XRX - Xerox

[mcliu]

Does anyone follow Xerox? Shares have been hit pretty hard following Q3, but on the surface looks quite attractive.

[Palantir]

Thank you for this. I had been following Xerox but lost interest after the runup. From what I've seen, every enterprise IT guy has struggled this quarter, IBM, ACN, and RHT and missed expectations, (Short HPQ?) so I suspect that it's not a huge deal.

 

[GrizzlyRock]

I spent a ton of time on Xerox in the summer of 2012 and was involved for awhile based on the magnitude of recurring CF being ignored in the market. Take a peak at the attached for a (year-old) high-level analysis (Legal disclosure: not a recommendation - purely for entertainment purposes). The slides aren't a full-blown analysis as I used them as backdrop for a verbal discussion so there are omissions herein.

 

Don't like Xerox at there levels.  If is goes back to $7ish I'll dust off my folder and take another look

GrizzlyRock_Xerox_Equity_11.12_CORNER_OF_BERK.ppt

[nkp007]

We made an investment a while ago. Then we sold.

 

There's a good business bad business dynamic going on. And eventually we realized services may not be able to outrun the decline in the printing business.

 

It's no fun having to run faster to stay in place.

[Cardboard]

I really like the girl that does their ads on TV.  :P

 

Cardboard

[Kiltacular]

I really like the girl that does their ads on TV.  :P

 

Cardboard

 

Agreed.  To bad we couldn't copy her :P

[moustachio]

I'm long Xerox through common shares and 2015 and 2016 leap calls. I was buying in the 9's and selling around 11 and bought back in after the 10% drop. Personally, I've scanned the end of the IBM thread and I find it hard to see why someone would choose IBM over XRX. XRX is a much better value IMO. For the Buffet lovers who would point at his actions, I'm guessing the main reason he is buying IBM is that the market cap is 15x XRX's market cap and so it is an easier place to put cash.

 

For anyone who is new to this stock and glancing at the key statistics, it is key to note that a large portion of their debt is offset by financial receivables that are due to them financing equipment sales to customers. A quote from the recent earnings call transcript:

 

Moving to the next slide, I'll walk through our capital structure and capital allocation plan. We ended the quarter with $7.5 billion in debt, which is $600 million lower than the June ending balance, driven by the senior note repayment, a portion of which we intend on refinancing. Applying the 7:1 leverage on financing assets, our allocated financing debt is $4.5 billion, leaving core debt of $3 billion.

 

Our financing debt continues to decline, driven by finance receivables sales and lower originations. Our strong year-to-date cash flow and expectation to be toward the higher end of our free cash flow guidance of $1.6 billion to $1.9 billion provides more flexibility with our capital allocation plan.

 

On share repurchase, given the positive cash flow trends, we expect that repurchases will be at least a couple of hundred million dollars above our $400 million minimum guidance.

 

On acquisitions, year-to-date, we've spent about $160 million relative to our full year guidance of between $300 million to $500 million. The slower pace of Services acquisitions has put a damper on Services revenue growth. But as I mentioned earlier, I continue to feel good about the quality and progression of the deals that are in our pipeline.

 

And finally, dividends will use about $300 million of cash, which factors in our Q1 dividend increase to $0.0575 per share a quarter.

 

 

While their printer business is declining, their services business is growing. Also, keep in mind that while revenue might be flat on a year over year basis, they have had ongoing share repurchase programs and their overall share count is going down. I would think some graphs showing some per-share metrics might be interesting, but I'm not the kind of guy to do those things. Eventually they should get to a point where their services business will be large enough relative to their printer business that there won't need to be much focus on the slowly dying side of their business. Another quote:

 

Services revenue now represents 56% of our total revenue, up from 51% in 2012, so we've passed the tipping point on revenue but still have work to do on margin.

 

The main reason for the drop is probably(IMO) a forecast for a not so good 4th quarter. This might be dead money for a while and their might be better opportunities elsewhere, but I think downside is limited and it might creep up due to buybacks and is overall undervalued. It should be a decent hold for a couple years, and options through leverage should increase upside. Another option is writing puts. Another couple quotes:

 

So in summary, a good quarter. Document Technology has stabilized despite some weakening in developing markets but will face a difficult margin compare in Q4. Services continues to face headwinds that will knock down growth and margin in Q4 but the underlying metrics remain positive, and we continue to work hard at improving our cost structure.

