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28 Imaging Spectrum Magazine ✴ October 2005 ✴ International Imaging Technology Council ✴ www.i-itc.org

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International Imaging Technology Council

www.i-itc.org ✴ International Imaging Technology Council ✴ October 2005 ✴ Imaging Spectrum Magazine 29

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What is Our Industry Worth?An Investment Banker and Investor PubliclyValue the (Very Private) Aftermarketby Martin Stein, Blackford Capital and Mark Wilser, Global Capital Markets

The inkjet and toner aftermarket is often described by thepress as a multi-billion dollar industry that is quicklygrowing, highly profitable and massively fragmented.

Recent articles in the Wall Street Journal, BusinessWeek, Fortune,Forbes and USA Today have all referenced the impact of the after-market on OEMs in the digital imaging industry. These articlesimplicitly, and in some cases explicitly, suggest that aftermarketcompanies are very lucrative, entrepreneurial businesses. Yetinsiders know the true story: While strong growth and large prof-its exist for some players, this growth and these profits are hardlyevenly distributed across the industry or even across segments ofthe industry. Some companies in the industry have grown muchfaster and have made much more money than their competitors.

Over the past two years, the industry has experienced significantchanges—changes that both portend the beginning of a cata-clysmic structural realignment for the industry as well as a massivereallocation of value to different players within the industry. In lay-man terms, the next chapter in the industry’s development maypresent a new roster of winners and losers. A great deal of money isat stake for the winners.

This article, written by an investment banker and private equity pro-fessional, both of whom have significant exposure to the aftermarket,presents a financial and strategic analysis of the industry and a guideas to how investors might value the industry in aggregate.

Size and Growth of the IndustryBy studying several illustrations that show the size and expansion ofthe imaging supplies industry, readers will be better able to grasp itspresent scope and future growth.

Big BusinessThe size of the imaging supplies market is shown in Figure 1. Glob-ally, imaging hardware and supplies represents approximately $100billion of revenues annually. Consumables represent 60 percent ofthis revenue, or $60 billion, of which approximately one third of the

market is in North America. Therefore, the retail ink and toner con-sumables market in North America is estimated to be $20 billion.Ink comprises roughly 50 percent of this market and toner accountsfor the other 50 percent of the market.

Mark Wilser is a principal at Global Capital Markets (www.globalcapitalmarkets.com), a leading WestCoast merchant banking firm based in Irvine, Calif. Wilser has significant experience in the digital

imaging industry and his firm has represented numerous clients within the industry including The TroyGroup, the largest manufacturer of OEM MICR cartridges in the world. He has over 15 years of

investment banking experience. Wilser received his MBA from Harvard Business School and his BS fromthe University of Virginia.

Martin Stein is the managing director of Blackford Capital, a private equity firm focused on middle-mar-ket acquisitions, and serves as treasurer on the executive board of the International Imaging Technology

Council. Previously, he served as president of Quality Imaging Products. Stein has received numerousindustry leadership awards and has substantial private equity, investment banking, operations and con-

sulting experience. He has published several Harvard Business School cases and received his MBA fromHarvard Business School and his BA from the University of Chicago.

International Imaging Technology CouncilFeature Article


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Worldwide Laser Consumables GrowthThe growth of laser cartridges on a unit basis is shown in Figure 2.Globally, laser supplies have grown from approximately 100 millionunits annually in 1999 to more than 225 million units in 2005, whichrepresents a 14 percent compound annual growth rate (CAGR) overthe past six years. Future growth will slow to healthy single-digit levels.By 2010, industry experts estimate there will be approximately 275million units sold annually around the world,which represents a 4 per-cent compound annual growth rate (CAGR) over the next five years.

Worldwide Inkjet Consumables GrowthThe growth of inkjet cartridges on a unit basis is seen in Figure 3.Globally, inkjet supplies have grown from approximately 400 mil-lion units annually in 1999 to more than 800 million units in 2005,which represents a 12 percent compound annual growth rate overthe past six years. Future growth will slow to low single-digit levels.By 2010, industry experts estimate there will be approximately 1 bil-lion units sold annually around the world, which represents a 5 per-cent compound annual growth rate over the next five years.

Remanufactured Market Share The market share of remanufactured toner cartridges over a periodof time appears in the graph in Figure 4. North America marketshare penetration of remanufactured toner cartridges in 1998 wasapproximately 20 percent. By 2005, the market share penetration ofremanufactured toner cartridges had increased to 30 percent. With-in the next three years, the market share of remanufactured tonercartridges is expected to be more than 35 percent.

Remanufactured toner cartridges are increasing their market sharefor several reasons:

• Superstores such as Staples, Office Depot and OfficeMax haveaggressively begun to push their private-label brands,

• Electronic retailers such as CompUSA, Best Buy and CircuitCity are all expanding their offerings, and

• Remanufacturers are successfully growing their businesses.

These increased market share levels of remanufactured toner car-tridges are being mirrored by remanufactured and compatibleinkjet cartridges, which currently have approximately 15 percent ofthe market but are expected to grow to a more than 25 percent shareof the market in coming years.


Stein and Wilser: What Is Our Industry Worth?

Ultimately, customer attitudes towards remanufactured and third-party brands have changed significantly over the course of the past10 years due to improved quality, increased marketing, strong brandendorsement (superstore private labels, IBM, Xerox, Lexmark),increasing customer sophistication and, of great import, the tenaci-ty of remanufacturers. Remanufacturers have been among the directbeneficiaries of this increased market share penetration.

Large OEM Profits on Imaging Supplies A summary of quotations from financial analysts over the past sev-eral years on the profitability of OEM supplies is presented in Figure5. As the industry is all too aware, the OEMs use a razor-blade profitmodel in the digital imaging industry. This means that printers aresold at low margins while profits are made on the high-priced con-sumables. Financial analysts estimate that the gross margins thatOEMs capture on consumables are as high as 60 percent. As long asOEMs maintain this razor-blade profit model, there will be a pricingumbrella under which remanufacturers can successfully operate.

