Can Old Imaging ‘Dogs’ Learn New Tricks?

In 1987, Tom Wolfe’s novel “Bonfire of the Vanities” and Oliver Stone’s film “Wall Street” depicted an amoral investment universe in which decisions are inevitably driven by whatever the numbers dictate is best for investors and their invested dollars. In financial terms this is logical: we do live in a capitalistic society, and a business’s investors (or shareholders) are the literal owners of the company and ultimately get to decide what the company is and does, who runs it, and what they expect in return for their investment dollars.

 On Wall Street, stocks that consistently underperform are referred to in derogatory terms as “dogs.” In the current bull market, whose rally started way back in March of 2009, most investors and shareholders have been happy with what they have seen the last five years — though the last 12 months have been somewhat less rewarding than the previous four. Still, in the last five years the S&P 500 Index has done nicely for those of us interested in the value of our 401k plans: in mid-March 2011, the S&P 500 Index (SPX) stood at 1,279; by mid-March 2016 it tallied at 2,106 — a 65 percent increase representing a Compound Annual Growth Rate (CAGR) of 10.49 percent. Not bad when 10-year treasury notes are hovering under 2 percent. 

Unfortunately for investors in several of the biggest players in the printing/imaging industry, the last five years have been less than stellar in comparison. Figure 1 illustrates the stock performance of HPQ, LXK, and XRX.

McIntyreChart

The best performing stock of these three examples is still what Wall Street would call a dog: Xerox grew at a CAGR of only 3.11 percent over the five-year period — less than one-third of the SPX. Lexmark’s CAGR over the same period was .22 percent; Treasuries might have performed better. HP is a special case as the company split into HP Inc. and Hewlett Packard Enterprise (HPE) in November — and investors received one share of HPE for each share of Hewlett Packard (HPQ) they owned in the breakup. As of this writing, shares of HPQ, the printing and PC company representing HP’s legacy business, were valued about $11.40, which would represent a -8.81 percent CAGR over this same period. But with a 1:1 share disbursement, as of this writing, shares of HPE were worth $16.77, a combined $28.17 when adding HPQ share values — representing an 11.3 percent CAGR over our measurement period, actually exceeding the S&P 500 index. We can only speculate what an unsplit HPQ’s valuation might be, but an arbitrary 20 percent valuation bump (a generous award mind you) from 2015’s $14.25 per share gets HPQ to $17.10 in 2016 — a .73 percent CAGR. Considering these numbers, is there any question why activist investors such as Carl Ichan have applied severe pressure on the management and boards of these three companies to take drastic measures to improve the value of their investments? In the parlance of investor relations press releases, shareholders are demanding the management of these companies “unlock” shareholder value anyway they can — most typically by splitting up into separate pieces whose combined value is greater than the market value of the existing shares. In simple terms, investors believe the sum of the individual values of the parts of these companies are worth more to the market than as currently constituted.

Why split?

When you have a company whose share values have dramatically lagged behind the market, any observer can ask: What is wrong with this picture? Why is this company’s stock value performing so poorly compared to others — even when the company is showing decent overall financial performance? The answer(s) to that question can be varied and complicated, such as:

• The company operates in a slow growth or declining industry — such as office printing overall. It is not sexy to most people and doesn’t attract investor attention. Spin-Off Research (www.spinoffresearch.com), a company that follows corporate spinoff activity, told us, “The printing market is a mature and slow-growing one, which is likely to consolidate. … An important thing to note among all three companies, irrespective of the presence of an activist (investor) pressure, is that they have all made wrong choices in acquiring companies.”

• It is widely accepted that most investors are less attracted to companies that are comprised of differentiated product/service divisions because the firm’s combined financials can be much harder to dissect and judge, and thus complicate the stock-buying decision. The same logic applies to “pure play” companies — firms whose business is concentrated essentially in a single market sector or segment are easy for potential investors to understand. It may also be true that some companies with multiple operating divisions can attempt to hide the weak performance of one group by combining reported performance numbers to obfuscate or mask the real situation. 

• Since “pure play” spinoff firms generally attract more investor attention, they attract more investment dollars; thus, the spinoff company’s valuation is likely to rise after the separation.

• There have been a number of reliable studies that have looked at resulting shareholder valuation post-spinoff, and they typically draw clear conclusions: the aggregate share values of the spinoff and the parent company exceed the valuation of the company prior to the breakup. According to research by Cantor Fitzgerald, the valuations of newly formed public spinoffs consummated between 2009 and 2013 outperformed the S&P 500 in their first year by an average of more than 17 percent.

• It doesn’t always work though: while Bloomberg’s 100-stock Spin-Off Index has historically outperformed the S&P 500, that hasn’t been true the last year or so — some say because investors are tired of so many recent and big spinoffs such as eBay and PayPal, and DuPont and Chemours. In 2015 the Bloomberg index, tracking spinoffs valued at more than $1 billion, found 14 spinoffs have lost an average 8.6 percent and their parents declined 2.4 percent.

• The public act of a major spinoff or breakup for any large, high-profile company is bound to attract business and trade press consideration, attention that company might otherwise not have gotten. It can also send a message to the investment community that the company is taking serious action to boost shareholder value, and therefore attract more investors — some of whom may like what they see.

• Since company management, and possibly its board as well, has been unable to keep share prices competitive with other investment options in the market, the rhetorical “change” question becomes substantive: if you don’t change something, how will the share price ever go up? Or, nothing changes if nothing changes.

