We came across a bearish thesis on Xerox Holdings Corp (XRX) on ValueInvestorsClub by ElmSt14. In this article, we will summarize the bears’ thesis on XRX. Xerox Holdings shares were trading at $17.30 when this thesis was published, vs. closing price of $11.33 on Aug 30.
Xerox, once a pioneer in office technology with a legacy stretching back to its creation of the first photocopier, has become a shadow of its former self. The company now primarily sells printers, copiers, and ink, generating $6.5 billion in revenue, with an additional $400 million coming from its financing business. Despite its rich technological history, Xerox’s current business is deeply entrenched in a market that is not only stagnant but in secular decline. The rise of digital alternatives and the shift towards paperless environments are accelerating, making the future for traditional printing bleak.
See Also 33 Most Important AI Companies You Should Pay Attention To
Xerox’s situation is further complicated by its shrinking market share within this declining industry. Competitors like Canon and Fujitsu have managed to maintain modest growth, while Xerox has struggled to keep pace, indicating a weaker market position even within an already challenging landscape.
The company’s financial structure also raises red flags. Xerox is heavily leveraged, carrying $4 billion in gross debt alongside convertible preferred stock. Much of this debt has interest rates that do not align with the company’s deteriorating credit quality and the current high-interest rate environment. Recent refinancing efforts highlight this issue, with Xerox forced to replace maturing bonds with new debt at significantly higher rates, adding $20 million in interest expenses while also diluting shareholders through convertible debt issuance. The company’s financial strain is likely to worsen as its free cash flow (FCF) diminishes and further refinancing becomes necessary.
One of the critical points for bearish sentiment on Xerox is the apparent overstatement of its free cash flow. While management has guided for $600 million in FCF for 2024, a significant portion of this figure is inflated by the sale of financing assets, which are included in cash flow from operations (CFFO). These sales are part of an agreement with HPS Investment Partners, wherein Xerox sells pools of finance receivables to HPS. This arrangement has artificially bolstered FCF, leading to a misleadingly optimistic financial outlook. Excluding these one-off financing asset sales, Xerox’s true FCF is far weaker, casting doubt on its ability to sustain its $1 per share dividend, especially as its core business continues to decline.
Moreover, Xerox’s management has a history of poor capital allocation and corporate governance. Over the years, the company has repeatedly made questionable decisions, such as buying assets at high prices and later selling them at lower valuations. The recent buyback of Carl Icahn’s shares in a debt-financed transaction at $16 per share, only for the stock to trade lower afterward, underscores management’s missteps. This move, which some view as greenmail, further strained Xerox’s balance sheet while offering little in return for long-term shareholders.
In summary, Xerox presents a compelling short case. The company is entrenched in a terminally declining industry, burdened by a levered capital structure with rising costs, and its financials are less robust than they appear due to overstated FCF. Combined with poor capital allocation and governance issues, Xerox is likely to face significant challenges, making it an unattractive investment at current levels.
XRX is not on our list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 28 hedge fund portfolios held XRX at the end of the second quarter which was 31 in the previous quarter. While we acknowledge the potential of XRX as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as XRX but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
READ NEXT: Analyst Sees a New $25 Billion “Opportunity” for NVIDIA and 10 Best of Breed Stocks to Buy For The Third Quarter of 2024 According to Bank of America.
Disclosure: None. This article is originally published at Insider Monkey.
