Xerox Corp (NYSE:XRX)’s Turnaround Has A Long Way To Go
For a long time, at least since Ursula Burns came in as CEO six years ago, Xerox Corp (NYSE:XRX) has been talking about a turnaround. But nothing meaningfully uplifting has seemed to come. Recently, the narrative has focused on strategic review with the management leaving options open for more assets disposals but ruling out a sale of the whole company.
What happened, one might ask, to make Xerox’s turnaround such an almost endless journey? Could it be that Xerox was in a much deeper hole than the management previously admitted or the more things change the more they remain the same?
As Xerox embarks on what the management calls a ‘broad review” of the company and its businesses, what you see ahead are more bumps and potholes. Should you prepare for a more rewarding turnaround journey or one that will only throw more setbacks your way? Either of these are possibilities. In the medium-term, Xerox will likely continue to disappoint, but on the long-term (and the long-term could be really long), some turnaround fruits might start to show – but there is no guarantee.
Xerox Corp (NYSE:XRX) operates in two main business segments namely Document technology and Services. Each of these businesses is under pressure.
Stagnation in Document business
About 90% of revenue in Xerox’s Document Technology business is recurring, which creates something like a subscription business model that insulates revenues and earnings from sudden shocks. Because of the subscription-like revenue flow in the Document business, Xerox is likely to sidestep some growth pressures in the segment, but prolonged pressures could significantly slow down growth or herald complete stagnation.
Although the Document business might sidestep intense pressure for some time because it is a bit more insulated from cloud interference, slowed growth or total lack of it in the segment is likely to introduce fresh challenges in Xerox’s other operations.
Document Technology has been the cash cow for Xerox. It generates cash for investing the higher-margin Services business and return to shareholders. Consequently, if growth in Documents fizzles out or the business catches the cold, the rest of Xerox sneezes. That is likely to be truer in the medium term as cloud continues to shake up more legacy technologies.
The Document division generated revenue of $1.8 billion in the last quarter, indicating a decline of 12% year-over-year.
Xerox Corp (NYSE:XRX)’s Services business is a higher-margin operation, but one that is also more vulnerable to cloud disruption. The rise of cloud is likely to hit Xerox’s Services business in several ways including customers defecting to cloud to enjoy greater efficiency and escape multi-year lock-ins of legacy IT services.
The impact of cloud interference in Xerox’s Services business continued in the last quarter (3Q2015) as revenue in the segment took an 8% plunge to $2.4 billion. Overall revenue in the quarter dropped 10% to $4.33 billion, short of the consensus estimate of $4.54 billion.
Cloud disruption in the Services business threatens Xerox’s future. The company is taking cash from Document to grow the Services division through acquisitions and organically. The investments being made in Services are expected to pay off at some point in the future – the sooner the better. However, as Xerox invests in Services to enable it to win more business, the company also has to figure out how to sidestep the unfavorable wave of cloud or at least tap into it for growth.
However, the dynamic situation in Services poses execution risks and the investments being made in the division could end up failing to deliver the intended results, triggering more woes for the company.
On a positive note though, many if not most of Xerox’s services are insulated from immediate adverse impact of cloud. Services offerings such as workflow, government healthcare and call centers are shielded from cloud disruption to a greater extent, thus allowing Xerox time to navigate its future.
Xerox Corp (NYSE:XRX) has an appetite for acquisitions. As the management embarks on the next phase of efforts to try and turnaround the business, more acquisitions are on the way. Already this year alone, Xerox has turned at least $200 million to small buyout deals. The management hinted that it will avoid making large acquisitions in the near-term, but it will be open for more bolt-on smaller acquisitions.
Buying growth is a sensible strategy, which to some extent has worked well for Xerox in the past and is likely to reward in the future. However, history is stubborn. History is full of lessons that large technology vendors never see, long-term benefits of their acquisitions. Consequently, while further acquisitions might bring some growth catalysts to Xerox, accelerated acquisitions are likely to make investors nervous.
The other risk in acquisitions is that larger deals or rapidly accelerated acquisition deals could consume more cash, thus leaving Xerox’s coffers dry and holding back some other projects such as returns to shareholders.
How Xerox could sidestep intense pressure
For the most part, the future of Xerox Corp (NYSE:XRX) is bleak. But there are a number of ways the company could, by design or default, escape enormous adverse impact on its performance.
Faster recovery of global economy: If the global economic slowdown lasts for only a few months and quick recovery happens, Xerox could escape some adverse impact on its business. China is a key global factor in the recovery of many global economies. The economic slowdown in China poses a major headwind for Xerox and multiple other technology vendors with international footprint. If China recovers quickly, adverse impacts on Xerox could be mitigated, but if China remains bad news for a longer stretch, more than already anticipated, pressure could mount on Xerox and further disoriented its turnaround.
Less painful cloud disruption: Greater emphasis has been put in cloud disruption of Xerox’s Services business. If Services business can stand up to cloud displacement and turn around faster, Xerox could sidestep some anticipated pressures.
Secure lifts in Document: Unforeseen shifts in the Document Technology market could see Xerox register growth in the business, thus escaping intense pressure in its business given that the health of Document is important for Services and other businesses.
Xerox Corp (NYSE:XRX) returns value to shareholders through buybacks and dividends. The management has committed to return 50% of free cash flow to shareholders. However, the management also insist on maintaining investment-grade rating on Xerox. As such, if Xerox can maintain $1.5 billion of annual cash flow, shareholder returns story could likely to remain positive for a long time.
Another boost to shareholder returns could come from successful re-engineering of the Services business to turn into a cash cow to complement Document business.
Xerox has exhausted its buybacks for the year after returning $1.3 billion to shareholders in period through September.
The newly declared broader review of Xerox Corp (NYSE:XRX) offers hope, but that doesn’t take away the reality that the future of Xerox is littered with rough bumps and slippery grounds.
Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.
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