Xerox's technology business continues to struggle

An iffy economy and a new feature on some of its multifunction printers drove down sales for Xerox Corp. in the first quarter of 2013.

The Connecticut-based printing and business process outsourcing company announced its latest quarterly financial results Tuesday. And for the three months ending March 31, the Rochester area’s largest publicly traded employer saw its revenues — at $5.36 billion — down 3 percent from the same quarter a year earlier. While Xerox’s BPO services continue to grow — up 4 percent and now accounting for 55 percent of the company’s income — the technology side of the house is struggling more.


In a statement, CEO Ursula Burns said the technology business — the umbrella under which sits everything from office equipment to big digital printing presses, as well as the business of supplying and servicing them — was hampered in part by Xerox in February announcing its new ConnectKey software system for multifunction printers. Those printers, however, did not begin shipping until the second quarter. Equipment sales were down 11 percent during the quarter.


“We’re continuing to shift our business model to adapt to market trends by expanding indirect distribution and streamlining our supply chain and product portfolio,” Burns said. “These changes, along with implementing broader operational improvements across the company, will result in increased margins that will help us scale profitable revenue in services while maintaining strong market share in document technology.”
After expenses, Xerox had profits of $296 million or 23 cents per share, compared with $269 million or 19 cents per share a year earlier.


Xerox’s sales fell slightly short of Wall Street expectations, but exceeded them on profits. Analysts surveyed by Bloomberg had expected, on average, revenues of $5.49 billion and profits of about $254 million or roughly 20 cents per share.


Business services have been an ascendent part of Xerox’s operations since 2010, when it bought BPO company ACS. Since then, while Xerox’s technology business has been stagnant or declining, services have grown to now represent the majority of money the company takes in. That continues to raise questions about the fate of local Xerox operations, particularly the Webster manufacturing campus where the company makes high-end digital presses and toner. At the end of 2012, Xerox employed 5,800 locally.


Citing the economy, Xerox in October said it planned roughly $100 million worth of restructuring — which typically translates into layoffs — to get costs down. And Xerox said Tuesday it expects to spend about $35 million between now and the end of June on further restructuring. Worldwide, Xerox employs about 143,200 — down 4,400 from just three months earlier as the company goes through some restructuring.
Xerox spokeswoman Karen Arena said she did not have specific information on the planned second-quarter restructuring and how many jobs might be affected, but that “we’re taking the appropriate actions to better adjust our cost base for market realities.”
“It was a slow start in document technology,” Arena said.

Is Xerox A Value Trap For Investors?

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We have been following Xerox Corporation (XRX) since the middle of January largely because David Einhorn (Greenlight Capital) had purchased 17M shares of the company in Q4 2011. We have stepped up our coverage of Xerox in October as the company's shares were trading at a 30% discount to book value. However, we are most certainly aware that just because a company's shares are trading at a low price to book value does not automatically make it a great value.

When we first started following Xerox, the company's shares were trading at a 5% discount to book in the middle of January. The primary reason why its price to book discount narrowed to a small 5% discount to book was due to investor enthusiasm surrounding David Einhorn's stake in Xerox through his Greenlight Capital hedge fund. Although Xerox is cheap by many traditional measures such as free cash flow yield, PE ratio and price to book, we have demurred from taking a position in the company because we have been concerned that it was a value trap. We previously covered why we saw it to be a value and in this report we will analyze why we think it may be a value trap.

Source: Morningstar Direct
Why Xerox May be a Value Trap:
Xerox's CEO Ursula Burns: Ursula Burns has been President or CEO of Xerox since April 2007 and during that time frame, Xerox's stock has registered a negative total return of 57%. Xerox earned $1.22 in reported EPS in 2006, the year before Burns became President. Despite spending over $4.1B in acquisitions and $2.6B on share repurchases, Xerox's Adjusted EPS is expected to be $1.08 and its reported EPS is expected to be $.85 after accounting for acquisition related intangible amortization and restructuring charges. Part of our apprehensiveness with regards to jumping into Xerox alongside Greenlight Capital is that we were concerned that the weak macroeconomic environment was an excuse for poor management and execution issues. We disagree with Oscar Schafer that Ursula Burns is a "tough, no-nonsense CEO" based on the performance of Xerox during her leadership of the company. We believe in calling things as we see them and we think it's appropriate to consider the poor results we have seen under Ursula Burns when evaluating her tenure.

