What is the first image that comes to your mind when I say "Xerox?" I tried to do this exercise with my friends and colleagues. The answers were different, but all boiled down to photocopiers and printers.
I think that’s an instinctive connection.
The Xerox brand has been linked to printing technology since 1906, the year it was founded. In 1938 the company invented a process today known as “xerography”, a kind of dry writing. Using this process, in 1959 they introduced the first plain paper photocopier (the famous Xerox 914), and some years later the first laser printer, invented in their laboratories in 1969.
I won’t go through the complete version of Xerox history, but one thing is clear: Xerox is the protagonist of (modern) printing technology history.
That’s why associating its brand to printing machines seems quite natural. After all, the company has been doing it for almost 106 years.
But, if we dig deeper into this affair, we easily discover that Xerox is no longer a pure printing machine producer: It is already in the process of turning itself into a service company.
The Xerox brand, which has been impressing people’s minds for over a century, as is perceived today, consists in fact of a brand bias, because most of Xerox revenues don’t actually come from equipment selling, but from offering a wide range of services.
In an ever more digital world, the need for physical equipment is decreasing relentlessly. On the contrary, the demand for services is growing exponentially.
In particular, referring to the printing sector, we can observe that:
- Digitalized data (documents, books, articles) volume is growing at an incredible pace. Moreover, it would be simply not possible (nor useful) to print everything.
- Company and institutions encourage people to print something only when strictly needed, both for environmental and for cost-cutting purposes.
- Fax machines will quickly become (tech) museum pieces, replaced by emails (people are free to print an email whenever it is really necessary).
- Combo printers (scanner and printer) will quickly replace most photocopiers (people will scan everything and print only when it is really necessary).
I think Xerox's management felt the responsibility to deal with these kinds of business dangers as soon as they became evident. I also think they brilliantly addressed and solved them.
Let’s find out how.
The Affiliated Computer Services (ACS) acquisition
In September 2009, Xerox announced it would acquire ACS for $6.4 billion. ACS was a leading firm in Business Process Outsourcing (around 80% of 2009 total revenues, 40% of that coming from government contracts).
A BPO firm is able to handle specific customer business functions, like human resources or accounting, integrating them with the rest of customer business as if it was a single company.
To put it simply, ACS specialized in organizing and managing every kind of company information and process, by adding its expertise in order to simplify customer business functions, make them cheaper and/or more efficient.
The acquisition was a big achievement for both companies. Let’s see why:
- Xerox has been able to leverage ACS added-value BPO services, channeling them to its wide range of customers
- Xerox added its document technology to ACS optimization processes, implementing them more effectively and decreasing costs
- Last but not least, ACS outsourcing expertise has been applied to Xerox itself, optimizing business functions, allowing them to cut most third-party outsourcing contracts
One thing that’s worth noting is that the ACS acquisition was not a discontinuity in Xerox's business model — it was just the last step in a slow path in the services-oriented direction.
Let’s have a look at current revenues breakdown in order to show what has changed since the ACS acquisition (the deal was completed in February 2010).
|Xerox revenues breakdown||2009||2010||2011|
|Total (in millions)||15,179||21,633||22,626|
One other point is: the operation contributed also to sell more equipment, probably partially because customers searching for a complete solution provider showed up and partially because Xerox was able to sell its printing machines to pre-existent ACS customers.
We know that integrating a big company into one even bigger company is an hard task. CEO Ursula M. Burns and her staff is still in the process of doing it and cutting costs in divisions belonging to the old ACS organization.
That’s really interesting to me as a value investor, because I firmly think that the best of the ACS acquisition hasn’t come yet!
The real power of the new XRX organization, the new BPO-centered business model, is that all the synergies working underground are currently hidden by the current economic weakness (especially in Europe), by the restructuring charges (mainly amortization of intangibles) and by initial investments needed to start new contracts (their services-related new signings were up 15% in the last quarter).
Valuation and investment thesis
As we’ve seen, XRX is slightly but inexorably changing its skin to move into the future, in an increasingly digitized world, capturing new market share in BPO and document outsourcing growing markets, so my guess is that very soon it will be considered and compared to consolidated services businesses like IBM and Oracle.
Moreover, I think it should be valued using multiples similar to these companies, not the current ones (if you check, for example, on Google Finance, you will see that XRX is still considered belonging to the Office Equipment sector).
IBM has a P/E multiple of 14.35 (considering fiscal year 2011 earnings). Applying this multiple to XRX would raise its price to $12.91 (always considering XRX fiscal 2011 earnings), giving it a potential return (at today price of $8.30) of 55%.
This consideration, added to the fact that the company expects its 2012 EPS to grow 10-15% and that it intends to repurchase its shares for around $1 billion (at today prices, it would be around 8% of total outstanding common shares), leads me to be really confident of the fact that XRX shareholders will be very well rewarded in the long run.
Disclosure: I am long XRX