Description

DXC Investment Thesis

DXC is the result of a combination of two companies, Computer Sciences (also known as CSC) and the old EDS, a consulting arm of HP (formerly HP Enterprise). These companies help Fortune 1000 firms do relatively simple things like run their back offices, as well as very difficult tasks like writing sophisticated software.  

Neither CSC nor HPE are growth businesses. On its own DXC, though it has a very cheap valuation (more on that later), is on its own relatively unappealing. What really drew me to DXC was its management, or more precisely DXC’s CEO and Chairman, Mike Lawry.  

Mike was a senior executive at IBM for many years. Around the middle of the year 2000, he joined ValueAct, a hedge fund run by Jeff Ubben. ValueAct is a highly respected activist fund that takes positions in companies that are undermanaged and through constructive (never hostile) interactions with management unlocks value trapped in businesses.

Value Act is anything but a short-term-oriented corporate raider.  It has a long time horizon and holds its positions for years. Its most recent claim to fame was the turnaround of Microsoft. Though it took a tiny 1% position, it instigated change that eventually led to the removal of Steve Ballmer.  

Mike Lawry was with ValueAct for a few years and then was sent to run Mysis, a troubled technology company in the UK that ValueAct had a stake in. Mike did a great job turning Mysis around. Then, in early 2013, Computer Sciences got in trouble. Mike was hired by the Computer Sciences board to turn it around. Around the time Mike was hired by CSC, I met Jeff Ubben, ValueAct’s CEO, at a conference in San Francisco, and I asked him about Mike Lawry. I don’t remember Jeff’s exact words, but he gave Mike a glowing stamp of approval (though he was sad to see him leave ValueAct).  

Fast-forward five years. Mike did an incredible job turning around CSC, unlocking tremendous shareholder value and more than doubling its operating margins. Under Mike’s leadership CSC shareholders tripled their money. In 2017 CSC merged with consulting division of HP to create DXC. With DXC Mike is using the same playbook he used with CSC.  

Mike Lawry embodies qualities I look for in a CEO: He doesn’t make empty promises, is very commonsensical, humble (he is ready to admit his mistakes), and is not just good at running (or turning around) businesses; he understands capital allocation. The capital allocation piece becomes paramount when you own a company that doesn’t have a huge growth runway.  

In late 2018 DXC “disappointed” Wall Street by reporting revenues that were a few hundred million “light” – some contracts had rolled over sooner than expected, some started later expected – and the stock got halved. DXC bought back 4% of its stock.  

Now let’s talk about DXC’s valuation. DXC is (insanely) cheap. In 2018, the year that is behind us, DXC made around $8 per share. In its investor day presentation in November 2018 management presented earnings targets for 2022 that are nearly $13. See below:

What is amazing is that the bridge from $8 to $13 doesn’t rely on very aggressive assumptions – only 70 cents comes from 2-4% revenue growth. Most of the earnings growth comes from cutting costs. CSC and HP have huge redundancies – too many data centers and too many offices. Automation will allow DXC to use its workforce more effectively.  

Here we have a company with a very stable, noncyclical business, trading around four to eight times earnings. At the same time, it has a terrific balance sheet – it can pay off its debt in less than two years. Let’s say DXC misses its $13 in 2021 by $3 and “only” earns $10. If we give it a conservative price-to-earnings multiple of 12 times, then it is a $120 stock. If it earns $13 and gets a multiple of 15, then it is $195.  

The DXC purchase of Luxoft. DXC bought Luxoft for $59 per share. From the DXC perspective this purchase makes a lot of sense. It gives DXC instant access to a highly skilled Eastern European workforce. DXC has a great presence in the US, something Luxoft lacked; and so Luxoft can now sell its services to American customers. DXC paid a high price based on Luxoft’s current earnings, which are temporarily depressed by the shrinkage of its largest customer, troubled Deutsche Bank (DB). As DB goes away and Luxoft’s business starts growing again it should earn $4-5 per share. Thus DXC bought Luxoft at a bargain price.  

Catalyst

Value is its own catalyst.