Stock Of The Day: Xerox

There are many great investors out there that I admire but whose stock picks I'm not attracted to. Seth Klarman comes to mind as I think he's likely the best value investor of our time but when scouring his 13-Fs I have never found something I wanted to own. On the other hand I have gotten a couple of ideas from David Einhorn as his common sense, value picks are right up my alley. Xerox has popped up once again on David Einhorn's 13-F. I looked at Xerox last year when it was a lot higher but decided to give it another look since the price has gone down so much.

The thing I like about technology companies is that the balance sheet is generally simple so I can focus on analyzing the business. Unfortunately, that is not the case with Xerox as they have large pension liabilities and they finance receivables. Bulls argue that one should ignore the finance related debt because the receivables are mostly short term. For the purpose of this analysis I will ignore the finance related debt but I will count the pension liabilities as debt. That gives Xerox a market cap of roughly $11 billion and an enterprise value of $16 billion. Counting the finance related debt would add $6 billion to the enterprise value.

Xerox receives 55% of its revenue from printing related hardware and the other 45% from consulting. Xerox is expected to produce $1.75 billion in free cash flow in the coming year.

What I like

  • The price to free cash flow is a very attractive 6.3 times.

  • The enterprise value to free cash flow is also decent at 9.2 times.

  • They are returning free cash flow to investors and paying down debt.

  • Some of their consulting businesses definitely deserve a higher multiple.

What I don't like

  • Printing is in a secular decline, albeit very slow. Price increases and increased market share could keep revenue steady to slightly higher at best.

  • 1/3 of their services business is printing related. A large portion of their services business is not high value, high margin business.

  • An outsized amount of revenue from services is government related. With a trillion dollar deficit and municipalities running deficits I am wary of any business that sells to government.

  • The complexity of the balance sheet is not a plus.

Its not difficult to see what David Einhorn sees in Xerox, especially because he likes owning cheap options. At 6 times free cash flow this should be a win as long as Xerox is able to keep cash flow steady or even if it declines modestly. Unfortunately, there are too many things that can go wrong here and there is a decent amount of leverage involved so I will take a pass.


Wednesday links: active learning | Abnormal Returns said...

[...] What does David Einhorn see in Xerox ($XRX)?  (Capital Observer) [...]

Ryan Vanzo said...

A few errors but otherwise a decent article.  Services are now 48% of revenue (this has been growing every year). Tech hardware is 45% with "other" around 7% (includes misc items and paper sales).

The market seems to be pricing the company as if it is still a pure play printing/hardware company, while in reality it is at least half IBM now.  83% of their revenue is now annuity income (recurring) and they are the leader in most of their consulting segments (which is really consulting, its outsourcing).

With the price the market is currently giving you, all the negatives seem to be priced in, with none of the positives. Thankfully the business is throwing off gobs of cash, so you can be patient and wait for debt to be paid down, dividends to increase, and stock repurchases to continue (>$1B left in remaining repurchase program)

Tsachy Mishal said...

To be clear, the write up was not meant to be negative. Apologies for not being precise on the numbers.

I prefer to look at these companies on an enterprise value basis. On that basis CA Technologies is similarly priced and Symantec is far cheaper. Both have large recurring revenue streams and fewer secular issue. I would not own IBM either fwiw.

Ally mishal | Graigor said...

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