located in Geneva, Switzerland. ^[2] Considering that the company relies on third party vendors and its facilities located in the Americas and Europe, we believe that Lexmark might not be able to compete with other players on price. Therefore, we believe that it will continue to struggle behind bigger players such as HP and Epson. Furthermore, it is extensively focusing on the A4 (paper format) printer segment that forms 77% of total printer sales and witnessed marginal growth of 0.6% year-over-year growth in the second quarter.  While the laser printer market has declined to 8.8 million in Q2, we estimate that Lexmark’s push in the sub-segment will result in improvement in its market share by 10 basis points to 4.61% by 2022 at the expense of margins.

Commoditization To Affect Supplies Revenues

Over the past few years, commoditization of printer and toner cartridges has come to fore. Independent suppliers, most of them third party vendors to OEMs or local producers in the market, offer refill and re-manufactured alternatives for original inkjet and toner supplies. These are often available for lower prices but generally offer lower print quality and reliability; however, users use these to reduce what they spend on printing. As a result, supplies revenues for OEMs have been declining for the past few quarters. Lexmark supplies revenues, inline with the industry trend, have declined over the past few years, accentuated by its exiting the inkjet business. While it continues to sign new licenses for its MPS business, the number of cartridges’ it sells continues to decline due to advent of longer lasting cartridges that print more pages. In the past it has declined from 7.2 cartridges per printer in 2011 to 5.22 cartridges in 2014 according to our calculations. We estimate that this will decline further to 4.82 in 2015, which will result in a decline in supplies revenues in 2015.

Managed Printer Service To Give Some Respite

Lexmark is offering managed print services (MPS), under which the procurement and maintenance of hardware and cartridges, along with other aspects of printing, are managed by Lexmark. As a result of these efforts, Lexmark’s MPS contracts have increased. This has positively impacted its printer supplies business. We believe that MPS integrated with Perceptive’s solutions will deliver value to Lexmark’s growing customer base. We expect MPS to become the biggest driver of revenue in ISS division going forward. Due to MPS contracts, we expect Lexmark’s laser cartridge pricing to stabilize at $227.

Additionally, the contribution from services to MPS business remains small. Currently, we forecast other parts and services revenue, which is primarily MPS revenues, to remain flat at $187 million.  However, if Lexmark bags more MPS contracts then this figure can be significantly higher.

You can drag the trend lines in the interactive charts above to see how various scenarios for laser printer market share, cartridges per laser printer and Perceptive software revenues affect Lexmark’s stock value.

We have updated Lexmark price estimate to $36.80 , which is 30% above its current market price.

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1. Worldwide Hardcopy Peripherals Market Declines Nearly 6% in the Second Quarter of 2015, August 24 2015, www.idc.com [↩]
2. 10-K 2014 [↩]