XRX - Xerox: Much More Needs To Be Done To Compete In New Era

2024-01-11 17:45:03 ET

Summary

• Xerox's stock price has rallied recently, but the company still faces long-term headwinds in its core print business.
• Management's pivot into IT services seems reactive rather than proactive, and there are few signs of successful transformation.
• Xerox's debt load limits its ability to fund a meaningful business transformation, and its valuation is still high considering industry challenges.

Investment Thesis

Xerox Holdings Corporation ( XRX ) has seen its stock price rally 50%+ since beating quarterly earnings estimates that had baked in a slowdown based on economic conditions worsening. The company has also recently announced new restructuring initiatives, namely the "Reinvention and Operating Model Evolution" . Despite these seemingly positive turn of events, the company still faces significant long-term headwinds in its core print business from digitization trends. Competition is also intense, with companies like Canon and HP eating into Xerox’s market share.

While management has pivoted into IT services, these efforts seem more reactive than proactive. So far, there are few signs of Xerox successfully transforming its declining print business towards faster growth segments. The ~6% dividend yield remains attractive, but is at risk unless clear signs of revival emerge. I believe Xerox’s business fundamentals remain challenged by strong and permanent headwinds, warranting a sell rating despite the stock’s low valuation and recent headlines.

Structural Decline in Core Print Business

Xerox's Print business includes workplace hardware like printers and multifunction devices, along with associated post-sale offerings like supplies, services and financing. Xerox is shifting focus to IT services, digital services, and cloud offerings, but print remains dominant.

The print business is in secular decline globally, and is estimated to keep shrinking over the next decade. Digitization and growth of paperless workflows have reduced enterprise printing requirements. Xerox’s print-centric model, with 80%+ revenues from print, makes it vulnerable.

Competition is intense, and fitter rivals like Canon and HP are aggressively targeting Xerox's position, as evidenced by the company losing share in recent years. Xerox also relies significantly on channel partners for distribution. If macro pressures or competitive dynamics weaken, partners may prioritize competing brands over Xerox.

Has Management Outlined a Convincing Strategic Pivot?

Xerox recognizes the need to reposition itself amid industry headwinds. Management is attempting a broader push into services like digital workflows, AI, IT services and cloud offerings. However, these efforts seem reactive and piecemeal rather than the bold, decisive transformation needed to reignite growth.

CEO Steve Bandrowczak noted on the Q3 earnings call regarding the company's "Reinvention" efforts - “Reinvention is a comprehensive and operational simplification of our business resulting in a strategic repositioning of the company to take advantage of favorable macro trends...”

The issue is, Xerox faces a profoundly challenging battle to shift towards services and software. This pivot attempt pales in comparison to true business model transformation underway at rival HP , which is aggressively targeting sustainable technologies and advancing its services-led strategy.

Xerox's recently announced "Reinvention and Operating Model Evolution" continues this reactive approach to addressing challenges. The plan focuses heavily on workforce reductions, realigning some executive roles, and hopes for $300 million in additional operating income by 2026.

But this reorganization skirts the core need for business model reinvention. There are no real innovative growth initiatives outlined - just vague mentions of "investment capacity for our growth segments" and hopes to “accelerate revenue diversification”.

No clear path emerges on how Xerox evolves beyond its legacy within print and associated post-sale offerings, which still dominate revenues. The cost-cutting-centric restructuring fails to deliver a credible strategy for outgrowing secular print declines, in my opinion.

And the rush towards services faces intense competition, with Xerox lagging rivals in breadth of offerings. The company also caters heavily to SMBs, where digitization and paperless adoption is accelerating.

Unless management quickly outlines bolder, more decisive actions to mitigate revenue erosion, Xerox’s declining competitive position across print could rapidly accelerate. Securing greater wallet share from existing customers provides some buffer, but is likely insufficient to fundamentally stabilize the business model long-term.

True transformation remains elusive - until major innovations emerge across digital services, cloud and AI-centric offerings, Xerox appears set for further market share losses. Its strategic pivot attempts thus far simply fail to adequately address the core threats, in my opinion. More reactive measures like the latest restructuring sidestep the problems rather than signal a convincing turnaround.

Xerox's Balance Sheet Reduces Transformation Capability

Xerox's high debt load hampers its financial flexibility to fund the significant investments required for business transformation. The company holds $3.8 billion of total debt, which is over 6x trailing twelve-month EBITDA.

The current balance sheet position restricts Xerox's capacity to pursue acquisitions or growth opportunities that could help reinvigorate its print-centric model. Unless cash generation improves markedly or there's a dividend cut, I don't see how the company can finance any material attempts at revitalizing growth.

Valuation Analysis

Xerox trades at a forward P/E of 17x. While below sector median of 29x, this still appears high given the company's weakening financial profile and secular industry challenges. The valuation gap to faster-growing IT services peers seems insignificant considering Xerox confronts an intensifying race against time.

Essentially, Xerox runs the risk of becoming a value trap if the core business melts without timely reinvention. The PC and smartphone industry shifts show how legacy technology providers can rapidly lose relevance despite low starting valuations.

While relative valuation multiples indicate some margin of safety, investors considering Xerox must weigh it against the potential for adverse business deterioration. Unless clear positive catalysts emerge soon, Xerox appears more of a value trap than an opportunity.

Downside Catalysts

• Accelerated revenue declines as digitization intensifies
• Loss of additional market share to rivals
• Potential dividend cut if cash flows deteriorate
• Recession disproportionately impacting SMB exposure
• Large acquisitions or growth investments without execution

Upside Catalysts

• Strong uptake of IT services and digital offerings showing business transformation progress
• Margin expansion from post-sale mix shift and further cost cuts
• PE interest unlocking value from Xerox's cash flows

Conclusion

Xerox trades at a reasonable valuation, but its print-centric model faces secular headwinds. Despite management targeting areas like IT services, efforts to reposition the business appear slow-moving and reactive so far. Until clear signs of revival emerge, I see unattractive risk-reward, given potentially rapid declines in Xerox’s core. Xerox is a Sell for me.

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