DXC - DXC Technology

[valueinvestor]

EV/OE is less than 6-11x depending on your perspective of restructuring expense.

 

No real runway for growth.

 

Investment thesis is reliant on cost-cutting initiatives that outpaces the slow decrease in revenues, due to a lot of redundancies from acquisitions and other activities.

 

On 2022 numbers, it is trading less than 2-5x.

 

John Lawrie is CEO, ex-partner of ValueAct.

 

 

[misterkrusty]

I'm not sure there's no runway for growth.  "digital" + Luxoft still less than half of revenues, but growing fast.  Probably 1-2 years before the growth starts to offset the declines in older business lines.

[mwtorock]

I'm not sure there's no runway for growth.  "digital" + Luxoft still less than half of revenues, but growing fast.  Probably 1-2 years before the growth starts to offset the declines in older business lines.

 

It seems to me they probably overpaid for Luxoft. I did some work on Luxoft before and the issue I found was that the two large banks customers were/are both working to shrink budgets. So they had to buy growth from somewhere else to offset that revenue.

 

Luxoft's competitive advantage was their talent pool in Eastern Europe, but employee feedback was not very positive when I checked two years back (in Poland and Bulgaria). Some more experienced or manager level people were  easily recruited by customers and competitors.

[misterkrusty]

your're not the only one who thinks they overpaid for Luxoft, but I'm not so sure.  Deutsche Bank has some well publicized troubles and DB was a huge customer, so that's been depressing earnings.  If they can't replace those revenues then, yes, DXC overpaid.  But if they can, Luxoft could get back to normal earnings - say, $4-5 on the old Luxoft sharecount, which would mean DXC paid less than 15x earnings.

 

I appreciate the scuttlebutt on Poland and Bulgaria.  My impression is that the vast majority of their talent is in Ukraine and Russia - would be good to talk to people there if that's possible.  Last I checked, Luxoft had the highest bill rate for any IT consultancy in the world.

 

I agree the restructuring charges are huge.  Do you know if mgmt has given any estimates about how much more of these we can expect? 

 

BTW, I believe they just won a settlement in court of 2/3 of a billion $, thus the rally yesterday.

 

FD: no position (yet)

[concerto]

Just wanted to ask if anyone's done some recent work around DXC? Looks like an incredibly compelling valuation (~2.7x LTM EBITDA, ~2x LTM EPS, even lower multiples when adjusting for the pending sale of three subsidiaries, one of which has already been sold at a higher-than-expected price). Company also pays ~6% dividend at the moment. New CEO in place with a new strategy (blaming recent underperformance on execution failures under the prior administration, we'll see if that argument holds water), but unfortunately the company's fundamentals seem quite weak (continued top-line and margin declines).

 

The company has historically been highly cash-flow generative ($2.1bn adj FCF last year vs. $1.7bn adj net income), but that'll likely come down next year. Street estimates $3.1bn EBITDA and $4.93 EPS, implying ~3.3x NTM EBITDA and 2.8x P/E. Comps trade ~8x CY'20 EBITDA and ~13x P/E, so it seems like DXC is trading at a pretty absurd discount right now even with relative underperformance. A (rapidly) melting ice cube dynamic would be the only way to really justify the valuation, but I don't have enough exposure to IT Services to really understand how these dynamics should work. Does anyone have scuttlebutt around the stickiness of the revenue base and/or perspectives around whether DXC fundamentals will continue to deteriorate? Intuitively, DXC seems like it should be quite sticky (its core business involves taking over management of a customer's entire tech stack) but recent performance, including 15%+ year-over-year decline in that core business, is making me nervous.

 

Interestingly (as a side note), the company's guidance of $5bn in net proceeds from its divestitures will be enough to repurchase the entire market cap at a significant premium to its current price (unfortunately, management wants to use these proceeds to pay down some of the company's $12bn debt balance).

[jeffsreng]

I'm biased. I'm a former employee.  I valued it at $100.  It's cheap.  I don't own any shares. I still prefer my short.

[concerto]

Got it - thanks. Interesting to hear that you're bullish as a former employee, as others (on Glassdoor, in trade publications) have made the DXC experience under Mike Lawrie sound like pure hell. Hopefully things have improved under the new CEO.

[valuedontlie]

i've watched it for years... has an IBM feel to it where a big slug of revenue is declining fast (DD+) and some areas are growing nicely (and likely very valuable)... i liked LXFT prior to their acquisition and imagine that business is still worth the $2bn they paid for it...

 

i think earnings and cash flow will be down big in FY21 as they've officially "reset the bar" but the divestitures get them near debt-free with room to deploy cash elsewhere... and should remain a cash flow positive business...

 

my take is things will look better 3yrs out...

[valueinvestor]

I'm biased. I'm a former employee.  I valued it at $100.  It's cheap.  I don't own any shares. I still prefer my short.

