Desktop Printer Business

Date: Mar 18, 2005
Contributor: Katy Pinelli

Printer market jammed

Lexmark's in a tight spot with Dell adding other suppliers and HP buckling down: but is it a buy?

The desktop printer business, of course, is all about selling the ink cartridges. The lowly cartridge essentially has printed money over the years for HP, Lexmark, and more recently, Dell.

Last week, however, we saw some new machinations in the market that may present risk-friendly investors with a buying opportunity -- if you can look beyond the short term news and peer out at longer trends.

Lexmark, the long-time second fiddle to HP in the printer market, got hammered last week by two negative, unrelated, stories.

The first was a downgrade by astute Needham and Co. analyst Charles Wolf.

He called attention to the fact that Dell -- which rebadges Lexmark printers -- was moving to other printer makers much quicker than he had anticipated. With Lexmark getting a smaller percentage of its key partner's sales, the blush was off the rose.

Then Hewlett-Packard executives made very clear last week they intended to make a push for market share in printers. Anyone who follows markets knows that "gunning for market share" means "we're dropping prices." HP's move -- should it happen -- pretty much forces Lexmark's hand.

"Theoretically, Lexmark could maintain prices and cede share," says Wolf. "But they're unlikely to do that. If they cede share their installed base won't grow, so the all-important cartridge revenue won't grow. If HP does price aggressively, Lexmark will be forced to meet their pricing."

A buying opportunity?
In light of these two events, Lexmark stock has tumbled 7 percent in the last two weeks and is nearing a 52-week-low. The reaction to Wolf's report and even the HP news seems overzealous, however, and may represent a decent opportunity to scoop up some shares.

Why? Even though Lexmark's percentage of Dell's sales is shrinking, Dell's overall printer sales are growing faster than most analysts expected.

Wolf, for one, had anticipated about $860 million in printer sales for Dell for the most recent quarter. According to his sources, it appears that number was closer to $1 billion (Dell lumps its printer sales in with digital cameras and other items). Lexmark's revenue from Dell in the most recent year was $570 million -- a pretty sizeable chunk of the company's $5.3 billion in revenue. (See correction).

"Even though Lexmark is getting smaller piece of Dell's pie, its absolute revenue is growing."

The HP news is far more troubling in the short term, but in the long term, any market share gain that Lexmark can pick up will pay off, thanks to the lucrative and recurring nature of printer cartridge sales.

Rob Enderle, principal analyst with The Enderle Group, sees this as an opportunity for Lexmark to differentiate itself in the market.

"Right now, Lexmark is defined by HP," he says. "They need to be known for something other than as a low cost alternative to HP."

Lexmark is a risky play, for sure. Compounding the risk: almost 90 percent of the float is owned by institutions, which don't take too kindly to these types of negative stories and could bail out in large numbers with further bad news.

But the printer cartridge market, as has been said many times before about the razor blades business, is a rare beast in the technology space: a category that mints money for its leaders. With Lexmark a strong number two in this market, and currently trading near its year-low, it's worth taking a look.




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