Source: Morningstar Direct and Xerox's Most Recent Guidance
Xerox's Quality of EPS: 2006 was the last year before Ursula Burns was CEO or President and it generated $1.22 in GAAP EPS and $1.05 in Adjusted EPS. 2006 saw its GAAP EPS exceed its adjusted EPS as $500M in Tax Audit Benefits were partially offset by $254M in restructuring charges and $68M in litigation expenses. The company had no adjustments to EPS for FY 2007 and it reported $1.19 in EPS for the year. Unfortunately for Xerox, its EPS from 2008 to present has seen a significant level of adjustments to EPS in each year. 2009 was the year with the lowest level of adjustments ($.15/share) and 2008 was the highest ($.84/share). Of Xerox's $4.90 in EPS from 2008 to 2012, nearly $2/share was clawed back for its never-ending "non-recurring adjustment charges to EPS". 2012 promises to be no different as it will see about $.25 in non-recurring charges for restructuring and amortization of acquisition related intangible assets. At least Xerox's management is only targeting $.15/share in adjustments in 2013 primarily due to amortization of acquisition related intangibles.

Xerox's Revenue Growth: Xerox's year-over-year revenue growth has never exceeded 3% on a pro forma basis in any quarter since its 2010 acquisition of Affiliated Computer Services. That's not to say that the ACS deal was a deal from hell. In our opinion, we believe that deal was a lifeline for Xerox as ACS's strength in IT Services has offset the weak performance from legacy Xerox operations. Xerox grew its services related revenues by nearly 5% year-over-year in Q3 2012 even though it was faced with significant global macroeconomic headwinds. Unfortunately for Xerox, this was not enough to offset a 10% revenue decline from its products and supplies as well as the associated technical service, support and financing of its products.

Source: Morningstar Direct
Xerox's Guidance: Even though we have not taken a position in Xerox, we believe that covering the company is comparable to water torture. The reason why we feel this way about Xerox isn't because the stock has gone down by 22% since we began increasing our research resources on it, but because the company has been steadily reporting guidance that has been soft and sour. We think it is becoming a trend on Xerox's part to meet consensus adjusted estimates and to reduce forward guidance and also to announce "non-recurring restructuring charges" that are "excluded from adjusted EPS guidance". At the beginning of 2012, Xerox issued adjusted EPS guidance of $1.12-$1.18. As of its most recent quarter, the company has once again revised its guidance down to a range of $1.07-$1.09, down from $1.07-$1.12 in Q2 2012. Xerox recently announced guidance of $1.09-$1.15 for FY 2013, which was 3% lower than its original guidance for FY 2012.

Source: Xerox's 2012 Earnings Reports

Conclusion
In conclusion, we have taken a fair and balanced approach to analyzing Xerox. We previously evaluated what we liked about Xerox and we have now analyzed what we don't like about Xerox. One thing that Xerox needs to do in order to enable it to unlock shareholder value is replace Ursula Burns with an executive who knows what he or she is doing. Burns has been President or CEO for five going on six years and has been CEO for more than three years. During Burns' tenure as President or CEO of Xerox, the company's shares have declined by 57% while the S&P 500 has recovered its financial crisis losses and generated a total return of 12% during that time. Xerox's 57% negative total return paled in comparison to the 32% positive total return generated by the S&P SPDR Technology ETF (XLK). Although we are pleased to see Xerox make overtures to shareholders by increasing the dividend and share repurchase authorization, we are getting irritated with the sour notes that we've been hearing from management and we question whether Xerox has the right management team to enable it to unlock shareholder value.

Source: Morningstar Direct
Additional disclosure: Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.