Xerox Corporation XRX
June 03, 2011 - 12:52am EST by
2011 2012
Price: 10.05 EPS $1.07 $1.15
Shares Out. (in M): 1,401 P/E 9.4x 8.7x
Market Cap (in $M): 14,081 P/FCF 7.4x 6.6x
Net Debt (in $M): 7,200 EBIT 0 0
TEV ($): 15,900 TEV/EBIT 7.6 (adjusted) 6.9 (adjusted)

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Xerox is a $14 billion market cap company that will produce over $4 billion in free cash flow from operations over the next two years, in addition to the $1 billion in cash it currently has on hand.  Over the next 5 years, XRX will produce over $10 billion of free cash flow.  The company is resuming share repurchases in Q3, and roughly 75% of available cash can be directed toward share repurchases (company guidance has been 70% to 85%).  Management stated last month at an investor conference that they would repurchase 60 to 70 million shares in Q3 and Q4, with an additional 100 million plus shares in 2012.  This is approximately 12% of the company over the next six quarters. 

Extrapolating that forward five years, and 40% of the share count disappears, which of course would have quite an impact on valuation multiples.  My typical starting point for looking at stocks is to look for single digit EV/EBIT ratios. Of course, this ratio doesn't apply to banks and other financials, given that financing transactions and loans distort that ratio.  Therefore, it makes some sense to adjust for Xerox's financing business.

After adjusting for some early redemption and refinancing of trust preferred securities, in addition to paying down $600 million of term debt, roughly 72% of its then remaining $8.6 billion in debt will be tied to its financing business, which argues for adjusting its enterprise value multiples downward (segregating the finance activities). 

While enterprise value is $22.1 billion, given that financing debt is $6.2 billion, a rough proxy for an adjusted-EV would be $15.9 billion.  2010 EBIT was $2.08 billion, with 2011e EBIT of $2.3 billion, leading to trailing and forward adjusted-EV/EBIT multiples of 7.6x and 6.9x, respectively.

7x EV/EBIT is a magic number to most value investors.  At the very least, it is a good starting place for further investigation.

Further financials: 2010 adjusted earnings per share was $0.94 (P/E=10.6x), with company guidance for 2011 for adjusted EPS of $1.05 to $1.10 (GAAP of $0.89 to $0.94).



It's one thing to buy back a small amount of shares on a high PE stock.  This seems to be a very different case.  85% of Xerox's revenues are annuity-like, working capital is in line with growth, and CAPEX requirements are modest (approximately $600 million annually).

Likewise, it is one thing to extrapolate today's earnings five years into the future, especially given the inherent uncertainties regarding sales of technology equipment.  However, more than 80% of Xerox's total revenues are recurring.  While XRX sells plenty of printers and copiers, most of its revenue comes from post-sale annuities such as maintenance, services, and financing.  When XRX signs a 10 year contract for Medicaid in California, or provides the EZ-Pass for the NJ Turnpike, revenue growth over the period of that contract may be unimpressive, but using those cash flows to retire shares at close to 7x EV/EBIT supports a virtuous valuation circle. 



Now for a bit of back story: in 2009, with industry leadership in document outsourcing, Xerox had $15.2B of a $132B market.  Its February, 2010 acquisition of ACS (Affiliated Computer Services), the largest diversified business process outsourcing firm in the world, added business process outsourcing (BPO) and information tech outsourcing (ITO).  The company now estimates that they have just $23B of an addressable $500B+ market.  Xerox has transformed from being 75% technology driven to currently 50% services.  Clearly, this is a defensive move that will allow Xerox to escape some of the constraints of a secularly challenged documents industry.  Xerox's current BPO and ITO business has had a five-year CAGR of 7%.

XRX's strong position in documents, in addition to a robust patent portfolio, is Xerox at its oldest.  The business is changing with the ACS accelerated expansion into services, and the company is now in sectors that most investors don't associate with the brand.  For example, XRX now annually processes 900 million healthcare claims, with 2/3rds of U.S. insured patients touched by their services.  Xerox also processes 60% of all U.S. child support services, 50% of electronic tolls, handles 1.5 million phone calls each day in their call center, serves 4.4 million employees and retirees through HR services, and processes 37 billion public transportation fares each year.  This is well supported by $1.5 billion of annual R&D spend, inclusive of $800 million of R&D from Fuji Xerox (owned 25% by Xerox). 

