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.