I decided to write this blog about Lexmark following the company’s absolute pummeling in the stock market – the Lexington-based company has lost about 28% of its market value since July 20. To the casual observer, Lexmark’s Q2 report was not all that terrible – the company re-emphasized its strategic path toward enterprise software, confirmed that, yes, the stronger dollar is hurting its results too, and actually provided a more upbeat forecast for the full year. Yet recent headlines – “layoffs”…“slashing”…“restructuring”! – read more like a defeated Kentucky coal miner than a profitable Kentucky software and printer-maker. Given this divided picture, my goal here is to provide some level-headed context of Lexmark’s actual business structure, performance, and future prospects.
In the broadest sense, Lexmark today operates two businesses that serve complementary strategic purposes and have different long-term growth trajectories:
- Business #1 is Printing. This segment still generates the vast majority of Lexmark’s sales (~83%) and profit and is the vendor’s traditional core business that originated from an IBM spin-off. While printing is a mature market that is likely in modest decline, the industry is still very large (+/- $70-$80B) and very profitable, generating lots of cash for businesses like Lexmark to make strategic investments and reward shareholders. Lexmark would also note here that it is gaining share in MPS, which is a segment of the market that growing anywhere between mid-single digits and low double-digits depending on who you ask.
- Business #2 is Enterprise Software. This business is comprised of at least 14 acquired companies that primarily offer content and process management software and services. Enterprise Software is the smaller evolving piece of Lexmark’s business and the one that is so strategically important to the vendor’s future. As recently as calendar Q4, Lexmark estimated that content and process management software was about a $10 billion market and was growing at around a 10% CAGR, representing a much smaller but faster growing opportunity compared to print.
Lexmark’s strategy with these two different but complementary businesses is to focus on growing MPS and Enterprise Software, which it labels as a means to ‘solve customers’ information inefficiencies.’ Similar to other imaging vendors, the MPS component of this strategy seeks to lock in customers in an otherwise commoditizing and highly price competitive printing market. This deeper customer relationship that MPS establishes can, if well executed, drive further opportunities for both the print and software businesses. Customers such as Piedmont Healthcare, which was originally a Lexmark MPS account and now uses an array of Lexmark Enterprise Software solutions, is a great example of the opportunity that Lexmark and other imaging vendors have to solve more complex customer workflow and content needs.
Like the industry at large, the evolution of Lexmark’s Enterprise Software division has not come without costs (literally and figuratively). Beginning with the purchase of Perceptive Software for $280 million in early 2010, Lexmark has spent around $2 billion building Enterprise Software, which generated around $150 million in sales in Q2 (~17% total revenue).
This $2 billion represents a significant investment for a company of Lexmark’s size, and, as the exclamations at top suggest, this spending has caused some recent changes at Lexmark. The vendor’s longstanding share buyback program is halted for now as the company pays off its $1 billion purchase of Kofax. It has substantially reduced a nice cushion of offshore cash and its debt has increased measurably. And, while Lexmark has purchased a sizable Enterprise Software division with lofty growth rates, the fact remains that the company’s acquisitions have been largely strategic to-date, with relatively low organic growth.
Meanwhile, things are not completely rosy in Lexmark’s printer business. MPS growth has been reliable, with a CAGR of just under 10% since Q2 2010. But since 2011 non-MPS sales have declined faster than MPS has grown, which further drags down a printer division that has also shed an entire inkjet division. And to make matters worse, Lexmark is now experiencing channel inventory issues in EMEA (where 36% of sales are generated), which will impact its Q3 sales and earnings (and cause reactions like what we saw in the stock market and news outlets above).
Despite a single three month reporting period and outlook that was not perfect, Lexmark the printer and software maker appears to be on the right path – one that it is quite committed to at this point! Lexmark is arguably one of the best vendors in the imaging industry in terms of its vertical-centric sales, and should benefit from consultative sales that drive opportunities for its evolving Enterprise Software business. That said, now that Lexmark’s M&A activity is over for now, the vendor must prove that it can not only build an impressive ECM portfolio, but that it can deliver solutions growth that justifies its $2+ billion in acquisitions.