On the surface, Xerox Holdings Corp. (XRX, Financial) does not look like a great investment. The stock price has not done well. Printing, Xerox's bread and butter, is declining as workplaces and workflow increasingly move to the digital world. Revenue and earnings have been declining for a long time. It looks like the age of the tech dinosaurs is ending, and the new more nimble cloud mammals are taking over the world.
The chart below shows Xerox's revenue and profit numbers for the last five years - kind of a disappointing picture. For those who follow the buys of the big-name hedge fund managers, this begs the question: Why does Carl Icahn (Trades, Portfolio) seem to like the stock so much?
Icahn keeps buying Xerox
Icahn started buying common shares of Xerox in 2015 according to his 13F filings. In the past year and a half, he has started to ramp up his position as the stock dipped.
To preface this, I have no unique insight on Icahn's investing process or motivations to buy Xerox. This is all my own personal speculation.
I think the answer may lie partially in valuation. The stock has a GuruFocus valuation rank of 8 out of 10. Note in particular the high price-to-free-cash-flow ratio of 6.52. The reciprocal of this ratio gives us the FCF yield, which is 15.3%. In other words, at the current price, each dollar of equity is producing 15 cents of free cash. Free cash flow (FCF) is the money a company has left over after paying its operating expenses and capital expenditures. The more free cash flow a company has, the more it can allocate to dividends, paying down debt, buying back stock and growth opportunities. Many investors regard FCF as a better measure than net earnings, which is considered more open to manipulation.
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The second clue as to Icahn's potential motivations for liking Xerox lies in the dividend and buybacks. The dividend is a lush 5%. The three-year average share buyback ratio is an astounding 11.5%. This means shares are being concentrated at an 11.5% rate per year.
Buybacks are a big part of how Xerox is rewarding its shareholders. Buybacks converted to yield terms are averaging between 10% to 15% over the last three to five years. Add this to the 5% dividend you are getting and that is some serious dedication to shareholder returns.
Below is a chart detailing Xerox's buyback yield for thefiscal year that ended in December 2021:
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Conclusion
Overall, I think I can see why Icahn likes Xerox and continues to add to it. The FCF, dividends and buybacks are three good reasons. The stock is clearly undervalued, but the market has no reason to close the valuation gap because the company is in decline. That's the value that Icahn is trying to unlock with his activist campaign in Xerox, in which he was trying to get the company to achieve a hostile takeover of larger competitor HP Inc. (HPQ, Financial).
As we can see from the GuruFocus performance chart below, the guru has only averaged a 1.9% total return (including dividends), over his holding period, which is pathetic given the massive bull market we have seen. However, he was doing quite well before the pandemic hit. The stock has not recovered as much as others in the market and is probably due for a reversion to the mean.
The GuruFocus valuation panel is showing very high Earnings Power Value (EPV) and Projected FCF Value.
Icahn is known for his activist strategy. While his initial attempt for Xerox to enact a hostile takeover of HP failed in 2019, it is likely that he will try again given that he has been ramping up his position in the stock recently (or perhaps he has something else up his sleeve that we don't know about). In 2018, Icahn scuttled a deal with Japan's FujiFilm (TSE:4901, Financial) and ousted the CEO. Unlike Warren Buffett (Trades, Portfolio), he does not like to own companies forever. When he thinks the juice is not worth the squeeze, he moves on to other oranges.
