That Heartbeat You Hear Is Xerox
The copier king seems firmly on the road to recovery. Now it needs to keep impressing investors with solid growth, and that's no small challenge
Like Lazarus, Xerox has come back from the dead. For two years during a bear market, the printer-and-copier giant bled money at an alarming rate. Its shares, which traded in the $50 range during the late '90s, plummeted to a low of around $4 last year. Then came an accounting scandal that kept its name in unflattering headlines for months. Today, execs and investors alike are smiling again. The stock is now in the $11 to $12 range, up almost 40% since the beginning of the year, as Xerox (XRX ) appears to have put its troubles behind it.
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Aggressive cost-cutting under CEO Anne Mulcahy helped generate a respectable $1.9 billion in operating cash flow and $91 million in net income on $15.8 billion in revenues last year. Worries over Xerox' ability to pay off $21.3 billion in liabilities -- $9.2 billion of them long-term -- have also been put to rest. At the end of June, it raised $3.6 billion with offerings of stock and bonds, and through bank financing, enough to earn itself a credit upgrade -- from BB- to BB -- from ratings agency Fitch.
Finally, on July 8, the Securities & Exchange Commission issued suspension orders against two former Xerox accounting officers, apparently closing the books on a scandal that last year forced the company to restate five years of sales revenues and pay a $10 million fine.
PROVEN FAT-CUTTER. The next milestone investors will want to examine comes on July 28, when Xerox makes its second-quarter earnings announcement. Analysts expect $89 million, or 12 cents a share, on revenues of $3.9 billion. While that's a penny less than the first quarter's adjusted earnings, when it rang up $3.76 billion in sales, Xerox has proved that it can cut fat. The big challenge now will be whether it increase revenues.
Analyst Shannon Cross of equity research boutique Cross Research thinks overall sales will be down slightly in 2003, from $15.7 billion last year. To meet analysts' 2004 expectations, Xerox would have to expand sales by about 7% next year -- or further reduce expenses. The problem with the second option: Not much is left to cut.
Indeed, Xerox has been down for so long that the best-case scenario for its rebound may already be priced into the stock, says Ulysses Yannas, an analyst with Buckman, Buckman & Reid, who has a neutral rating on the shares. For the stock to rise, growth "has to be proven," he says. Until then, he would prefer to pick up Xerox at around $8 during the dips that will likely come as investors debate whether Xerox' 2004 growth rate will be closer to 4% or 7%.
NO PREMIUMS. Xerox's growth could approach 7% -- and that would be a good sign for investors looking for a long-term investment. It's reasonable to assume that recent product price cuts and added focus on services should help Xerox grow faster than other printer-and-copier makers. And its strong presence overseas -- which represents a big chunk of the 40% of its overseas revenue -- will benefit from the weak dollar, says Yannas. Plus, Xerox sales are closely tied to the U.S. economy, which is recovering.
Over the next year, price-cutting could grab it an additional 2% to 3% share of the printer market, where it now holds 18%, estimates Peter Grant, an analyst with market consultancy Gartner. In the past, Xerox sold its printers and copiers at a premium of 10% to 15% over rivals' products. But several months ago, it introduced 21 new models and cut prices to the most competitive levels in its history, according to the company.
As a result, Xerox wares now sell at or below the cost of competitors like Sharp, says Andy Slawetsky, a vice-president with imaging consultancy Industry Analysts. Independent tests already show that Xerox equipment makes copies faster than virtually all rivals, and customers consider its salesforce among the best-trained, adds Slawetsky. Also, Xerox software is considered an industry benchmark.
LUCRATIVE SWITCH. What's more, Xerox plans to capitalize on customers' transition from black-and-white copying and printing to color. Overall revenues from monochrome printers are declining, but the U.S. market for color printers will grow from $1.2 billion this year to $1.8 billion in three years, estimates Grant. As corporations switch to color, revenues could grow dramatically, since Xerox receives about 9 cents per page on color copying, vs. about a 1.5 cents for black-and-white prints, Slawetsky says. Xerox also has increased its focus on services, already a $3 billion-plus part of its business.
Not that it doesn't face challenges: With Xerox dropping its prices, the competition will likely follow suit. In fact, Grant predicts that average selling prices for color printers will fall by more than 20% this year. That's less than last year's 25% decline, but Xerox would likely be obliged to respond with yet another cut. And its margins could drop from the current 42% to 40%, say analysts.
Also, in both products and services, Xerox will hit stiff competition. Hewlett-Packard (HPQ ) is expected to come out with a new color printer-copier within the next 12 months. HP declined to comment on new-product introductions, but it's working to make its pricing easier to understand in the hope of appealing to small and midsize businesses, says Chris Morgan, vice-president for imaging and printing sales and marketing at HP. Both it and IBM (IBM ) are pushing package deals for smaller companies, offerings that go beyond information-technology network services tied in with printers and copiers.
OUT OF THE DOGHOUSE. Xerox insists it isn't worried. "We expect that [rivals] don't have a lot of room in which to cut prices," says a spokesperson. "At the same time, we're confident that Xerox has the right business model to drive profitable revenue from these products while remaining competitive in this aggressive industry." The company is in a quiet period and was unable to comment for this story beyond this statement.
At this point, silence is looking pretty golden. When you've been to the doghouse as Xerox has over the past several years, just getting out counts for a lot. It's "on the right track," says Cross. "But they have a ways to go. They now need to show they can execute." If investors see that it can, Xerox could well wind up in the penthouse.
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