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Printing a Record of Growth

By Olga Kharif At first glance, it might seem a bit strange that Evergreen Technology Fund manager John Rutledge has poured nearly $1 million into Hewlett-Packard (HPQ) shares not for its booming PC business nor its servers and storage equipment -- but for its printers. Rutledge likes that business' prospects so much that he also invested an additional 4% of the $18 million he manages into printer maker Lexmark (LXK).

At a time when tech investors snap up shares of PC makers (figuring corporate users will be upgrading their old machines) or networking-gear suppliers (considering the proliferation of wireless networks), the printer sector gets no respect. Investors have largely overlooked the market. Heavyweight HP receives 31% of its revenue from imaging and printing devices. Yet, although it has launched a splashy marketing campaign, its stock is trading at $24 -- or just 15 times 2005 earnings vs. p-e's of 20 to 30 times 2005 earnings for many tech outfits.

REAL-TIME PIX. Yet segments of the printer market are expected to enjoy faster growth and higher margins than many other tech areas. That's partly because consumers increasingly view printers as peripherals for digital cameras, says David Haueter, an analyst with market consultancy Gartner Dataquest (see BW Online, 2/13/04, "Digital Cameras: A Brighter Picture").

Digital-camera sales grew 64% last year, to 50 million units, according to Photo Marketing Assn. estimates, with anecdotal reports of some users bringing their printers to weddings to surprise the newlyweds with photos of the event before they leave on their honeymoon. Cell phones with embedded cameras have been the mobile industry's hottest sellers in 2003 as well.

What's more, consumers seem willing to pay more for more capabilities. These days, says Gartner Dataquest analyst Peter Grant, consumers like multifunction devices (MFD), which combine printing, copying, and faxing and sell for $200 or more, vs. $49 to $100 for simple inkjet machines. From the second to third quarter of 2003, sales of stand-alone printers fell from 75% to just 58% of the total U.S. inkjet market -- with MFDs taking the rest of the share, estimates Claudio Checchia, an IDC research manager. The world market for MFDs grew by 21% last year, to nearly $2 billion.

MISSING ENGINE? A further plus for the industry is that consumers tend to use their photo printers and MFDs more often than their old machines -- and they buy more replacement cartridges, which are the real money-makers for the printer companies. Consumers typically replace their inkjet cartridges, priced at $20 to $40, three times a year, estimates Rutledge -- and each cartridge costs only a few bucks to make. And folks who buy an HP printer tends to buy HP cartridges.

Not all segments of the printer world are so active. The corporate market, where Xerox (XRX) is strongest in many areas, seems stagnant today as businesses continue to be thrifty and avoid purchasing new gear until absolutely necessary. Although shares of Xerox, the leader in many imaging and printing devices, have hit a three-year high of $15.31 in January, the outfit is growing primarily through gains in categories such as MFDs -- rather than through market growth, says Jim Firestone, Xerox' chief strategist. "The market is strengthening, but there are no indications of robust corporate replacements," he says.

Xerox got out of the consumer printer business -- the real growth engine in this recovery -- when it restructured in the face of financial problems back in the summer of 2001. But it might come to regret that decision, says Grant. And though Xerox denies it, Grant believes it should start reselling consumer inkjet printers from partners -- or create its own products.

CHEAPER CARTRIDGES. In the current market, analysts think HP and Lexmark may be the best investments. Canon (CAJ) and Seiko Epson also have vibrant consumer printer businesses, but HP and Lexmark are the leaders in fast-growing sales of inkjet MFDs, with 58% and 21% of the U.S. market, respectively. HP also dominates the sales of inkjet photo printers, with two-thirds of the U.S. market, while Lexmark is No. 3, behind Epson.

With printer demand driving growth, Lexmark on Jan. 26 reported record revenue of $4.76 billion for 2003, up 9% vs. 2002. Its profits increased 20%, to $439 million. Analysts expect HP, which will report its first-quarter 2004 results on Feb. 19, to show increasing printer sales as well.

In the long term, the biggest challenge for printer makers may be improvements in cartridge refills, making their replacement unnecessary. Furthermore, in the U.S. and Europe, a legal battle has been ongoing against Lexmark, which has suffered some setbacks, that could make it easier for third-party vendors to sell cartridges for Lexmark's and other vendors' printers. And that could open the door further to discount cartridge and ink makers, eating deeply into printer manufacturers' profits.

SEAMLESS CONNECTIONS. Still, the smooth ride should last through this year as the printer giants improve their products and technologies. Already, most manufacturers offer devices that read memory cards from digital cameras, feature LCD (liquid crystal display) screens to offer photo previews, and provide spec sheets. Many, like HP, also sell digital cameras that work seamlessly with their printers.

Other positive trends could come into play longer-term. In the next few years, many manufacturers are set to adopt a standard called PictBridge, which will allow any camera to communicate with any manufacturer's printer. That could further boost sales, Haueter says.

The producers are also working on making it easier to print pictures from cell phones. HP has announced that it's developing a printer with Bluetooth wireless technology to transfer and print photos from Nokia (NOK) phones. And, on Feb. 12, HP, Canon, and Epson announced a group, dubbed the Mobile Printing & Imaging Consortium, to develop standards for printing snapshots from cell phones.

The bottom line: Printer sales should remain red hot. And that means manufacturers could be printing money for some time to come. Kharif covers technology for BusinessWeek Online from Portland, Ore.

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