 

As a result, we expect that fourth quarter total company revenue will be down a couple of percentage points year-over-year and operating margin will be lower than our prior year 10.6%, yielding an expected earnings per share of $0.28 to $0.30 for the quarter, bringing our full year EPS guidance to the low end of the range.

 

That said, Q4 will be a more challenging quarter. We'll face more difficult compares and continue to absorb health care sector investments, while not fully realizing the benefits of our longer-term margin initiatives. For our fourth quarter, we expect, as Kathy said, adjusted EPS of $0.28 to $0.30. This includes approximately $0.02 of restructuring and $0.02 from higher pension settlement expenses.

 

And we are narrowing our full year adjusted EPS to $1.08 to $1.10.

 

Throughout 2013, we've navigated the headwinds of negative Services mix, a slowdown in developing markets and continued weakness in Europe, while continuing to make investments in areas of opportunities such as health care. We have delivered at the high end of our range over the last 3 quarters and with strong cash flow.

 

In spite of this, Q4 is anticipated to be a weaker quarter but I'm confident that we are taking the actions to position us better for the future. And we look forward to sharing

 

I like the shareholder friendly capital allocation, and I think as a smaller company it is much easier for them to put cash to work. I think investors will do well whether they are buying back undervalued stock, increasing their dividends or acquiring companies that will bump up their services business. Another quote on their acquisition pipeline:

 

As we look to 2014, we expect growth will begin to pick up again, driven by favorable signings and renewals, a strong new business pipeline and a richer and more mature pool of acquisition prospects.

 

With 1.6 to 1.9 billion in free cash flow projected this year, and a market cap of under 12 billion, they could theoretically buy back a significant portion of the company's shares. Because of that I could not imagine being short this company for long or seeing it getting significantly cheaper for long. I recommend reading this most recent earnings transcript if you are interested in this company, which all of my quotes came from:

http://seekingalpha.com/article/1769372-xerox-management-discusses-q3-2013-results-earnings-call-transcript

 

Disclosure: I'm a retail investor, long this stock, and probably should do more in-depth research than I do. I haven't and don't model things like their printer business and how it will be doing five years from now, even though maybe I should. Do your own due diligence and don't take any of this as a recommendation.

 

 

 

 

[Packer16]

While on the surface IBM may appear comparable, they are apples and oranges.  IBM has focused on software and services and built this organically from inside.  Xerox on the other hand purchased its services and the folks who run it are very promotional.  I live in Rochester and know a number of folks who work at Xerox and it has the potential to be a dieing mess, similar to Kodak.  The printer business is (which is their strength) is a dieing business.  The services are more akin to CSC than IBM.  This in my opinion is a melting ice cube that is managed poorly with the services guys (ACS management) taking over the place once there non-compete has expired.  Just my 2 cents.

 

Packer

[tombgrt]

I'm long Xerox through common shares and 2015 and 2016 leap calls. I was buying in the 9's and selling around 11 and bought back in after the 10% drop. Personally, I've scanned the end of the IBM thread and I find it hard to see why someone would choose IBM over XRX. XRX is a much better value IMO. For the Buffet lovers who would point at his actions, I'm guessing the main reason he is buying IBM is that the market cap is 15x XRX's market cap and so it is an easier place to put cash.

 

He could just take over Xerox with one year of earnings if he wanted so I don't see your point. Could have offered $9-10b at the end of 2012 and enjoy tax benefits etc by making it a integral part of BRK instead of buying stock in IBM. Yet he chose the latter. Why? ;)

 

Buffett has followed IBM for 50 years. He didn't just pick IBM because it is an ultracap. Far from!

[moustachio]

Fair enough tombgrt, I might as well retract that point. I don't think XRX is exactly Buffet's style of business(not viewed as high-tier quality like IBM, see Packer's post), so I don't know why I threw that in there in the first place. IBM is obviously a higher quality business, but XRX has a much higher FCF yield.

[mcliu]

At a 15% FCF yield, the "Printer" business probably needs to fall a lot faster than its current levels for this to go wrong.

 

I own shares, but I do have trouble evaluating the quality of the "Services" business given all the moving pieces (subsidiaries, acquisitions, product lines). Same issue with IBM, it feels like such a complex machine..

