Lexmark Pre Earnings: Printer Revenue To Decline, Software Revenue To Report Growth

Lexmark International (NYSE:LXK) is set to release its Q3 2016 results on October 28th. ^[1] The company announced that it has entered into a definitive merger agreement with a consortium of investors led by Apex Technology Co., Ltd. (Apex) and PAG Asia Capital (PAG), under which Lexmark will be acquired for $40.50 per share in an all-cash transaction with an enterprise value of approximately $3.6 billion, net of cash. ^[2] On 22nd July, the company announced that its shareholders have approved the merger. Post the close of the transaction, Lexmark’s common stock will cease to be publicly traded on the New York Stock Exchange. The merger remains subject to approval from China’s State Administration of Foreign Exchange (SAFE) and other customary closing conditions.  The parties continue to expect the transaction to close in 2016. While the company declared weaker than expected result in Q2, our expectation for Q3 results are as follows:

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Hardware Sales To Dent Revenue Growth

Laser printer and cartridge division is its biggest business unit and makes up 75.2% of Lexmark’s estimated value. According to IDC, the worldwide hardcopy peripherals market shipment declined by 3.8% in Q2 2016. ^[3] The trend indicates that the decline in demand for both inkjet and laser printers slowed down in Q2, as was the case in the first quarter of the year. However, most of the improvement in the global market was largely driven by strong demand in the color laser (21ppm+) and mono laser (21-30 ppm) segments with 18.0% and 8.9% year-over-year growth, respectively. We believe this trend persisted in Q3 as well, and this could have impacted revenue growth at Lexmark. Since Lexmark has been concentrating on the large work group segment (color and mono printer segment) that is typically attached directly to large workgroup networks in corporations, we expect Lexmark to report higher average sales prices for the number of units of printers it sells in Q3.

Furthermore, as there has been a gradual shift in hardcopy peripheral devices away from the desktop and towards more shared and centralized solutions. This shift is driving some of the growth in the printer hardware sales. It is also bolstering revenues for companies that provide MPS, which includes procurement, maintenance and other aspects of printing. Lexmark is offering managed print services (MPS), under which the procurement (of hardware and cartridges), maintenance (of printers and printing solutions) and 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.

Revenue Growth from Perceptive Software in Focus

The Perceptive software division is the second biggest business unit and makes up nearly 24.8% of Lexmark’s estimated value. As Lexmark plans to become an end-to-end solution provider, Perceptive Software is becoming an increasingly important division for Lexmark. During Q2, revenues from this division grew by 12% to $167 million, driven by an acquisition. The company witnessed excellent growth across subscription, maintenance, and professional services. Before the acquisition, Lexmark had guided to 15% growth in Perceptive’s revenue for 2016. We expect that the growth in Perceptive’s licensing revenue due to recent acquisition will contribute to both topline and bottom line in Q3 (and FY2016). Therefore, in this earnings call, we will continue to closely follow the deal pipeline for the Perceptive software business.

We currently have a  $30.78 price estimate for Lexmark, which is 23% below its current market price.

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1. Lexmark Press Release [↩]
2. Lexmark agrees to be acquired by Apex Technology and PAG Asia Capital, April 19th 2016 [↩]
3. Worldwide Hardcopy Peripherals Market Shows Signs of Improvement in the Second Quarter, According to IDC, August 30 2016, www.idc.com [↩]