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After activist investor Carl Icahn made a massive investment in Xerox late last year, there was an expectation he would shake up the company.
Now Icahn is living up to his reputation as an activist investor who spurs big changes. Xerox announced it will split into two companies: one focused on document technology and the other on business process outsourcing. The Xerox spinoff will give Icahn three seats on the board of the business process outsourcing company.
Icahn has stated that he believes Xerox to be severely undervalued. Xerox had fallen nearly 30% over the past year before seeing a spike in the recent week following the announcement.
While the initial reaction has been positive, I am still doubtful that the change will spur the growth that Xerox needs. With mobile computing and digital files becoming increasingly common, the printing and hardware solutions offered by Xerox are a dying product.
An M&A U-Turn
The decision to break Xerox into two companies is effectively reversing the biggest merger of the century-old company. Nearly six years ago Xerox purchase Affiliated Computer Services Inc. for about $6 billion. The company was suffering from revenue slowdown and needed to revive its core printer and copier business.
However, flipping acquisitions that do not live up to their promise is not uncommon. Xerox CEO Ursula Burns stated that the company was always prepared to change direction as the market demanded it.
Burns said, “These two companies will be well positioned to lead in their respective rapidly evolving markets and capitalize on the opportunities that now exist to expand margins and increase market share.”
Industry Trends
The Xerox spinoff decision largely follows a trend in the industry. International Business Machines (NYSE: IBM) shed its printer and personal computer division years ago, and more companies continue to realize they can operate better with a singular focus on services or hardware.
A more recent spinoff occurred last year with the Hewlett-Packard split. It chose to separate its printer and personal computer business from its enterprise servers and storage devices business.
Now Xerox is following suit. Document technology – Xerox’s legacy business of printers and equipment – had $11 billion in revenue in 2015. By comparison, the business process outsourcing business had revenue of $7 billion last year.
Burns will continue to run the document technology company. Carl Icahn will hold his three board seats on the business process outsourcing company and will advise in the search for a CEO of that company.
Future of Document Technology Business
The legacy business of Xerox is the bigger revenue source, but that is also where growth is declining.
Printing technology is a mature industry with significant competition. There is competition throughout the supply chain from entry-level printing equipment to high-end business equipment. In addition to direct competitors within the industry, there is a growing shift toward “going paperless” that is driving down demand.
Over the past few years revenue has fallen 12% in Xerox’s document technology segment. This side of the business does have continuous revenue streams past the initial equipment sale though maintenance services and supplies. This will also be the part of the business operating Xerox’s financing arm.
To put it bluntly, even Carl Icahn can’t turn this faltering business segment around. The opportunity for investors is within the business process outsourcing division.
An Opportunity With BPO
While BPO revenue was down over the past year, it can largely be attributed to poor management – a factor that should be corrected with the spinoff.
The BPO side provides services to government and industries like health care and transportation. It has benefited from Obamacare and the necessity for hospitals to reduce costs.
Under new management the growth potential is there to invest in an undervalued company. Icahn is also committed to getting management to cut costs on this side of the business.
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