The New Adventures of Old Xerox

by John McIntyre

In what will be the last quarterly report before the company splits, on October 28 Xerox released its third quarter earnings report and delivered more details about the pending spinoff of its business services group, to be named Conduent. The company stated that the separation work was proceeding as previously announced, and that the spinoff and creation of Conduent would be accomplished before the end of 2016 – so sometime in the next seven weeks. Considering that the Thanksgiving and Christmas holidays are included in that end-of-year period, a lot of midnight oil will be burned by the Xerox team in pursuit of completing the task at hand.

Xerox’s next quarterly report will be made by the remaining Xerox business entity representing the company’s traditional document technology operations. In announcing the firm’s Q3 results, Xerox Chairman and CEO Ursula Burns said, “I would like to note that today has particular significance for Xerox, as this will be our last earnings call as a combined entity. Next time we report earnings, we will be two separate companies, each on their own path to enhance value for our clients, employees, investors and other stakeholders.”

The breakup of the firm was driven by activist stockholder Carl Ichan, who was unhappy with the performance of Xerox’s stock in one of the strongest bull markets in history. Ichan probably did a simple comparison between the performance of XRX shares and the S&P 500 Index over the last five years, let’s say. Here is what he found:

Uh oh.

During this period, the S&P 500 Index performed 13 times better than XRX shares. Tough to sell that folks, when you factor in five years of inflation (including 2016, very close to an aggregate 10%) – particularly to guys like Ichan.

In December 2006, a decade ago, Xerox shares were trading in the $17 range – about a 50 percent decline. Double Uh oh.

Admittedly, this share valuation table doesn’t include the dividends Xerox has paid to shareholders over this period, but if you are a happy investor just receiving predictable dividends without share value appreciation, you can invest in low-risk alternatives like utility stocks or even bonds. Investors like Ichan, who reportedly owns an approximate 10 percent stake in the company, think corporations should do better, and he demanded Xerox perform better. One way to increase share valuation if the market doesn’t think it is attractive? Split it up, dress it, talk it up and take it to the dance. Typically, the market valuation of the two resulting equities will exceed the market valuation of the original business entity – a phenomenon that has been frequently seen in the current bull market. One only needs to look at the increase in combined share valuation that resulted from the 2015 breakup of HP into HP Inc. and Hewlett Packard Enterprise. Somewhat like the HP breakup, the Xerox split will create a print/copy/MPS/document services-centric entity, and a non-document/print-centric business process/services unit — Conduent.

The company has not announced a specific date for the actual split, but we can guess that an announcement revealing that date will be forthcoming soon. While reporting the company’s Q3 results on October 28, Burns, said “We are now just two days away from what we call our soft separation phase. This involves separating our corporate functions, business infrastructure and IT systems into discrete capabilities for each company. It is a test run at operating independently for the new companies that will help us ensure a smooth day-one launch … In short, we are moving rapidly toward our separation and remain on schedule to complete it by year-end.” Leslie Varon, corporate VP, interim CFO, and VP IR, explained that while the official split hasn’t happened yet, “Conduent will be filing its third-quarter results in the next few weeks,” which allows potential Conduent investors to evaluate what they might be buying into. Xerox calls the company’s transformation a “new path forward,” and even has a website dedicated to explaining the process: https://www.xeroxpathforward.com/

What remains is still, essentially, Xerox

The print/copy/MPS/document technology company that emerges from the breakup, Xerox, strongly resembles the company that the world has traditionally identified with copiers, copying, toner and printing. The “new” Xerox starts out life as the market leader in managed print services according to industry analysts, and describes itself as the “Global leader in document management and document outsourcing with superior technology, solutions and innovation capabilities,” including a claim that it is “managing 60 billion printed pages per year.” The company’s messaging and positioning emphasizes the service-centric aspects of the firm’s portfolio and not its famous print and copy heritage.

In a fact sheet issued by the company outlining details of the “new” Xerox, the firm will show revenues of $11B and employ 39,000, with a direct and channel sales presence in about 180 countries (about $280K in revenue per employee). Spinoff Conduent’s profile is quite different, befitting its services-centric business model, showing revenues of $7B and 96,000 employees (about $73K in revenue per employee). The below chart compares Xerox to the average metrics for the Fortune 500 as reported in 2016:

While lagging in a revenue-per-employee comparison, Xerox’s 13+ percent profit per employee looks mighty tasty to investors – and it has to be, because the company’s Document Technology unit has been reporting quarterly revenue declines every quarter for several consecutive years. Uh oh.

Xerox Document Technology Segment Quarterly Revenue Performance (CC, Y-Y), %

I didn’t go back before Q4 of 2013, but I am guessing it wasn’t pretty either. Very much like HP Inc.’s performance over the last several years, both companies, heavily vested in the copy/print/document output category, while often competing in different channels and in different market segments, continue to exhibit secular revenue declines while consistently delivering attractive profits. This same model is what has been attracting investors to the BTA and copier dealer channel the last few years: a business that is relatively stable, and can be highly profitable when tightly managed — and it has to be tightly managed because revenues are declining.

Unlike HP, which has laid out a path to possible growth by acquiring the Samsung printer group and is mounting a new offensive to capture pages in the A3/copier channel, Xerox has enunciated no such concrete plan to reverse its eroding revenue fortunes. Revenue growth can come from the “contractual” channels Xerox is very strong in, channels that industry analysts project are growing and will continue to do so. So organic growth is likely, the company is already the recognized market share leader in MPS – so further share growth in a category that becomes more intensely competitive by the hour – is questionable, and MPS does not represent the lion’s share of Xerox’s revenues. Xerox’s acknowledged strength in the growing light production and production print — especially color — segments is an opportunity for growth, but the company has been hemorrhaging sales/installs in the entry and mid-level office print segments for years, lost installs that inevitably lead to lower supplies and services revenues in future quarters that will have to be offset by increases in color or in higher speed segments. One problem with planning your growth in color or in higher speed print/copy segments: every other print/copy OEM is aiming at exactly the same applications, segments, and customers.

In Part II, we will look at Xerox’s prospects going forward as a separate company.

John McIntyre serves as a senior analyst for BPO Media. With more than 40 years of experience in the printing industry as an analyst, product developer, strategist, marketer, and researcher, he has covered the printing and supplies sectors for prominent market research firms such as Lyra Research, InfoTrends, and BIS Strategic Decisions, and served with major OEMs such as Samsung, NEC, and Diablo Systems/Xerox. McIntyre is the former managing editor of Lyra’s Hard Copy Supplies Journal and has conducted research and consulting engagements examining issues such as market and business strategies, product positioning, distribution channels, supplies marketing, and the impact of emerging technologies. Follow John on Twitter @John2001S.