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Is buying Xerox right move for Fujifilm?

CEO believes copiers have a future, but some analysts are unconvinced

A logo of Fujifilm Holdings is seen at its headquarters in Tokyo on Feb. 1. (Photo by Kosaku Mimura)

TOKYO -- About 10 years ago, Shigetaka Komori, then president of Fujifilm Holdings, told a Nikkei reporter: "If I were 10 years younger, I would have considered buying Xerox." A deal to purchase its U.S. partner did not materialize, partly because Fujifilm had a lot on its hands at the time. It was about to get into the medical business and Komori was also serving as board chairman at NHK, the Japanese public broadcaster.

Somewhat ironically, a decade on and at the age of 78, Komori -- now company chairman and CEO -- has finally decided to buy Xerox. Critics say that buying a company whose growth has been slowing may not be a good idea. But at Wednesday's press conference Komori was confident about his decision after 10 years of toying with the idea. "There is room [for growth] for copiers," he said decisively.

So what is the growth potential for these machines that led him to decide on the acquisition?

On Wednesday Fujifilm also said it will restructure its subsidiary Fuji Xerox, in which Xerox holds a 25% stake. This includes a plan to cut 10,000 jobs. The restructuring plan reminded some of the similarly bold reform Komori implemented in the early 2000s, when Fujifilm was trying to weather the storm caused by a sharp decline in demand for photographic film.

The uniqueness of Komori's strategy is that he offers a clear vision, and then pushes the company to be both on the offensive and defensive at the same time. In his previous reform, which he called a "second founding" of the company, Komori drastically cut fixed costs at the profitable photo film unit, while shifting resources to new areas such as films for liquid crystal displays and medical products.

Over the medium to long term, the copier market is expected to shrink, thanks to efforts to use less paper and the spread of cloud computing. But Komori insists that "the market is still there." Perhaps, compared to the demise of the photo film market, which was Fujifilm's core business, the copier market's fall is not as worrying -- yet.

The plan is to first rejuvenate Fuji Xerox by rigorously implementing reforms such as the job cuts, reorganizing production bases and making development processes more efficient, and then integrate its operations with those of U.S. counterpart Xerox, streamlining sales, marketing and other operations across different regions in a bid to increase efficiency. When the whole reform is complete, Fujifilm reckons, the newly integrated Fuji Xerox will generate over $1.7 billion in additional annual pretax profit by fiscal 2022.

Investors largely welcomed the buyout plan, pushing up Fujifilm's share price by 4% on Wednesday in New York. In particular, they liked the turnaround plan for Xerox and the plan to hand out $2.5 billion of extra dividends to existing shareholders.

Not everyone is optimistic about those plans, however. Masayuki Kubota, chief strategist of Rakuten Securities Economic Research Institute, said: "This acquisition can be seen as Fujifilm being talked into buying [Xerox] by Carl Icahn [the activist investor who holds the largest stake in Xerox]. For now, it can be viewed as negative or positive." Fujifilm will acquire only 50.1% of the integrated Fuji Xerox, meaning, "about 50% of [new Fuji Xerox's] profit will belong to outsiders." The analyst also added that "it is also unclear if Fujifilm can integrate a giant like Xerox smoothly."

But Komori is more positive. He thinks that Fuji Xerox and Xerox are currently swimming in the rough waters of a rapidly changing business environment for the office equipment business with their hands in shackles, due to the territory system that artificially divides the companies' global markets.

The conventional business model of office equipment makers -- sell lots of copiers or multi-function printers to companies and earn money from expendable toner -- has become a thing of the past. Today, these companies' mainstay business is a managed print service, or MPS, a model created by Xerox. The service includes everything related to printing in office from installing equipment to managing its operation and replenishing expendables for corporate customers, helping clients' efforts to improve productivity and cut costs. In other words, the main battlefield for copier companies has shifted to service rather than the sale of products.

Yet Xerox, the pioneer copier maker, has found the territory system to be a structural obstacle to the MPS. As the service's prime customers are global companies operating around the world, an office equipment maker needs to be capable of completely looking after printing-related works at all of a customer's offices scattered around the globe. But under the territory system, Xerox's sales and marketing area is confined to Europe and the U.S., while that of Fuji Xerox is limited to the Pacific-rim region, including Japan, China, Southeast Asia and Oceania. Although Xerox and Fuji Xerox have been working closely together for a long time, the territory system has significantly shackled them in their dealings with multinational corporate customers. The integration of Xerox and Fuji Xerox will contribute considerably to the Xerox group's efforts to expand market share.

Another long-time headache for Komori is Fuji Xerox's tendency to high costs. The company's operating profit margin was 7.7% in the year through March 2017, compared with 9.7% for rival Canon's office equipment business in the year to December 2017, for instance.

"High SGA [selling, general and administration] expenses," Komori has repeated, in referring to Fuji Xerox's problems. The expenses are inherent in company activity.

As signified in the use of the term "xerox" to mean "copy," the brand power of Xerox was once enormous. That led Fuji Xerox to take great pride in itself, causing the company to focus on sales to corporate customers where its strong brand power counted. In the eyes of Komori, this approach "lacks sufficient cost consciousness." He has already taken measures to rectify Fuji Xerox's proneness to high costs, and is poised to step up reform efforts after the merger with Xerox.

The stock price of Fujifilm climbed to 4,698 yen on Thursday, up 12% from Wednesday. Taking into account the stock price drop after a U.S. press report on Jan. 11 on a possible expansion of the tie-up between Xerox and Fuji Xerox, one can say that Fujifilm shares have only recovered to around the closing level of Jan. 11 (4,724 yen), prior to the report. Fumio Matsumoto of Dalton Capital Japan said: "A sharp rally in one day should be interpreted as the effect of bad news running its course, and should not be taken as the result of buying into expectations of a synergy effect from the merger."

The acquisition of Xerox through what Komori calls "creative means without entailing the drain of cash" has certainly reassured the stock market. But whether the acquisition should be welcomed hinges on whether Komori's structural reform and pursuit of synergy can be steadily implemented. The market is not so sure of Fuji Xerox's ability to follow through with the task.

Xerox management has faced a flurry of calls from its shareholders to reconsider the merger with Fuji Xerox. If Komori's vision for the merged company ends up being pie in the sky, the shareholders of Fujifilm could in turn urge the Japanese company's management to sell the new Fuji Xerox and specialize in the medical business.

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