Remanufacturing Industry Large, Growing and ProfitableFour future scenarios for the aftermarket are projected in Figure 6.The scenarios are arranged from the most conservative to the mostaggressive:

• Scenario 1: This scenario assumes that remanufactured toner has30 percent of the $10 billion North American toner market ($3billion of retail sales), and that remanufactured and compatibleink has 15 percent of the $10 billion North American ink market($1.5 billion of retail sales) for an aggregate $4.5 billion of retailsales or a blended 23 percent of the market. Assuming that themarket grows by 5 percent per year and that remanufactured and

compatible products do not gain any share, by 2010, the marketfor remanufactured and compatible inkjet and toner cartridgeswill be approximately $5.5 billion to $6.0 billion annually.

• Scenario 2: Scenario 2 uses the same starting assumptions asScenario 1 to arrive at $4.5 billion in retail sales. Assuming that themarket grows at 5 percent per year and third-party providers capturean additional 1 percent of the total market share per year,by 2010,themarket for remanufactured and compatible inkjet and toner car-tridges will be approximately $7.0 billion to $7.25 billion annually.

• Scenario 3: Scenario 3 uses the same starting assumptions as Sce-narios 1 and 2 to arrive at $4.5 billion in retail sales. Assumingthat the market grows at 10 percent per year and third-partyproviders do not gain any market share, by 2010, the market forremanufactured and compatible inkjet and toner cartridges willbe approximately $7.1 billion to $7.35 billion annually.

• Scenario 4: Scenario 4 uses the same starting assumptions as allprevious scenarios to arrive at $4.5 billion in retail sales. Assum-ing that the market grows at 10 percent per year and third-partyproviders capture an additional 1 percent of the total marketshare per year, by 2010, the market for remanufactured andcompatible inkjet and toner cartridges will be approximately$8.9 billion to $9.1 billion annually.



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The size of the retail third-party ink and toner market, therefore,is estimated to be between $5.5 billion to $9.0 billion by 2010,which is a compound annual growth rate somewhere between 5percent and 15 percent for the next five years. Cumulatively, that isbetween $30 billion to $40 billion of value to be allocated amongthe different industry players. By any measure, there is a great dealof money at stake.

Change, the Only ConstantOver the last several years, a large portion of the lead articles inImaging Spectrum, Recharger Magazine, ENX, Asay Publishing andother industry publications have described, in lugubrious detail, thechanges underway in the industry. To summarize, these changesinclude, but are not limited to:

• Consolidation: Clover’s recent acquisition of Dataproducts andAdsero’s pending acquisition of Turbon AG will create two addi-tional players in the industry with more than $150 million in rev-enues. Combined with NuKote, these top three players will controlan estimated $600 million of the wholesale revenue of the indus-try (approximately 20 percent). While the industry still remainshighly fragmented, these large players will have a substantial com-petitive advantage over other smaller companies within theirindustry due to the benefits of economies of scale in purchasing,production, new product development and marketing.

• Pricing Compression and Introduction of Asian Products: From2000 to 2003, toner prices at major wholesale remanufacturersdeclined by an average of 3 to 5 percent per year. In 2004 and2005, wholesale remanufacturers experienced price declines of 14to 16 percent per year. In 2000, industry average wholesale pricesfor national remanufacturers on a 27X cartridge was $60, whileaverage cost was approximately $40 ($20 profit). In 2005, the aver-age wholesale price for a 27X cartridge has dropped to $35, whilethe cost had dropped to approximately $25 ($10 profit). Theseprice declines have been the result of a few factors, including theintroduction of toner products from Asia (led by Printer Essen-

tials), increased visibility on pricing due to Internet dealers (ledby numerous new entrants), the office products channel negotiat-ing prices down from their vendors by almost 30 percent in 2004(led by Clover Technologies), and excess capacity by U.S. manu-facturers. While many products (Lexmark, Xerox, Brother) arestill profitable, the downward pricing pressure will remain so longas 1.) Asian manufacturers continue to have access to the NorthAmerican market and, equally important, 2.) there is excesscapacity in North America.

• SKU Proliferation: The number of SKUs in the market has grownexponentially. From 2000 to 2002, national remanufacturers wereable to maintain a leading-edge position on new product releasesby releasing an average of 10 to 15 new engines per year. From2003 to 2005, national remanufacturers were required to releaseup to 40 to 50 new engines per year. Moreover, the cost to releasea new product (9000X, 4600, 2500, etc.) has increased each year;as a result, a larger portion of annual revenues for manufacturersis required to remain a leader in product breadth.

• Dell and Samsung: The entry of Dell and Samsung into the mar-ket with low-priced laser printers and supplies has presented anopportunity for a number of remanufacturers over the past twoyears. However, cores are hard to find and, as a result, for manynational players, the Samsung and Dell products are substantiallyless profitable than the rest of the business. In the coming years,Dell will continue to push prices down for the OEMs, which mayforce Hewlett-Packard (HP) to lower its prices. BusinessWeek andthe Wall Street Journal have both run several articles on HP’sefforts to lower its costs in the digital imaging business. Remanu-facturers who do not adopt their business model could face a highprobability of getting squeezed out of the market as the historicOEM pricing umbrella may be reduced in the coming years (con-sider the 8500, 1010a, etc.).

• Vertical Integration: Several years ago, NuKote acquired ICMI.Today, Nukote also collects a substantial amount of cores eachmonth. Having integrated into core collection and toner pro-duction, NuKote probably enjoys a cost position unrivaled byremanufacturers who are not producing over hundreds ofthousands of cartridges per month. Additionally, FutureGraphics has recently expanded into core collection and inkjetproduction. MSE, in addition to manufacturing toner andinkjet cartridges, is now a net positive collector of cores, whichit resells to other companies. In the coming years, more compa-nies will integrate their operations vertically in order to achievea lower-cost position than their competitors.

