Thesis:
Lexmark issues debt that yields less than 7% to buy back equity yielding more than 20%. This policy is sustainable and will in time force up the share price to at least twice the current level.
FCF yield & Earnings yield > 20%
The company:
Lexmark International, Inc. (LXK, Financial) is a vertically integrated developer, manufacturer and supplier of printing and imaging solutions. Lexmark's product line includes laser printers, inkjet printers, multifunction devices and associated supplies and services.
Manufacturers such as Lexmark and Hewlett Packard use the razor/blades approach to sales, selling the printer as cheap as possible and making up for it as customers buy high-margin replacement toner and ink.
The Company sees continued erosion in end-user inkjet supplies demand due to the reduction in inkjet hardware unit sales and is executing a strategy focused on higher-usage segments of the market (SOHO).
According to IDC www.idc.com :
The inkjet market remained the dominant segment in 4Q08, with 22.8 million units shipped, but it was also hit the hardest with –18% year-over-year growth.
Monochrome laser was the second largest technology segment with 7.2 million units shipped and year-over-year shipment growth of –17.3%.
Color laser shipments, the third largest segment, was essentially flat year over year and was the only segment not to experience a decline in the quarter.
Lexmark is the fifth worldwide market player overall, it lost two points in total market share (4.7%). The strongest growth for Lexmark was the global Laser MFP segment where its shipments grew 20% year over year.
Debt capacity:
With 200m (a record low) of net income under:
- recession conditions
- an (allmost record) high capex of 245m
Lexmark should be able to service 1B of long-term (interest bearing) debt.
Long-term debt now stands at 600m. The company should be able to sell 400m of additional debt.
Lexmark currently has 800m of cash and cash equivalents on it's balance sheet...... meaning the company could spend ~1.2B on it's policy of aggresively buying back shares without cutting back on it's currently high capex.
From the 10q: "As of March 31, 2009, there was approximately $0.5 billion of share repurchase authority remaining."
With a market cap of 1.1B, Lexmark is able to sustain it's policy of buying back shares till the very last share. If by so doing the equity yield should rise above the yield of it's debt, it would be in the interest of shareholders to change the policy and buy back debt or return excess cash to shareholders in the form of dividend.
For the FCF yield of the equity to come near that of the debt, the stock price must triple.
Specific Risks:
1) Lexmark's strategy of gaining market share in the Laser MFP segment could fail.
2) Lexmark could spend it's cash on a dumb acquisition
As to the first risk, this could conceivably be dealt with by shorting the bonds.
Catalysts:
1) Lexmark announces an accelerated buy back program.
2) A takeover bid by Dell or any other strategic buyer.
Any and all questions and comments welcome as usual.
Lexmark issues debt that yields less than 7% to buy back equity yielding more than 20%. This policy is sustainable and will in time force up the share price to at least twice the current level.
FCF yield & Earnings yield > 20%
The company:
Lexmark International, Inc. (LXK, Financial) is a vertically integrated developer, manufacturer and supplier of printing and imaging solutions. Lexmark's product line includes laser printers, inkjet printers, multifunction devices and associated supplies and services.
Manufacturers such as Lexmark and Hewlett Packard use the razor/blades approach to sales, selling the printer as cheap as possible and making up for it as customers buy high-margin replacement toner and ink.
The Company sees continued erosion in end-user inkjet supplies demand due to the reduction in inkjet hardware unit sales and is executing a strategy focused on higher-usage segments of the market (SOHO).
According to IDC www.idc.com :
The inkjet market remained the dominant segment in 4Q08, with 22.8 million units shipped, but it was also hit the hardest with –18% year-over-year growth.
Monochrome laser was the second largest technology segment with 7.2 million units shipped and year-over-year shipment growth of –17.3%.
Color laser shipments, the third largest segment, was essentially flat year over year and was the only segment not to experience a decline in the quarter.
Lexmark is the fifth worldwide market player overall, it lost two points in total market share (4.7%). The strongest growth for Lexmark was the global Laser MFP segment where its shipments grew 20% year over year.
Debt capacity:
With 200m (a record low) of net income under:
- recession conditions
- an (allmost record) high capex of 245m
Lexmark should be able to service 1B of long-term (interest bearing) debt.
Long-term debt now stands at 600m. The company should be able to sell 400m of additional debt.
Lexmark currently has 800m of cash and cash equivalents on it's balance sheet...... meaning the company could spend ~1.2B on it's policy of aggresively buying back shares without cutting back on it's currently high capex.
From the 10q: "As of March 31, 2009, there was approximately $0.5 billion of share repurchase authority remaining."
With a market cap of 1.1B, Lexmark is able to sustain it's policy of buying back shares till the very last share. If by so doing the equity yield should rise above the yield of it's debt, it would be in the interest of shareholders to change the policy and buy back debt or return excess cash to shareholders in the form of dividend.
For the FCF yield of the equity to come near that of the debt, the stock price must triple.
Specific Risks:
1) Lexmark's strategy of gaining market share in the Laser MFP segment could fail.
2) Lexmark could spend it's cash on a dumb acquisition
As to the first risk, this could conceivably be dealt with by shorting the bonds.
Catalysts:
1) Lexmark announces an accelerated buy back program.
2) A takeover bid by Dell or any other strategic buyer.
Any and all questions and comments welcome as usual.