 

Hey Jeff! Any chance you're willing to elaborate? I tried looking at the numbers, but it's hard to give it more than $50 a share. Secondly, the cost-cutting efforts do not seem to be appearing in to the financial statement.

 

As for the divestiture, that's great, but if mis-allocated, it could be worth nothing or even worse, less.

 

i've watched it for years... has an IBM feel to it where a big slug of revenue is declining fast (DD+) and some areas are growing nicely (and likely very valuable)... i liked LXFT prior to their acquisition and imagine that business is still worth the $2bn they paid for it...

 

i think earnings and cash flow will be down big in FY21 as they've officially "reset the bar" but the divestitures get them near debt-free with room to deploy cash elsewhere... and should remain a cash flow positive business...

 

my take is things will look better 3yrs out...

 

What do you mean by "reset the bar" - any chance you can elaborate too? Do you mean the reduction in debt levels or the fact they "digested" their acquisition?

 

Edit: Been on the sideline on this one too.

[valuedontlie]

i'm a shareholder...

 

new CEO came in after Mike left... outlook for earnings over the next few years is lower (i.e. new CEO resets the bar)...

 

they talked about converting 80-85% of EPS into FCF and GAAP EPS should be $3.25+ in FY20 and expanding from there... i'd love to see them do a big buyback but given all the uncertainty, getting to debt-free isn't a bad move for most companies...

[valuedontlie]

also, if you're going to treat operating leases as debt you should look at it on a rent-adjusted earnings basis....

[valueinvestor]

i'm a shareholder...

 

new CEO came in after Mike left... outlook for earnings over the next few years is lower (i.e. new CEO resets the bar)...

 

they talked about converting 80-85% of EPS into FCF and GAAP EPS should be $3.25+ in FY20 and expanding from there... i'd love to see them do a big buyback but given all the uncertainty, getting to debt-free isn't a bad move for most companies...

 

Ahh you learn something new everyday - but even considering that $100 per share as Jeff mentioned is hard to see without a 20 multiple and it becomes a growth engine again.

 

My value at the most would be $50-60 dollars, but considering my lack of understanding of the "moats" surrounding the business, I was comfortable being on the sidelines.

 

What do you think I'm missing here?

[concerto]

I don't think this is a $100 stock, or perhaps even a $50 stock, but something in the $25-35 range (5-7x P/E) should be justifiable pretty easily even with a margin of safety in mind and a great return (vs. $13 current price). Looking through some of the articles on The Register through the years (as well as the lawsuit recently filed by Kingstown Capital), it looks like the failures of the company since the CSC/HPES merger can be largely attributed to Lawrie's desire to massively cut costs without regards to the potential impact that rationalization could have on project delivery and top-line. This I think could be interpreted as an incremental positive, as failures in execution due to a specific cause (ridiculous cost-saving initiatives) can be addressed under a new regime. It might not be a great margin expansion story anymore, but hopefully we won't see 5-10% yoy revenue declines moving forward.

 

I don't think there's any real moat here, except that when DXC is running your IT infrastructure they're probably difficult to replace. That being said, their ITO business managed to decline 15%+ year-over-year this past quarter so maybe even that stickiness isn't real.

 

With regards to the valuation multiples - I might be missing something, but the debt calcs include capital leases only (not operating leases) so there are no further adjustments needed to EBITDA as far as I can tell. Sorry if my accounting skills are a bit rusty at the moment.

[valueinvestor]

I don't think this is a $100 stock, or perhaps even a $50 stock, but something in the $25-35 range (5-7x P/E) should be justifiable pretty easily even with a margin of safety in mind and a great return (vs. $13 current price). Looking through some of the articles on The Register through the years (as well as the lawsuit recently filed by Kingstown Capital), it looks like the failures of the company since the CSC/HPES merger can be largely attributed to Lawrie's desire to massively cut costs without regards to the potential impact that rationalization could have on project delivery and top-line. This I think could be interpreted as an incremental positive, as failures in execution due to a specific cause (ridiculous cost-saving initiatives) can be addressed under a new regime. It might not be a great margin expansion story anymore, but hopefully we won't see 5-10% yoy revenue declines moving forward.

 

I don't think there's any real moat here, except that when DXC is running your IT infrastructure they're probably difficult to replace. That being said, their ITO business managed to decline 15%+ year-over-year this past quarter so maybe even that stickiness isn't real.

 

With regards to the valuation multiples - I might be missing something, but the debt calcs include capital leases only (not operating leases) so there are no further adjustments needed to EBITDA as far as I can tell. Sorry if my accounting skills are a bit rusty at the moment.

 

Makes sense - no worries about it - valuation is more an art than science so as long a range can be made that's fine. I was wondering what Jeff meant by $100 stock - thought I was missing something huge.

 

However, I agree with your valuation for the most part.