• The Rise of Color Products: Chad Golden of Static Control Com-ponents announced to the industry in 2000 that “color was com-ing” and forecasted an inversion from mono to color in comingyears. He was prescient in his forecast, albeit a few years early inhis prognostication. Color cartridges, both inkjet and toner, are



more challenging for industry participants to remanufacture,have a higher quality threshold by end users and require a largercapital investment to release. Color cartridges now account for asubstantially larger portion of industry revenues than they didseveral years ago and, according to most industry experts includ-ing Golden and Lyra Research, Inc., the share of color cartridgesis only expected to increase in the future. Remanufacturers andsuppliers who do not successfully conquer the challenges of colorproducts will compete in a rapidly dwindling share of the market.

• Decline in the Number of Dealers in the Market: Ten years ago,industry experts proclaimed that there easily were 5,000 remanu-facturers in North America and only a small fraction of thosecompanies outsourced any production. Five years ago, 5,000 deal-ers was an aggressive estimate for the number of remanufacturersin North America, and a solid portion, although less than amajority, of those remanufacturers had begun to outsource someof their production. Today, industry experts would be hardpressed to claim there are 3,000 remanufacturers in North Amer-ica, and a good 75 percent of these dealers/remanufacturers out-source some or all of their production. This trend follows that ofthe office products industry, which saw a decline from more than5,000 independent dealers in the 1980s to less than 800 dealerstoday, due to the consolidation efforts of USOP and the rise of thesuperstores. The same is true for other industries: The copierdealer industry, which saw players such as IKON and DANKAacquire and consolidate hundreds of dealers; the electronics VARindustry, which is forecast by Forrester, VARBusiness and manyothers, to be facing massive consolidation; and any other highlyfragmented market with more than 1,000 similar business mod-els serving a national market. The number of retail distributionoutlets for remanufactured inkjet and toner cartridges willdiminish as larger, highly sophisticated retailers (Office Depot,Staples, Boise Cascade, Corporate Express, Quill) and more directchannels of distribution (Internet, mail order, etc.) capture a larg-er share of the market.

• Rise of the Private Label: Ten years ago, very few of the majoroffice supply distributors (United, SP Richards, etc.), electronicssupply distributors (Ingram Micro, Tech Data, CDW), imagingsupply distributors (Arlington, Daisytek (formerly), NEAMCO(formerly), Katun, ACM, etc.), or superstores (Office Depot, Sta-ples, OfficeMax) offered private-label remanufactured toner orinkjet products. Today, having recognized the customer accept-ance, high profits, strong growth and lack of a national third-party aftermarket brand, almost every significant player has aprivate-label product offering, and almost all of them are growingtheir private-label toner and inkjet brands at an amazing pace.This trend will accelerate in the future to such an extent thatOffice Depot, Staples and OfficeMax private-label products,which historically accounted for less than 2 percent of total retailsales, could account for more than 10 percent of total retail indus-try sales in the coming years.

• Introduction of Cost-per-Page Pricing Models: Led first by the copi-er dealers, who have had a cost-per-page pricing model for overtwo decades, and second by the printer OEMs (including, but notlimited to HP, Xerox, Toshiba, Lexmark), who have bypassed thetraditional distribution channels and sold deca-million dollar,multi-year deals to Fortune 500 end users, the aftermarket hasfinally started to embrace cost-per-page selling models. Industryleaders such as Print Inc., Multi-Laser, Miracom Network andWilder Technologies, among others, are pioneering new value-capture mechanisms for the supplies industry. Cost-per-pageselling models have been a hot topic, having appeared in industrymagazines, having been the most highly attended seminar topic atthe Int’l ITC Annual Conference and World Expo, and havingbeen represented by many booths at the ITEX Conference.Cost-per-page is one of the—if not the—greatest value-creationopportunities in the industry today, and the field is still wide open.

• Lawsuits: OEMs are undertaking an extremely aggressive legalstrategy to impede the success of the aftermarket. Lexmark’s caseagainst Static Control, launched in 2003 and decided in favor ofStatic Control in 2005, was the first shot across the bow. Since then,Lexmark has filed lawsuits against MSE, NER, Image ProjectionsWest, Pendl and Clarity Imaging Products, with claims rangingfrom the Prebate program to marketing misrepresentation. HPalso has filed a lawsuit, which has now been settled, against Inkcy-cle—a major supplier to superstores—for patent violations, and alawsuit, which has not yet been settled, against Rhinotek—theleading branded player in the aftermarket—for misrepresentation.History repeats itself as NuKote was the subject of numerous law-suits in the mid-1990s, a factor which may have contributed to itsbankruptcy in 1998. A current lawsuit, Independent Ink v. IllinoisTool Works and Trident Inc., which will soon be heard by the U.S.Supreme Court, could have the most dramatic affect on the indus-try of all. If the case is decided unfavorably, the precedent couldmake antitrust litigation more difficult and costly. OEMs are notthe only companies pursuing legal recourse. Countless remanufac-turers are embroiled in litigation over intellectual property and



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other issues common in a technologically-based industry. Giventhis hostile legal environment within the industry, even the mostconservative forecasts should expect the larger industry players tobe required to allocate significant—and inordinate, relative toother industries—funds to cover legal expenses due to threatsfrom OEMs and industry competitors.

• Outside Investments/New Entrants: The size, profitability andfragmentation of the industry has attracted significant attentionfrom new entrants over the past several years, including Paper-Mate, Polaroid, IBM and other well-funded, sizable corporations.Additionally, private equity groups are frequent attendees atindustry trade shows and have begun investing in the cartridgeremanufacturing industry (Richmont Capital’s acquisition ofNuKote in 2000, Blackford Capital’s acquisition of QIP in 2001,Kestrel Partners’ and Champlain Capital Partners’ investments inClarity Imaging, XSYS Printing Solutions formation by CVCPartners in 2004 and Stonhenge’s investment in West Point in2005). This interest will continue in the future as long as there isan opportunity for investors to make decent returns throughfinancial engineering within the industry.