[bmichaud]

XRX management is a complete joke - I feel like I'm reading Dr. Seuss reading the earnings calls.

 

The perpetual restructuring costs and odd D&A/capex accounting created by operating lease equipment makes FCF appear higher than it truly is.

 

Far more interesting below $8 if at all....

[dwy000]

I looked at this a year or two ago too - I think after Einhorn bought into it.  You can probably discount for the dying side of the business or just milk it for cash as long as possible and get comfortable at some single digit price for the whole company.

 

My issue is with the financing part of the business and cash flows.  They have been selling off the financing receivables for cash (in addition to just having them melt off as the underlying business slows).  A substantial portion of operating cash flow over the past few years has been from liquidating financing receivables - and booking gains on the sales.  If you back those out the underlying business looks even worse than the headlines (and bottom lines) show.  In addition, I think the receivables have been growing while sales have been flat to declining.  Not good trends.

 

Falling knife, melting icecube or whatever analogy you want, I'm sure there's a decent underlying business here somewhere I just can't figure out when it gets there and how ugly its going to be in the meantime.  Especially with the amount of debt outstanding. 

[bmichaud]

And again management makes no effort to actually highlight the value of the underlying business. They merely guide to FCF and EPS, while making no mention of receivables run down and buybacks driving those two figures.

[mcliu]

Yes, they are playing some games with the accounting as discussed during the Q3 call, but I've spread the financials (see attached), and adjusted the numbers by 1) removing all of the financing business, 2) adding $200M in restructuring and $350M in pension payments and it still doesn't look that bad.

 

Obviously not the $2.4B in cash flows that management is talking about, but it's still a 10%+ yield and there's still value from the financing business that should bring it to around 15%.

 

What am I missing?

 

I do agree that better management would make me a lot more comfortable with this company.

Xerox_Financials.pdf

[bmichaud]

Ok so looking at the LTM numbers on CapIQ we have (ex. finance division): 

 

Revenue $21,771

COGS 15,244

SG&A 4,249

R&D 608

Amort 331

Restruct. 150

EBIT = $1,189

D&A 1,213

CAPEX 700 (adding up capex + acquisitions + intangible purchases is roughly 700)

Adj. EBIT = 1,702

Net Income = $1,191 (30% tax rate)

Shares Out 1,259

FCF Per Share = $.95

 

Other assets include:

1,722 current loans & leases

1,329 Fuji JV

2,957 LT loans & leases

533 finance division other assets

948 cash

Total Non-Core Assets = $7,489

 

Total debt = $7,541

 

So the way I look at it is the Company could sell off all of the non-core assets and retire almost its entire debt load, then you are left with a FCF stream to equity holders of around $.95 per share. I'm giving them the benefit of the doubt by valuing all non-core assets at 100% of BV and ignoring the pension and unearned revenue liabilities.

 

At these levels, you are essentially buying a company with little to negative growth at fair value, since one should require a 10% return at FV give or take. As Buffett says, a growing business is worth a heck of a lot more than a dying business.

 

When I got involved with XRX in early 2012 I felt pretty strongly that they should raise their debt levels and repo stock aggressively. As you can see above, net debt levels are not that high, thus in theory there is capacity. However, after observing mgmt for over a year and watching service margins not only fail to deliver on the post-ACS goal of rising but rather falling, I don't believe XRX should be adding debt to this business, particularly to buy back stock at these levels.

 

Bottom line, it just seems like there are easier battles to fight than investing in XRX at these levels. I'd rather buy a growing business with pricing power and growth potential at 15X earnings than a little to no growth company at a seemingly cheap multiple of 10X.

[mcliu]

Why do you take the 30% tax from your Adj. EBIT and not EBIT? I mean they're not getting taxed on their D&A..

 

It's trading at 10x, excl. the financing business, but the financing does still generate some value despite the way they're using it to smooth earnings. I'm looking at historical taxes and the financing earnings which makes cash flows slightly more attractive.

 

Do you have any examples of companies that have pricing power and growth potential trading at 15x in is market? I would definitely rather buy a wide-moat quality company like that at 15x than Xerox as well, but I can't find any.

[bmichaud]

Why do you take the 30% tax from your Adj. EBIT and not EBIT? I mean they're not getting taxed on their D&A..

