Piper Jaffray analyst, George Tong, thinks splitting Xerox (NYSE: XRX) into two entities could drive valuation upside of 40%+ on cost savings and increased management focus. Financial results were weak as expected but the focus going forward is likely to be on the transformation rather than the tone of current business.

Xerox announced it will be splitting into a services company containing its BPO business (39% of revenue) and a hardware company containing its document technology and document outsourcing businesses (61% of revenue) in a tax-free transaction by year-end. Improved execution and better ability to manage each entity's unique growth, investment and capital allocation requirements in disparate industries. They believe the resulting re-rating of XRX's services multiple from 7x 2016E EBITDA currently to 9.5x where peers trade could drive valuation upside of 40%+.

Xerox announced a $2.4B three-year transformation savings program in connection with the split, with $600M in savings being incremental. We expect the incremental $600M savings to more than offset onetime separation costs and dis-synergies associated with the split. We believe not all cumulative ACS cost synergies, which totaled approximately $350M, will need to be given back in the form of dis-synergies due to the opportunity to build a lean overhead structure leveraging zero-based budgeting and given the recent ITO divestiture that slimmed down XRX services.

4Q results released in conjunction with the split announcement were largely as expected, and notably include strong signings growth and productivity initiatives in the services business.

The analyst cut the PT to $13 from $15 to reflect recent compression of peer multiples (9.5x 2016E EBITDA from 10x in services, 5x from 5.5x in hardware). No change to Overweight rating.

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Shares of Xerox closed at $9.75 yesterday.