• Rise of the Franchise Model: In the past three years, one of thehottest growth stories in the industry has been the rise of thefranchise model. Leading franchisers include Cartridge World,Caboodle, Island Inkjet and Rapid Refill Ink, who collectively areadding more than one new franchise per day in North America.While the model is still too early to be proven in its entirety,assuming that the franchisors can capture volume discounts fromsuppliers, provide training to franchisees and share joint market-ing expenses, the franchise model may prove a dominant businessdesign in the coming years.

There are scores of other trends affecting the industry, including com-petition from copier dealers, new technologies, new business models,SKU proliferation, outsourcing and international competition.

All of these trends are conspiring to require changes in the businessmodels of existing players as value migrates from the successfulbusiness models of the last chapter to the successful business modelin the next chapter of the industry’s evolution.

Value Creation/Value DestructionJoseph Schumpeter in his 1942 treatise, Capitalism, Socialism, andDemocracy, writes:

“Capitalism, then, is by nature a form or method of economicchange and not only never is but never can be stationary. And thisevolutionary character of the capitalist process is not merely due tothe fact that economic life goes on in a social and natural environ-ment which changes and by its change alters the data of economicaction; this fact is important and these changes (wars, revolutionsand so on) often condition industrial change, but they are not its

prime movers. Nor is this evolutionary character due to a quasi-automatic increase in population and capital or to the vagaries ofmonetary systems, of which exactly the same thing holds true. Thefundamental impulse that sets and keeps the capitalist engine inmotion comes from the new consumers, goods, the new methodsof production or transportation, the new markets, the new forms ofindustrial organization that capitalist enterprise creates.”

Schumpeter articulated that, in capitalism, there is always economicchange. The odyssey of the aftermarket, though seemingly unique,is, at the broadest level, all too common to any maturing industry.

Industry Evolution: Competitive StructureA basic pictorial representation of what happens to industries overtime is provided in Figure 7. At the birth of an industry (1987 to1992 for the cartridge aftermarket), there are a small number ofplayers serving a previously unmet need for customers. The indus-try has high margins and offers a high growth opportunity.

Over time, as other players recognize the opportunity within theindustry, more competitors emerge. The early stage of an industry(1992 to 1998 for the cartridge aftermarket) will be characterized bya large number of small players, i.e., a high degree of fragmentation.The customer need is well recognized and firms begin to organizethemselves in structures that will best serve the needs of their cus-tomers. Growth continues and margins begin to decline as certaincompetitors work to differentiate themselves based on price.

As an industry reaches middle age (1998 to 2005 for the cartridgeaftermarket), it is characterized by segmentation within the marketacross customers (different needs) and suppliers (different businessmodels to meet different needs). Additionally, middle age industrieshave stratified competitive fields with some larger players who have



been more successful at growing their business, some mid-sized play-ers who have performed consistently with the market and somesmaller players who have underperformed in the market. Growthbegins to slow for the industry and, in direct correlation, marginserode as companies lower their prices to take advantage of economiesof scale and allocate overhead costs over a larger base of production.

Finally, industries enter the mature phase (2005 to ???? for the car-tridge aftermarket), in which a few large players control the vastmajority of production, a few small players serve select and uniquecustomer needs and there are very few companies that survive in themiddle. Middle companies are not competitive against the largerplayers because they do not have sufficient economies of scale to bea low-cost producer; and they are not competitive against the small-er players because they do not have sufficient expertise in a particu-lar customer segment to provide a higher value add. As a result, themiddle collapses as micro-segments of customers flock to the largeand small suppliers, based on which business model best meets theirneeds. The clearest indication of the mature stage of an industry israpid price compression, consolidation amongst suppliers and cleardelineation of discreet customer segments.

Industry Evolution: Growth and MarginThe theoretical revenues and profits of an industry over time arecharted in Figure 8. The chart has a time frame that roughly over-laps with the toner and inkjet aftermarket, as it begins in 1990 andgoes through 2008.Additionally, revenue and profit numbers shouldroughly correlate with those of the wholesale manufacturers in theaftermarket at various points in time. As the chart indicates, overtime an industry’s revenues (green line) will grow as the customerneed becomes defined and as more companies create business mod-els to serve this need. As businesses work to increase supply/capac-ity of the product or service, the industry grows and, typically, thereis excess capacity. At that point, prices and margins (red line)decline at a rapid pace. Ultimately, equilibrium is reached betweensupply and demand and, most frequently, revenues and profits sta-bilize at a level equal to the cost of capital for the industry.

Value Creation: Good Choices and Good Execution A conceptual framework for analyzing the impact of good strategicchoices and strong business models on value creation for differentplayers within a market or a segment of a market is presented in Fig-ure 9. The chart depicts different value creation or value destructionpaths over time. What separates high value creation from modestvalue creation from modest value destruction to high value destruc-tion are good strategic decisions, good business models and goodexecution. Companies that make good decisions and execute wellwill achieve higher value creation over a given period of time thancompanies that make poor decisions and execute poorly.

For example, in the wholesale manufacturing channel, any industryobserver would be hard-pressed to argue that MSE, Laser ImagingInternational and Clover Technologies have not been three of themost successful national remanufacturers over the last five years.These companies have made sound strategic choices, have success-ful business models and have executed effectively. MSE has investedheavily in R&D, positioned itself as the high quality company, andaggressively advertised its brand. Laser Imaging International isfirst to market with new products, positioned its products as strongvalue, and offers a very broad product selection. Clover Technolo-gies has entered the office supplies channel, which was previouslyoccupied by larger remanufacturers, and positioned itself as theaggressive newcomer. Each of these companies has made differentchoices, but they each have created substantial value over the pastseveral years.

A similar situation has occurred in the component distribution busi-ness. Static Control Components and Future Graphics have grownexponentially over the past five years. Like their counterparts on thewholesale side, these distributors have made sound strategic choices,have strong business models and have executed effectively. StaticControl has invested heavily in R&D, has been first to market with ahost of new products, and has spent more money on marketing than



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any other firm in the industry. Future Graphics has expanded itsproduct offering, integrated vertically (by offering inkjets and broker-ing cores), and positioned itself as the high-service company. Again,both of these companies have made different strategic choices, but, asa result of making the right choices, having strong business models,and executing effectively, they have each created significant value.

