Tuesday, October 20, 2009

Lexmark Gets Some Love

Lexmark reported earnings today. Before and after restructuring charges, the earnings were positive. Seemingly shocked that Lexmark didn't announce a bankruptcy, Wall Street bid up its shares 16% or so to $26 a share.

Readers of Lonely Value should not be too surprised.

The earnings release is ugly, littered with GAAP to non-GAAP reconciliations. More importantly, the company left out a cash flow statement. This is a pet peeve of mine and a corporate trend that I simply don't understand.

Nonetheless, I still like Lexmark.

After today's price increase, Lexmark has a $2 billion market value (79 million shares outstanding). The balance sheet sports $909 million in cash or 45% of total market capitalization. Pause for a moment to let that sink in.

The company's total debt amounts to $810 million and doesn't come due until 2013 and 2018. And as I've mentioned previously, the company has a sizable hole in its defined benefit pension plan. Despite these warts, Lexmark still looks like a bargain to me.

While Lexmark could pay off its obligations now, these long-dated liabilities may actually have value for equity holders. This is not just because of the prospect of massive inflation. I recently saw a video of Seth Klarman (Baupost) in which he discussed News Corp. A questioner asked him why he owned so much NWS stock given all the company's debt. Klarman pointed out that the maturities were so far in the future that it actually enhanced his view of the equity value.

The parallel with Lexmark is there.

The $2 billion market value for Lexmark would make a bit more sense if it weren't making money. But it is. Reported earning (after restructuring charges) are paltry, but the company generated $147 million in operating cash flow in the quarter. Net that against $51 million in capital expenditures and you get a healthy free cash flow. Management even said there are signs of stabilization in the business.

When I decided to buy Lexmark, there were few places to look for validation. This is a second rate company whose best days are behind it, right? Perhaps. But is that really the point? Lexmark got so cheap (and perhaps still is) that it became a good investment.

When I first wrote about Lexmark on June 11th, it had a market value of $1.3 billion and nearly $1 billion in cash. For the "value is in the eye of the beholder" crowd, Lexmark was (and perhaps still is) a lesson in objective value.

If I've learned anything in this business, it is to be content to think your own thoughts and that conviction must be found within.

Lexmark isn't the next Hewlett Packard, but it has been a far better investment of late. It isn't the buy it was only months ago, but it is still worth a look. Dell just may take my advice and buy it too.

Disclosure: Author owns shares of Lexmark and News Corp.

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