Moody's Downgrades Xerox Corp. (XRX) to 'Baa3'; Outlook is Negative
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Moody's Investors Service ("Moody's") downgraded the ratings of Xerox Corporation (NYSE: XRX) following Xerox's announcement of the intended debt capitalization for its Document Technology ("DT") and Business Process Outsourcing ("BPO") businesses, which plans to separate into two publicly traded companies by the end of the year. Among the affected ratings are the downgrades of the senior unsecured debt to Baa3 from Baa2 and short term ratings to P-3 from P-2. The outlook is negative.
The rating action concludes the review for downgrade, initiated on January 29, 2016, when Xerox announced its intention to legally split the DT and BPO businesses. The DT business will remain with Xerox, while the BPO units will be spun off into the newly-formed Conduent Incorporated.
The downgrade reflects Moody's view that following Xerox's planned separation, the remaining DT business will be a smaller company with less business diversity and profitability than the current combined business, and be more exposed to the headwinds facing the global print industry. Post separation, Xerox's DT business will have over $10 billion in revenues, and will also include the document outsourcing business that is currently reported in Xerox's Services segment. Moody's expects growth in document outsourcing to at least partially offset the ongoing high single digit sales declines at DT, driven by the transformation of the print industry.
Moody's analyst Gerald Granovsky said, "Moody's expects that Xerox will maintain its solid market position in its core A3, mid-range print and document outsourcing markets, and use its strong brand name recognition to leverage worldwide distribution capabilities to defend its share and potentially grow in underpenetrated areas of the market, such as A4." Overall, Moody's expects the company to stem its revenue declines to the low single digits in the next couple of years, with the potential for flat to modest revenue gains thereafter. About 75% of Xerox's pro-forma revenue is derived from post-sale activities that include document outsourcing, managed print services, maintenance service, supplies (toner and paper), and finance income. These elements provide a base of revenue predictability and typically serve to partially offset declines in equipment sales.
Moody's also recognizes the importance of providing customer financing as part of the overall selling proposition as it provides a competitive advantage and greater flexibility in structuring large technology purchases. Therefore, the rating agency expects Xerox to maintain very conservative financial policies, which should be helped by the implementation of its three year $2.4 billion cost reduction plan. Moody's expects Xerox's financial adjusted debt to EBITDA leverage to be in the low 2.0 times range, compared to the high 2.0 times range it had prior to the separation.
The negative outlook reflects the pressures on the company's core business, execution challenges and the limited financial flexibility if it were to be more aggressive with shareholder payouts or partake in larger acquisitions, which may be necessary to compete, especially if benefits from the separation take longer to materialize. The outlook may be stabilized if the company is tracking well in its plan to stem revenue declines and demonstrates ongoing margin improvement.
Given the negative outlook, a rating upgrade is unlikely in the near term. Ratings could be upgraded if Xerox demonstrates consistent business execution that leads to consistent revenue growth, improved operating margins, and improved cash flow generation. An upgrade would also require conservative financial discipline and maintaining the asset quality of its finance operations while reducing the refinancing risk associated with the finance liabilities. These results would be evidenced by maintaining adjusted operating margins in the low double digits, adjusted total debt to EBITDA below 2x, and improving free cash flow generation.
Ratings could be downgraded if Xerox's credit metrics weaken, evidenced by greater than expected declines in revenues or the failure to achieve anticipated operating margin improvement. Downward rating action could also occur if Xerox incurs leverage to undertake any combination of share buybacks, dividends or significant debt-financed acquisitions that result in adjusted total debt to EBITDA exceeding 2.5 times level for a sustained period.
Issuer: Xerox Corporation
Commercial Paper -- Downgraded to P-3 from P-2
Senior Unsecured Debt -- Downgraded to Baa3 from Baa2
Senior Unsecured MTN - Downgraded to (P)Baa3 from (P)Baa2
Senior Unsecured Bank Credit Facility - Downgraded to Baa3 from Baa2
The principal methodology used in these ratings was "Diversified Technology Rating Methodology" published in December 2015. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
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