Ultimately, companies within the industry will need to make a set ofchoices based on the industry dynamics that affect their businessmodels. Companies that make good choices and execute effectivelywill capture substantially more value than companies that do not.

A Dynamic Industry StructureThere are a myriad of ways to analyze an industry’s structure. Forthe purposes of this article, we will look at the structure through twodifferent vantage points: horizontally (channels of distribution toend user) and vertically (steps of the value chain).

Horizontal Structure: Five Distinct Channels for CompatibleToner and InkjetThe horizontal structure of the industry is illustrated by Figure 10.It delineates five distinct distribution channels by which remanufac-tured and compatible inkjet and toner cartridges go to market andoffers very rough revenue projections for each channel:

• OEM Channel: The OEM channel consists of OEM companiesthat offer a branded remanufactured product; examples include

Xerox,Verbatim, Toshiba and NCR, among others. These compa-nies typically outsource production to one of the wholesale man-ufacturers in North America or Asia. Because of the strong brandrecognition of these OEMs, typically their aftermarket toner orink products are able to command a higher price point in theretail market. This channel is estimated to be approximately $125million in retail revenues.

• Imaging Supplies Channel: The imaging supplies channel consistsprimarily of companies that specialize in the distribution ofimaging supplies, such as, on the wholesale side, Supplies Net-work, Arlington, NEAMCO, Printer Essentials and, on the retailside, remanufacturers, franchisors such as Cartridge World andIsland Inkjet, and, of course, Internet e-tailers, such as 123inkjetsand Carrot Ink. Wholesalers sell in a two-step distribution modelto the dealers within the industry; wholesalers also includewholesale manufacturers such as QIP, MSE, LII and Teckn-O-Laser. The imaging supplies channel is currently the largest of thefive channels with the highest penetration of remanufacturedproduct; however, the imaging supplies channel has the slowestgrowth as the office supply channel and electronics supply chan-nel are gaining share at substantial rates. Remanufacturers dis-tribute approximately $2.55 billion of product to end users andfranchisors, and e-tailers distribute an estimated $250 million ofproduct to end users. Competitors in this channel include MSE,LII, PTI/QIP, Teckn-O-Laser, West Point Products, NER, MKG,ILG, Printer Essentials and many, many more.



• Office Supplies Channel: The office supplies channel consists ofwholesale distribution (United and SP Richard) and retail distri-bution. Retail distribution can be subdivided into contract/com-mercial (Boise Cascade, Corporate Express), catalog (Quill,Viking) and superstores (OfficeMax, Office Depot and Staples).Wholesale office supply distributors have a two-step distributionmodel to office supply dealers and sell an estimated $50 million ofwholesale value, with dealers both marking up approximately 50percent and buying directly from wholesale manufacturers to sellat $300 million of retail value.Almost all of the major distributors,both wholesale and retail, in the office products channel havestrong, profitable and high-growth private label brands. Given thedemands of this channel, there are very few manufacturers whoare capable of supplying these large customers. Competitors inthis channel include NuKote, Clover/Dataproducts, Curtis Young,LTI, GRC and Image Projections West.

• Electronic Supplies Channel: The electronics supplies channelconsists of wholesale distribution (Ingram Micro and Tech Data)and retail distribution. Retail distribution can be subdivided intocatalog/e-tail (Buy.com, PC Mall, PC Connection, Tiger Direct)and superstores (CompUSA, Best Buy, Circuit City, Fry’s Elec-tronics). Wholesale electronic supply distributors have a two-step distribution model to value-added resellers (VARs), withdealers marking up approximately 50 percent to sell $100 millionof retail value of third-party ink and toner. Only branded prod-ucts are sold in this channel and, amongst the three major play-ers within the channel—Rhinotek, Amazon Imaging andPTI/QIP—Rhinotek is by far the dominant player. Given thehigh costs of entry into this channel, the sophisticated buyers,and the dominance of an existing player, it is unlikely that newplayers will break into this channel.

• Mass Merchants: The mass merchant channel consists of high-volume retailers that specialize in neither office supplies nor elec-tronics supplies, but sell OEM and third-party ink and toner.Examples of such retailers include Target (selling Dataproductsink), Walgreen’s (selling QIP ink and toner online), Costco (sell-ing Rhinotek and MSE products), and Wal-Mart (selling NuKoteink and toner). Because the mass merchants do not specialize inoffice products or electronics, consumers do not consider thischannel a destination point for imaging consumables. As a result,despite the more than $1 trillion of general merchandise sold inthis channel, third-party ink and toner are estimated to com-mand a relatively modest share of the overall industry revenues,approximately $125 million of retail sales.

While this horizontal analysis of the distribution channels for third-party ink and toner products does not represent all avenues bywhich products get to the end-user, it does provide a helpfuloverview of some of the main channels. There still are numeroussuccessful companies—retail, wholesale and distribution—that arenot represented in Figure 10, but which also play a substantial rolein getting product to market.

Vertical Structure: Industry Value ChainFigure 11 outlines the industry value chain or activity with the var-ious steps of sourcing, production and distribution in order for aninkjet or a toner cartridge to go to market. At the beginning of thevalue chain are component manufacturers who produce drums,toner, mag rollers, wiper blades and all of the necessary compo-nents that go into the production of a cartridge, and core brokerswho collect used cartridges from end users. In aggregate, compo-nent manufacturers and core brokers represent some $300 millionto $400 million of revenues and have gross margins ranging from20 to 40 percent, with some companies higher than this average andother companies lower than this average. For components, drums



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and toner represent the two largest component categories, repre-senting a combined 30 to 50 percent of all component revenues.Some of the largest companies in the industry—Fuji and Mit-subishi, namely—manufacture toner and drums for use in theaftermarket. Gross profits for this portion of the activity chainrange from $40 million to $80 million as shown in Figure 12. How-ever, only a very small fraction of the revenues and profits of Fujiand Mitsubishi come from the aftermarket. For core brokers, themarket is dominated by ERS and Greentec, with no less than 20additional regional players who have a similar business model.Gross profits for this portion of the activity chain range from $40million to $80 million (see Figure 12).