• Faced with this share stagnation dilemma, many companies take the opposite tack; they search for acquisition targets to change their business and competitive market dynamics in the belief that the combined entity will alter the company’s fortunes. Sometimes, it actually works. However there are also a number of reliable studies that have looked at resulting shareholder valuations and company performance post-acquisition: the track record is not that great. 

• Historically, divisions were spun off because they were performing poorly or delivering lower margins, dragging down overall corporate financial results. Companies were unlikely to get a respectable price for weak divisions if they sold the operation to another firm — and the seller had to pay capital gains taxes when they did — so spinning off a weak division in a breakup, even if the new investors paid the same or even less than the likely value of an outright selloff, made prudent financial sense.

• There is reasonable evidence to suggest that the spinoffs, freed from the possible distractions and culture differences of the enmeshed corporate organization of the parent, and able to focus on their core business, are freer to innovate those businesses — often demonstrating improved performance (which they need to do to reward their new investors). When that happens often enough, it generates more investor interest in pending spinoffs. When large companies break up, they often espouse the benefits of increased focus, flexibility, efficiency, and dynamism as the benefits to both the parent entity and the spinoff or the split. Of course, these same companies often espouse the benefits of synergy, efficiency, and dynamism as the benefits to the business when they announce an acquisition. 

• A nicely performing spinoff offers its investors another appetizing prospect: perhaps it attracts enough attention to trigger an acquisition offer, further enriching its shareholders.

• As a straightforward case, we can look at HP. Clearly, the two companies’ overall market cap and combined share value have significantly improved post-breakup as of mid-March 2016, thoroughly justifying management’s decision to make the split. In the same vein, HP’s 1999 decision to spin off Agilent Technologies, which comprised many of the test and measurement operations of the original HP, enriched shareholders of both companies, and Agilent continues to prosper on its own. By contrast, we won’t even delve into the disastrous HP acquisition of Autonomy in 2011 for $11 billion, only to write off about $8.8 billion of Autonomy’s value just a year later. 

So, what’s next then?

It is hard to argue with investment activists who apply pressure to companies to take action to reward shareholders for their investments when the rest of the market is exhibiting broad-based valuation growth. Besides, they own these companies — they can decide what to do with them anyway. In fact, many of you reading this are actually the owners of these companies via 401ks and other investments we make with every paycheck. The imaging industry is still just a business, and in the end, the numbers do matter to all of us — OEMs, dealers, service organizations, parts makers, toner and ink supplies companies, and the customers that need and use these products. Having great, whiz-bang technology doesn’t mean squat if nobody makes any money selling it. These same OEMs, dealers, service organizations, parts makers, and toner and ink supplies companies all have to make money, especially the OEMs, from whom the initial overall market value of our entire industry originates.

Since (so far anyway, and admittedly not all the polls are closed yet) the Big HP Breakup has yielded positive investment value for the company’s shareholders, the prospect of a splintering of both Lexmark and Xerox would not appear to be events to be feared, or even events that signal the industry is failing. The Spin-Off Research team suggests that in each case, “The decision to split is primarily a result of the discord in growth profiles for the hardware and software businesses and also because the task of integrating these businesses post acquisition proved to be tougher and (more) uneconomical than estimated.” In the case of Lexmark (which, as of this writing, had not officially announced a split), that analysis appears to be spot on. Looking at Xerox, Spin-Off Research comments that the company “has been grappling with hardware-service transition issues since early 2000s … XRX purchased Affiliated Computer Services … in 2009. Though Ms. Burns stood by her decision and reaffirmed the value in keeping the company together, splitting the hardware and services businesses seems to be a logical move now.” A reasonable assessment is that for all three companies, digesting and integrating major acquisitions over the last decade just hasn’t worked out. 

One could easily argue that anyone with a vested interest in the imaging industry should be excited and eager to have these spinoffs improve the performance of the resulting entities, ultimately strengthening the industry overall. It is apparent that these companies had to do something — what they have been doing has not been working. It is also possible that these new companies with new strategies and products and services may open up new business opportunities for everyone involved. 

If the historical evidence is any indicator, what we get from the HP, Xerox and potential Lexmark breakups will be six companies whose overall market and investor interest is far greater than it currently is, and perhaps a more innovative and spirited industry. If investors ignore this industry, the capital will not be available to grow and develop the products and services necessary to re-ignite industry growth and help it transform itself to meet market demands. Since many already think of this industry as a paper-based dinosaur, maybe we can surprise them all by giving birth to several agile new businesses that will show everybody a thing or two, and draw investment dollars into the printing and imaging business. 

This article originally appeared in the April 2016 issue of The Imaging Channel.

John McIntyre

John McIntyre

serves as a senior analyst for BPO Media. With more than 40 years of experience in the printing industry as an analyst, product developer, strategist, marketer, and researcher, he has covered the printing and supplies sectors for prominent market research firms such as Lyra Research, InfoTrends, and BIS Strategic Decisions, and served with major OEMs such as Samsung, NEC, and Diablo Systems/Xerox. McIntyre is the former managing editor of Lyra’s Hard Copy Supplies Journal and has conducted research and consulting engagements examining issues such as market and business strategies, product positioning, distribution channels, supplies marketing, and the impact of emerging technologies.