EUR 850.00 For Business Accounts Only

Morningstar | Poor Renewal Rates Stifle Xerox's Revenue Growth; Maintain $27.50 FVE

Xerox's revenue declined in the third quarter as poor renewal rates plagued managed document services. Meanwhile, equipment sales fell, which compounded Xerox’s renewal problem. Despite revenue declines, Xerox saw operating margin expansion due to a focus on improving selling, general, and administrative expense. While Xerox has seen decent demand for new offerings like the Iridesse Production Press and new signing growth, we don’t believe these are key to sustainable top-line growth. We are maintaining our $27.50 fair value estimate for this no-moat company.

In the third quarter, revenue was down 5.8% year over year at $2.35 billion. All regions experienced year-over-year revenue declines. Post-sale revenue (responsible for 78% of total revenue) was down 6.4% year over year as equipment saw weak demand. Managed document services grew 0.9% at constant currency, yet it marked growth deceleration as MDS relies on robust renewals, and renewals only improved by 400 basis points to a weak 79%. This is below Xerox’s goal of 85%-90%. While new signing growth in the quarter was higher than overall signing growth, we’re not encouraged; we believe new signings have little meaning since they come off a smaller base and will likely fall victim to Xerox’s larger renewal issues once considered next quarter. Breaking out equipment revenue, which was down 3.8% overall, entry and midrange saw growth of 7.7% and 0.3%, respectively, while high end was down 6.9%. Other saw the worst decline, down 64.3%, due to issues in the original-equipment manufacturer business.

Adjusted operating margins increased 100 basis points year over year to 13.1%, the majority of which came from SG&A improvement. While adjusted earnings per share were down by $0.04 year over year, this was slightly better than expected. A $0.01 benefit came from share repurchases, partially offsetting a $0.05 negative impact from the adjusted tax rate.

Finishing out the year, Xerox raised its operating cash flow and free cash flow outlook as it is still undergoing capital expenditure scrutiny despite the official "Strategic Transformation" efforts being put on hold after the Fuji deal fell through. Operating cash flows are now projected to come in $100 million higher, at $1 billion-$1.1 billion, and free cash flow is now expected to come in at $900 million-$1 billion.

While Fujifilm won an appeal in mid-October to fight for renegotiation of the missed merger between Fujifilm and Xerox earlier this year, Xerox claimed it is not concerned about the appeal and made no suggestions that it would consider renegotiating.