On the component side, many, though certainly not all, of the com-ponent manufacturers sell to distributors who then sell to remanu-facturers. Static Control, Future Graphics and Oasis are clearly thethree largest component distributors, with six to eight other smallerplayers. In aggregate, the distributors control some $400 million to$500 million of revenue and have margins between 10 to 30 percent.Therefore, gross profits for this portion of the value chain arebetween $50 million and $150 million (see Figure 12). Traditional-ly, as industries consolidate, the value of the distribution businessmodel diminishes because there are fewer buyers and fewer sellers,and the only value add for distributors is to inventory and shipproduct. Within the toner and ink aftermarket, distributors play amore active role in product development as well as service and edu-cation for the remanufacturers.

National remanufacturers currently represent some of the greatestaccumulation of profits within the industry as they sell $1 to $2 bil-lion of remanufactured toner and ink with estimated margins of 20to 40 percent. In aggregate, this represents $200 to $800 million ofgross profit that is distributed among the players in this segment ofthe value chain (see Figure 12). The top 20 remanufacturers controlover 50 percent of the current market share and, in the next three

years, will probably control 80 to 90 percent of the market share.Some remanufactured product is then sold to distributors, whomark up the product 10 to 30 percent and sell to the channels previ-ously outlined in Figure 10. This step of the value chain receives$200 to $300 million in gross profits.

Finally, the product makes its way to retail distribution. Manyremanufacturers both manufacture the product and distribute it toretail customers/end users, and, thus, are able to get the maximumamount of profit from the transaction. It should be noted that inrecent years, the economies of scale of larger remanufacturers havereduced the delta between the cost to manufacture in-house andthe cost to outsource production. In aggregate, this step of the valuechain controls $400 million to $1 billion in gross profit. While thisnumber is two times larger than the gross profits controlled by thenational remanufacturers/wholesale manufacturers, the retail dis-tribution currently is so diffuse, that no single player representsmore than 5 percent share of the retail market. As a result, grossprofits are more fragmented in this step of the value chain thanthey are in the national remanufacturer/wholesale manufacturerstep of the value chain.

It is valuable to understand allocation of profits along the valuechain in order to understand where the profit zones are within theindustry. The profit zone is the area of the industry where themajority of profits are allocated, typically because that activity cre-ates the most value for the customers. In the aftermarket, wholesalemanufacturing and retail distribution are the two largest profitzones. This does not mean that there are not profits elsewhere inthe industry, just that the largest aggregation of value for the mostcompanies exists within those two steps of the value chain, andcompanies that are the most successful within those two steps willhave the highest potential for value creation because they are play-ing in the largest profit zones. Similarly, it also means that these arethe locations in which profitability will be most quickly reallocat-ed. For wholesale manufacturers, profits are clearly being dispro-portionately allocated to the largest wholesalers (Clover, NuKote,MSE and Laser Imaging International, amongst others), with somenotable exceptions (Turbon and Teckn-O-Laser). And for retaildistribution, profits are clearly being disproportionately allocatedto the superstores, contract stationers and catalog/commercialretailers, such as Staples, Office Depot, Corporate Express, BoiseCascade/OfficeMax and others.

Determining the Worth of the Industry Given the size, growth and structure of the industry, combined withthe macro-economic trends—industry maturation, consolidation,pricing compression, vertical integration, decline in number ofdealers, etc.—and the industry specific trends, such as the entranceof Dell and Samsung into the market, SKU escalation, rise of colorproducts, increasingly complex technology and so on, what valuewould investors place on the industry?



Joy James’ three-part article series,“Finding Black Gold: Exit Strate-gies For Large Scale Remanufacturers,” in Recharger Magazine earlythis year, offered a clear analysis of various valuation methodologiesused by investors as they evaluate the worth of a business. As Jamespointed out, different investors may place widely different values onthe same business, given the different assumptions that eachinvestor uses when evaluating the business.

Methods for Calculating ValueFor a public company, the value that investors place on a company iseasy to determine because the measuring stick is quite objective andis always apparent: the stock price. Stock prices increase as value iscreated through successful strategies and effective execution. Stockprices decline as value is destroyed through poor strategies and inef-fective execution.

For private companies, value is less obvious and can have a degreeof subjectivity, but is by no means less important. As such, for pri-vate company owners and their management teams to manage formaximum value, they need to understand what drives value andhow to measure it. Without timely and accurate feedback, a compa-ny can pursue an ill-advised strategy, falsely believing it is on theright track.

Value is typically calculated using one of three main methods:

• First, companies are valued using the discounted cash flowmethod. In the discounted cash flow method, a complexfinancial model is developed whereby the future financial per-formance of the company is projected and cash flow is calcu-lated on an annual basis for some number of years as afunction of profits and investment requirements. These futurecash flows are then discounted back to a net present valueusing a discount factor that takes into account the currentinterest rate environment, the capital structure and the risklevel of the business.

• Second, companies are valued by comparing the values ofother similar companies to the company in question. Whencomparing companies, the subject company is compared withits peers on a number of dimensions, including profits, salesand book value, to public companies in the same industry (forwhich stock prices and, as such, company values are readilyavailable), and then applying appropriate discounts for publicto private and company size as well.

• Third, companies are valued by using transaction data fromother mergers and acquisitions of similar companies.

EBITDA as a Measure of Company ValueUltimately, value for companies is driven by cash flow, which is oftenapproximated by EBITDA (Earnings before Interest, Taxes, Depreci-ation and Amortization). In fact, the single most common metric of

business valuation is a multiple of EBITDA. In today’s market, mostbusinesses range in value from 3.5 to 7 times EBITDA. Figure 13outlines the basic factors that determine EBITDA multiples.

Expected growth rate results from growth of the market and a com-pany’s competitive position. Figure 14 outlines a number of factorsthat influence the financial world’s view of business risk.

