Xerox Can't Copy Its Past

NEW YORK (TheStreet) -- Past performances aren't indicative of future results. This is arguably the most popularly cited "buyer beware" statement about the market.

In the case of Xerox (XRX), a company known for its copiers and printers, management has tried -- unsuccessfully -- to duplicate its history of strong revenue and earnings performances. Due to restructuring-related charges and growth challenges with outsourcing services, its largest business, management warned in October that profits for this quarter would come below expectations. So I caution investors about bidding up these shares, which are now at their 52-week high. Xerox's money-printing days are over.

With Xerox stock still 80% below its all-time high, it would be a gross understatement to say that the company has seen better days. While investors have every right to be encouraged by the company's 82% gains in 2013, I believe this was more of a reaction to how far Xerox had fallen. In many respects, Xerox's 2013 performance was similar to the rebound seen in Hewlett-Packard (HPQ).

Understand, however, that companies don't reach these depths because market dynamics tip in their favor. Management has been (and remains) under constant pressure to deliver the growth that Wall Street craves. To its credit, Xerox has listened attentively and has responded with several acquisitions over the past couple of years. One of these buys was software-as-a-service (SaaS) company Customer Value Group that was picked off last year for an undisclosed amount. Clearly Xerox is not sitting on its hands. 

Management seems willing to look for growth opportunities anywhere -- as unassuming as the prospects may be. Without meaningful results in ventures like IT outsourcing to offset the eroding printing and copying business, management might as well have done nothing. And investors waiting too patiently for this story are doing themselves a disservice while better growth opportunities pass by.

Xerox will report fourth-quarter earnings results Friday. The Street will be looking for 29 cents in earnings per share on revenue of $5.64 billion, which would represent a year-over-year revenue decline of almost 5%. And this is while earnings per share are expected to decline by a penny. Relative to what the company has done over the past several quarters, I believe Xerox will have no problem with these targets.

Although the October quarter wasn't spectacular, Xerox did show positive signs with its restructuring efforts. The services segment, which now makes up close to 60% the company's total revenue, grew 3% year over year and posted a 9% jump in profits. I will grant that 3% growth is nothing to write home about. It did, however, offset the 4% decline in the legacy document technology business.

On Friday, management must be able to answer how long the services business can carry the entire load, given that the printing and copier business remains in a continuous decline. Making matters worse, as evident in the single-digit growth posted in the third quarter, services revenue has now begun to slow.

While I won't overreact and put so much weight on one quarter, management must assure investors that this was either an anomaly and/or that it has a strategy to re-accelerate services revenue. The other area to which investors must pay special attention is operations -- specifically in terms of profitability.

For instance, although the services segment beat estimates in the October quarter with margins of 9.9%, this still trailed Accenture (ACN) and IBM (IBM). In that regard, I do question why Xerox stock demands a premium above a company like Canon (CAJ) that outperforms Xerox in every meaningful metric, including revenue growth, gross margin and operating margin.

I hear analysts conveniently spewing the word "catalyst" to talk up the stock. One of these have been the $32.5 million (all cash) partnership Xerox recently struck with 3D printing leader 3D Systems (DDD). The arrangement allows Xerox access to 3D printing capabilities, which it hopes will revive its wilting hardware business. Relatively speaking, though, $32.5 million isn't a lot of money, given Xerox's cash flow of more than $3 billion.

Essentially, beyond Xerox buying the ability to say that "we are in 3D printing," I don't see any meaningful advantages with this partnership -- at least not based on the value of the deal. Investors are nonetheless soaking this up while ignoring the instability and restructuring that remains.

Accordingly, I would be a seller here ahead of earnings on the basis of stock's valuation, unrealistic expectations and lack of visibility. It is one thing to see the value and appeal still attached to the Xerox name -- it's another to believe that past performances are indicative of future results.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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