The imaging industry has been fixated on who is going to buy Xerox. The conventional wisdom is that HP is the best fit. That could happen, though it's unlikely. Here’s why Clover would be a better investment for HP—and why it would be a good thing for the channel.
How big is Clover? It’s difficult to tell, as Clover is owned by Golden Gate Capital: a private equity group (PEG). Clover has two divisions, wireless and remanufactured ink and toner.* Two things we do know: Golden Gate borrowed money to buy Clover based on Clover’s balance sheet. This is a fairly standard PEG practice. I know very little about the wireless division, but at Clover, imaging has always led the business.
The amount of that Clover debt is about$650 million. As a guide, let’s assume the revenue for Clover Imaging is around $700 million. These are big numbers. Here’s what else we know:
- Toner revenue is decreasing—assume 5% per year as print declines.
- Margins and revenue are under pressure from offshore manufacturers like NineStar, Aster, and Print-Rite.
- HP has been aggressively trying to replace compatible supplies with OEM within MPS clients.
- Color ink and toner are becoming a larger part of the market—which are segments the aftermarket is traditionally weaker at in comparison.
- Clover has a dominant position within the private label business for Staples, Office Depot, Xerox, and other large international resellers—accounts that are also mired in multi-year revenue declines.
As revenue and margins decrease, servicing debt could become difficult. At the very least, there is a greater risk in managing the debt, which could increase the financing costs for Clover/Golden Gate. Financing costs on $700 million in debt are likely more than $50 million/year. Clover has options to increase revenue, but the core business of remanufacturing cartridges is decreasing year over year.
Clearly, I’m not an investment advisor for Clover, but the longer Clover waits for a bigger exit, the less attractive it is.
So, why should HP be interested?
This may be a surprise, but HP’s manufacturing costs for supplies are substantially lower than Clover’s. HP does not need to pay to recover empty cartridges or pay expensive reverse engineering and research and development for control chips. Those two components add $10-15 per unit, where HP’s costs would be around $2-3. Since HP is much larger, their costs for items, like drums and toner, are also likely cheaper than Clover’s.
Translation: HP can make a healthy profit without changing Clover pricing.
If Clover is profitable being Clover, imagine if production costs were slashed under HP? Yes, this is speculation, but tell me why it doesn’t make sense? Immediately after acquiring Clover, HP would see revenue increase by $700 million, annually, with the acquisition—a nice bump for HP. You could argue that revenue would increase further as customers would opt for HP aftermarket supplies over competitors—primarily offshore products. Customers would also possibly pay a premium knowing the supplies are “HP manufactured” and represent less IP risk.
The HP supply chain is also better than that of Clover, or any other remanufacturer. They also have the best distribution network BY FAR in the entire imaging network. HP does not suffer product constraints based on empty core availability, so their revenue post acquisition would be higher with superior product mixes. No doubt, there could be massive cost reductions in rationalizing sales, marketing, finance, manufacturing, and logistics. An HP owned aftermarket entity would encounter fewer of these issues.
The precedent for this type of acquisition already exists: NineStar bought HP’s primary competitor, Lexmark. Alternatively, imagine NineStar buying Clover, HP would not welcome that; if anything, an HP purchase could be seen as a defensive move. I have no vested interest in a transaction between HP and Clover. For those veterans, it would be an amazing “full circle” story for an industry that has long seen HP as the enemy.
Xerox by this measure may be a less attractive transaction for HP.