Within the digital imaging marketplace, there are many examples ofpublic companies including HP, Lexmark, Staples, Office Depot andUnited Stationers, that can provide assistance at determining valua-tion. Additionally, there have been some recent high-profile publictransactions—Snapfish.com, which was acquired by HP in April, isone of the largest and most recent examples—which provide valua-tion comparables. However, many of these companies distribute arange of products in addition to imaging supplies, and the imagingproducts they distribute consist primarily of OEM hardware and sup-plies. Therefore, comparisons between stock prices and multiples ofrecently completed transactions can be challenging. There are only alimited number of pure play publicly-traded manufacturers and dis-tributors that focus only on aftermarket inkjet and toner supplies.

A Case Study: Adsero’s AcquisitionsTeckn-O-Laser: Perhaps the purest comparison and most recent exam-ple for aftermarket manufacturers and distributors was the acquisitionof the Teckn-O-Laser Group by Adsero Corporation in January of



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2005. Adsero’s first quarter results for 2005 were $7.4 million (U.S.) ofrevenue—$29.6 million annualized—with an EBITDA of $609,000(U.S.), $2.436 million annualized, which is an 8.2 percent EBITDA.Regarding Adsero’s acquisition of Teckn-O-Laser, an official at Adserowas quoted as saying,“We valued the business on the basis of EBITDA.The multiple that we used was affected by several factors . . . .”

The original letter of intent (LOI) deal for the purchase of Teckn-O-Laser is compared with the final closing deal in Figure 15.

Note that the purchase price was reduced by almost 40 percentbetween the original LOI and the actual closing deal. Based onAdsero’s first quarter results, Adsero purchased Teckn-O-Laser for amultiple of 4.2 times EBITDA. On a multiple of revenues, Adseropurchased Teckn-O-Laser for 0.34 times.

There are several additional points to note regarding this transaction:

• Fluidity: The deal changed significantly from the Letter ofIntent to the closed deal. This often reflects a closer look at theacquisition target, a change in the target’s business during thedue diligence period and/or changes in the financing market.

• Time to Close: The seven months it took to close the deal ison the long side (more typically takes 45-60 days), and thelonger period may reflect significant renegotiation, financingchallenges, and regulatory difficulties navigating the compex-ities of a reverse merger.

• Deal Structure: There was a significant reduction in cash (bothat closing and deferred) and the introduction of contingentpayments. Contingent payments, often referred to as an“earnout,” are payments that depend on the future perform-ance of the business.

Contingent payments are used to “bridge the gap” when the sellershave a different view of the business than the buyers; it is no secretthat this is often the case. Theoretically, this is an elegant solution to

divergent views of the world. However, because circumstances oftenchange post-closing and accounting ambiguities can support/justi-fy multiple viewpoints, disagreements and litigation can result. Thiscan become costly both financially and in terms of divergence ofmanagement focus from the business.

When a seller is paid in whole or in part with acquirer stock, the sell-er is in effect making an investment in the buyer’s business, which ona forward-going basis includes the seller’s business. Preferred stockhas a claim on the assets of the company senior to common stockand additionally may have a current return. Together with theearnout, stock and options, deferred payments and the like represent“financial engineering” that makes many deals possible where thebuyer either does not have adequate cash resources to make, or can-not justify, an “all cash offer.” Since from the seller’s perspective cashpaid at closing is the only certainty, a highly experienced and knowl-edgeable investment banker can be a critical advisor for the seller.

A final observation on the Adsero/Teckn-O-Laser deal is that com-plex, difficult-to-finance deals of this nature can be expensive.Adsero reported that there were $1.7 million of transaction feesassociated with the completed deal, which is a very high dollarvalue, given the total size of the transaction (almost 20 percent ofthe cost of the deal was transaction fees).

Turbon AG: Adsero has continued its acquisition strategy with itsApril 2005 offer to purchase Turbon AG for $49 million U.S. dollars,consisting of $40 million in cash and $9 million of Adsero stock. Inpurchasing the stock, Adsero will assume $21 million Euro of bankdebt, which would equate to an enterprise value of more than $70million U.S. dollars.

Turbon, a global imaging supplies company publicly traded on theFrankfurt exchange, has had three years of declining sales and prof-its. Between 2002 and 2004, sales had declined from $140 millionEuro to $123 million Euro (a 12 percent aggregate reduction), whileEBITDA declined from $11 million Euro to $6.6 million Euro (a 40percent aggregate reduction) during the same period. Gross marginsfor Turbon AG have also declined steadily in the last four years, start-ing at 21.7 percent in 2001 and ending at 18.5 percent in 2004. Forfirst quarter 2005, Turbon sales continued to decline compared tofirst quarter 2004 ($34.2 million Euro versus $29.7 million Euro, a 13percent decline), while EBITDA also declined (from $2.6 millionEuro to $1.8 million Euro, a 30 percent decline) for the same period.

Based on the most recently completed 2004 results, Adsero’s pur-chase price, excluding the assumption of bank debt, represents a 5.5times multiple of EBITDA and a 0.33 multiple of revenue. Includingthe bank debt, which is essential in valuing the total enterprisevalue, the valuation of $49 million of cash plus approximately $26million in debt, Adsero’s purchase prices represents a 8.44 timesmultiple of EBITDA and a 0.51 multiple of revenues. While this val-uation might be considered aggressive by many analysts, it clearly



indicates that Adsero has strong projections for positive changes itcan make to the business, such as the ability to cut costs or restruc-ture the business, the net impact of which will be a significantincrease in earnings post-closing.

In June 2005, Adsero announced that it had purchased 10 percent ofTurbon and had paid $1 million with the $4.6 million-U.S. dollar bal-ance due July 29. The deadline for payment of the $4.6 million dollarbalance was extended until August 31, reminiscent of the Teckn-O-Laser acquisition, which is likely resulting from the challenge offinancing the transaction. At press time the deal has not closed.

