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Online Extra: Lexmark May Not be Sexy, But...


Sometimes, boring businesses make the best investments. Lexmark International (LXK) is in the ho-hum field of selling low-cost printers. But by boosting sales and beating Wall Street's expectations despite a brutal environment for tech spending, it has accomplished something very few tech companies can brag of recently. At $60, Lexmark is trading nearly 50% above its September, 2001, low of $41 -- while the Nasdaq 100 Index recently slipped below its September mark.

Much of Lexmark's recent gain came after it reported first-quarter revenues on Apr. 22. It posted sales of $1.05 billion, a 6% boost over the prior year's period -- and that after recording a 9% jump in revenues for all of 2001, to $4.1 billion. Lexmark also managed to beat analysts' earnings estimates by 10%, with net income of $71 million, or 53 cents a share (even though earnings slid 11% from the prior year, as it cut prices on some models).

Lexmark's relative good fortune, combined with a slight rise in its share price over the past 12 months, landed it the No. 16 spot on this year's BusinessWeek IT 100 list of the best-performing tech companies.

BELIEVABLE BUSINESS. For beleaguered tech investors, Lexmark's business model is easy to understand, generates good profits, and is predictable. The company sells printers on the cheap, actually subsidizing ink-jet models that start at $49 at retail, then reaping profits on the sale of high-margin ink cartridges. The more printers it sells, the larger the base of customers it can expect to buy cartridges. Indeed, sales of supplies made up 52% of its first-quarter revenues, vs. 48% a year ago.

"Investors can look at [Lexmark's] numbers and believe in them," says Joshua Wyss, an analyst at Soundview Technology Group who rates the stock a buy. Even if businesses forego spending on new hardware, they'll replace printer toner, he reasons. "In a market where investors are afraid to own anything, people will step up and own this."

Long term, both businesses and consumers -- who account for about 50% of Lexmark's sales and dominate its fast-growing ink-jet business -- are expected to print increasing amounts of information off the Internet and from e-mail. Growth in digital photography is also spurring demand from consumers.

SATURATION POINT? Particularly successful have been Lexmark's new "all-in-one" models that combine a fax, scanner, and printer starting at $149. Such multiple uses also lead to more ink consumption, says Mark Sisk, Lexmark's head of investor relations. Merrill Lynch credits sales of the all-in-one products with helping Lexmark beat estimates in the first quarter.

Despite all that's going right at Lexmark, it faces plenty of near-term risks. For one thing, precisely because the printer business is so stable and profitable -- at least, relative to PCs and software -- it's becoming increasingly competitive. In fact, in a recent note, Merrill Lynch worried that the business is becoming saturated.

Hewlett-Packard (HPQ), in particular, is expected to devote more resources to dominating this market (it's already No. 1 in printer sales worldwide). Compaq (CPQ), which used to sell Lexmark printers, is expected to switch to HP. But Lexmark should pick up additional sales from other PC makers that will no longer bundle HP printers.

EU INQUIRY? In another development that Lexmark investors are closely watching, Dell Computer (DELL) is expected to soon enter the printer business, most likely by signing with another company to manufacture its branded units. Lexmark is in the running for this contract, but it could just as easily lose out to a competitor such as Epson.

Soundview's Wyss says the stock could jump $5 if Lexmark wins the contract, and it would likely slip a bit if not. Sisk says Lexmark is already a supplier to Dell and hopes to expand that relationship, but he declined to comment on the negotiations.

Another risk Lexmark investors need to keep in mind: A controversy over the price of printer cartridges is building in Europe. In May, a European Union commissioner commented in a speech that he intends to investigate the ink-jet cartridge market for noncompetitive practices. No formal inquiry has been announced, but Wyss expects it to occur over the next 12 to 24 months and affect all printer makers.

However, any EU remedy that reduced profitability of the cartridge business would simply lead the companies to raise prices on the hardware, he says. Sisk, who acknowledges that the supplies business subsidizes the hardware, says the EU hasn't contacted Lexmark about the matter.

SHOOTING THE GOOD. By far the biggest challenges facing Lexmark shares are the continuing weakness in tech spending and the skittish stock market. Even as the general economy improves, tech spending is showing few signs of picking up. Lexmark says it expects second-quarter sales to grow at least as fast as in the first (and possibly at a double-digit rate) and that earnings per share should be in the range of 56 cents to 66 cents, vs. 65 cents a year earlier. Landing somewhere in that broad range seems achievable, analysts say.

Nonetheless, if tech stocks fall further, Lexmark could decline along with them. "That's my biggest worry," says Morningstar analyst Joseph Beaulieu. "In this environment, even the good companies are being taken out and shot along with the bad ones." He estimates that $57 a share is a fair price for Lexmark's stock and suggests that investors buy on the dips.

Given the near-term risks, those averse to suffering more volatility in the tech sector may want to stay on the sidelines. But for long-term investors brave enough to buy into tech now, if the stock gets cheaper, it could be worth snapping up. By Amey Stone in New York


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