Business process outsourcing is a natural extension of Xerox's managed print services, which fulfilled a need that many businesses demanded, and routinely led to 30% cost efficiencies.  Now Xerox is extending their outsourcing services to cover HR, accounts payable, marketing, customer care, and processing health care records.  Post-merger, the company estimated that they would have over $5 billion in synergy pipeline, and $100 million in cost synergies. 

Another benefit of XRX's business model, as it relates to expanding into BPO and ITO, is that XRX's customer relationships are "high touch".  XRX's traditional customers purchase products and services under bundled lease arrangements.  This creates the powerful combination of predictable revenue streams and continuous customer relationships.

Here is a snapshot of Xerox's diversified services offerings:
            34% document outsourcing (manage print = 27%, multi-channel marketing = 7%)
            12% government solutions (child support, student loan, govt records mgmt)
            10% commercial IT (data center outsourcing, etc)
            8% HR services
            8% transportation services (tolls, fares, taxes, collections)
            6% financial services (A/P, A/R, data processing services to auto financing)
            6% healthcare payer (claim processing, credit card applications, etc)
            6% government healthcare (Medicaid, pharmacy benefits, health records)
            6% customer care (device support, supply chain efficiency, back office support)
            4% healthcare provider (consulting solutions)



Xerox recently hosted an investor day, and provided the following guidance:


2010 actual

2011 guidance

2012 guidance





Gross Margin


33 - 35%


Operating Margin






$0.90 - $0.95


Adj. EPS


$1.05 - $1.10

$1.10 - $1.20


However, the most important guidance was for available cash flow (after planned debt reduction and dividends) of $1.0 billion to $1.2 billion for 2011, and $2.0 billion for 2012:

(in billions)



Cash from Ops


$2.6 - $2.9




Free Cash Flow


$2.0 - $2.3

Debt Reduction






Available Cash

$1.0 - $1.2



This is a very simple investment story.  As the CFO states it:

"Operating cash flow, again, about 11% of revenue, annuity-driven, very stable, more than 85% of our revenue comes from annuity.  Very modest Capex requirements and this will enable us to return capital to shareholders.

"In terms of free cash flow over time, we will be generating over $10 billion of free cash flow during the next five years. Our use of available cash model is something that is very well known to this group. We talked about it consistently in the past. It doesn't change. Share repurchase is our primary focus. It will be more than 70% of our available cash in 2011 and 2012, so 60 million to 70 million shares target for 2011. Over 100 million shares in 2012 consistent with cash generation and obviously depending on share price. And we are targeting the majority of our available cash over the next five year for share repurchases.

"I've been asked, since I joined Xerox, several times the question, so what is the biggest surprise that you got coming in from the outside? And by far the biggest surprise that I got is that every time we say as a Company that you know we are doing share repurchases then the question comes will you do share repurchases? And I thought -- I concluded that probably it's my accent that creates the confusion. But it is truly the primary focus of the Company and we've been consistent about it. And it is what we are going to do during the course of this year and next year and for the foreseeable future.

"We will supplement share repurchases with acquisitions because it is an important element for our growth strategy and also positions us very well in new and emerging areas as we look ahead and then dividends. We've got a very strong and stable cash flow so there is potential for growth."


There does not seem to be a wide range of outcomes for Xerox stock on a five year forward basis, if Xerox retains its current commitment to direct at least 70% of free cash flow toward share repurchases.  At today's valuation, Xerox could buy back fully half of its existing share count, which would drive FCF toward a ridiculous 30% rate.  The annuity-like consistency of its revenues, coupled with management's commitment to smart capital management, makes XRX one of the most compelling of the double digit FCF large cap stocks.



This is not meant to be a buy or sell recommendation, and my firm frequently has both long and short positions in many of the securities mentioned. 


Significant share repurchases to begin in second half.
Continued recognition of annuity-like nature of revenues and income.
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