 

The seemingly positive difference between GAAP D&A and CAPEX/Acquisitions/Intangible purchases is primarily the result of equipment held for operating lease purposes - the equipment purchased for lease does not show up as CAPEX but rather as a "change in operating assets". So the D&A flows through the income statement but the equipment purchases get buried in the changes in working capital and other assets/liabilities.

 

All that to say - if the financing division were to be liquidated for book value as I outlined, XRX would no longer have D&A of $1.2B, but rather something likely along the lines of its $700MM capex/acqui/intang budget. So I view it as more conservative to tax-effect the difference between GAAP D&A and CAPEX.

 

It's not dissimimlar to Pfizer, where D&A is MASSIVE relative to annual capex and acquisitions. As PFE runs off its legacy drugs and thus its huge amortization line item, eventually that tax benefit will go away. You could be precise and model out the PV of excess tax benefits, but I find it easier to just assume the current investment budget is steady state, and tax-effect the difference.

 

It's trading at 10x, excl. the financing business, but the financing does still generate some value despite the way they're using it to smooth earnings. I'm looking at historical taxes and the financing earnings which makes cash flows slightly more attractive.

 

There are many different ways to skin the XRX cat - I happened to account for the financing value by giving XRX credit for 100% of BV for all of the receivables and equipment. Had I counted net financing income in the FCF number, then the net debt figure (at $0 in my scenario) would have risen by the book value of the financing division, thus I view the financing division cash flow valuation as a wash....

 

Do you have any examples of companies that have pricing power and growth potential trading at 15x in is market? I would definitely rather buy a wide-moat quality company like that at 15x than Xerox as well, but I can't find any.

 

PG is one that potentially comes to mind - if it can successfully remove $10B in costs, earnings power is materially higher than its current EPS configuration.

 

MDLZ & PEP, while not trading at 15X, have some serious financial engineering potential. Even if Peltz is not successful in his financial engineering campaign, at worst you are buying both below fair value WITH significant market attention on both businesses to improve margins and potentially split up the PEP North American Beverage business.

 

Also - Nestle is reportedly interested in buying the Italian maker of Nutella (can't remember the name....), and would likely have to pay 30X or higher for it. Given Hershey currently trades for 23 to 25X in a slow-growth market, MDLZ would likely garner a significantly higher valuation (than it trades at now) in the event a Nestle or another global food player would be interested. 30X $1.50 "core" eps is $45, but with margin expansion MDLZ should be earning closer to $2, which means a $60 price in the event of a 30X take-over PE.

[mcliu]

Thanks bmichaud. Good replies, very helpful.

[bmichaud]

To my point on MDLZ, lots of market attention spearheaded by Trian....

 

http://www.marketfolly.com/2013/10/nelson-peltzs-presentation-on-mondelez.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+MarketFolly+(Market+Folly)

 

 

[johnny]

Anybody messing around with this merger? I have no opinion on the actual strength of the business or it's Real Value, but it seems like the current price is right around Icahn's opinion of the IV of the merger. But he clearly thinks he can squeeze another 20% out of Fuji.

 

Since I know nothing about Xerox: The Company, I'm only here because the political (and geopolitical) implications here are very interesting to me. POTUS has spent the past 30 years vaguely bitching about how Japan (then China) rips us off. I'm not saying I think Icahn necessarily passes this situation on to Trump, and I'm not even sure I know what Trump would do with that information. But the facts are:

 

1. Icahn knows Trump

2. Icahn is known to know Trump

3. Icahn is alleging a fact pattern here that is fantastically harmonious with the populist narrative of trade-rape that Trump so enthusiastically (and successfully!) deploys.

 

This can't be escaping the grasp of a single relevant party in Japan. Maybe a single-digit billion dollar deal isn't enough to attract any attention. But if I were on Shinzo's team, I'd be strongly leaning on Fuji to pull their punches and try to arrive at a ~win-win~ outcome. Fuji trying to save a few billion bucks could very well result in Japan being put back in the trade dog-house if Trump finds it politically useful to redirect some heat off of China. As it stands they already are being conspicuously sidelined on the DPRK issue, despite being the most at-risk state in the process.

 

Disclosure: imprudently large position, no annual reports read

[Spekulatius]

XRX’s Meter could as well fall under a protectonistic narrative and get cancelled by the POTUS, due to risk of job losses etc. The cost savings need to come somewhere after all. Unless I were damn sure that he intrinsic value is higher than the current EV, I would not touch this.