Setting a Value on the IndustryTo value the industry as a whole, we can use the overall size andgrowth of the industry combined with the two Adsero transactionsas a comparison. Clearly, there are a host of assumptions that arebeing made (detailed above) and a very limited sample set (twotransactions), but this information is, at this point in the industry’shistory, our best indication of aggregate value. It goes without say-ing that there are many cloudy areas in determining the overallvalue, including—but not limited to—the relationship betweenwholesale manufacturing and retail distribution, issues of verticalintegration, the size of the firm being considered and intellectualproperty issues. Buyers (outside investors) would discount theindustry based on the negative industry trends listed at the begin-ning of the article, while sellers (companies within the industry)would tout the positive industry trends listed at the beginning of thearticle. Additionally, larger firms would be allocated a substantiallyhigher portion of the total value than would smaller firms.

Figure 16 contains an abbreviated valuation analysis of the industryin aggregate, excluding any retail distribution due to the complexi-ties of our industry’s distribution channels. Using the informationin Figure 11, which broke out the industry value chain and allocat-ed revenues across different segments, basic assumptions are maderegarding the revenues, gross profits, operating expenses (SGA),EBITDA, EBITDA margins and EBITDA valuation multiples. Fromthese assumptions, we can postulate an aggregate value range (thelow end of the range given the most conservative assumptions andthe high end of the range given the most aggressive assumptions)for each segment of the value chain and, ultimately, for the indus-try—excluding retail distribution—as a whole.

Clearly, there is a significant range in values between the lowest andhighest valuation levels. This range is based on the given dynamicsof that sector of the value chain and the particular dynamics ofcompanies within that segment. Segments with higher revenue lev-els, higher margins and higher growth will have higher valuations.Companies within this segment that are performing better thantheir peers will have a disproportionate share of the value for thatsegment of the industry.

Given the very high range in valuation levels within each segment,with the highest aggregate valuation levels 8 to 10 times higher thanthe lowest aggregate valuation ranges, one can approximate a morenarrow range by looking at the midpoint in value range. Again,while different investor groups would view different companies indifferent lights, one can conservatively estimate that the midpointvalue level, plus or minus 10 percent on either side, represents anapproximate value level for that segment of the industry.

Remanufacturing—not distribution, core brokering or componentmanufacturing—represents the largest concentration of financialvalue within the industry. As remanufacturing consolidates, certainnational remanufacturers will capture a larger share of this valuethan others. Similarly, within each segment of the value chain, cer-tain players will capture a larger share.



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Correlating the DataFigure 17 uses the most general approximation to correlate thisaggregate industry valuation analysis with Adsero’s acquisition ofTeckn-O-Laser and Turbon. So, if one assumes that there are 30 mil-lion remanufactured printer cartridges sold annually in NorthAmerica (220 million worldwide times 30 percent North Americashare times 35 percent remanufactured cartridge market share) andthat Teckn-O-Laser produces 600,000 of these cartridges (2.0 per-cent share of the market), the $10 million value paid for Teckn-O-Laser represents approximately 2.50 percent of the low-end of theaggregate value—$400 million—for the wholesale manufacturingsegment of the industry.

Similarly, if one assumes that there are 60 million remanufacturedcartridges sold globally (slightly less than 25 percent of the totalnumber of global units for toner cartridges) and that Turbon pro-duces 2.4 million of these cartridges per year (4 percent of globalmarket), the $71 million value paid for Turbon represents 3.55 per-cent of the high-end aggregate value—$2 billion—for the wholesalemanufacturing segment of the industry.According to publicly avail-able first quarter reports, 62.5 percent of Turbon’s revenues are tonercartridges, which compute to U.S. $94 million. Assuming an averagewholesale price of $40 per cartridge, that equates to just under 2.4million cartridges per year for Turbon.

It is worth noting that Turbon has 40 percent of its revenues comingfrom inkjet cartridges, ribbons and other imaging supplies. There-fore, it is not entirely accurate to ascribe the full value of the trans-action to the manufacture of toner cartridges. However, as Turbonpoints out, while it is a dominant player in the ribbon business, it isa declining market globally. Thus, the value associated with this partof the business is presumed to be less than the other parts of thebusiness. In any case, the numbers generally correlate with the totalvalue of this segment of the industry.

Creating the Value of Our IndustryIn aggregate, excluding retail distribution of remanufactured inkjetand toner cartridges, the industry’s value is approximately $3 bil-lion, with a strong argument for it to be worth substantially less andan equally strong argument for it to be worth substantially more.Large-scale, wholesale remanufacturers control over two-thirds ofthis value, however, there are few wholesale remanufacturers thatare as large as some of the other players in other sectors of theindustry. Some of the most highly-valued companies within theindustry, who have established high valuations through an aggrega-tion of revenues, are not involved in wholesale remanufacturing:(listed in no particular order) Static Control, Mitsubishi, FutureGraphics, Fuji, etc.

One of the most interesting questions regarding the valuation of ourindustry is whether a dollar of profit for a wholesale manufacturertoday is valued at the same level as a dollar of profit for a componentdistributor, or a component manufacturer, or a core broker. Giventhe dynamics in the industry today, it appears that the most valuecreation (or at least the greatest change in the allocation of value)over the next several years will occur in the wholesale manufacturersegment. Therefore, one could argue that the best place to invest inthe industry today is in wholesale manufacturers. Moreover, it ishighly probable that over the next five years certain segments of thevalue chain will lose value while wholesale manufacturers capture asubstantially larger share of the aggregate value for the industry. Asthe consolidation within the industry accelerates, as the industry asa whole grows, and as the rest of the trends within the industry bearout, it is highly likely that there will be a $1 billion value story (andseveral hundred million dollar value stories) within the wholesalemanufacturing channel.

In sum, our industry has clearly created substantial value over thepast 10 years. There is a significant amount of additional value to becreated and to be captured over the next 5 to 10 years. Companiesthat recognize the elements of value creation and prepare them-selves to capture this value will be much better positioned to makeprofits and, thus, achieve a higher equity value for their business.Similarly, companies that do not concentrate their efforts on finan-cial value creation are likely to lose value in the coming years. As weidentified at the outset of the article, the next chapter in the indus-try’s development will most likely present a new roster of winnersand losers—and a great deal of money is at stake for the winners.

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