Description

Xerox’s stock price has gone from a high of $60 in July 99 to $21 today, a 65% depreciation The company has $31.30 a share of revenue, $3.50 a share of cash flow (earnings plus depreciation), a multiple of 6x, and projected 2000 earnings of $2.00, a multiple of 10.5x, while the historical average P/E is 16 for the past 10 years ( the real multiple expansion happened in 98 and 99 with P/Es of 21.2 and 24.5 respectively). The company announced on December 10th an earnings disappointment 40% below the consensus estimate of $0.66 for for fourth quarter at that time, a run rate of $2.64 annually.

Could this be a true fallen angel?

DIAGNOSIS

However, book value is $9.10 a share, a price to book ratio of 232%, an earnings power valuation far in excess of net assets implying a substantive competitive advantage or franchise (mote around the economic castle) even after a 65% depreciation in share price.

That is the big question, can Xerox maintain its competitive position in the face of increased competition especially from Cannon along with rapid technological changes. Today are people making copies or making Xerox’s?

($000,000's)

Market Value of Equity $21.0625 x 669 million shares $14,091 million
Preferred Stock $ 674
Total Debt $15,638
Less: Cash $ (106)

Enterprise Value $30,297

Enterprise Value Per Share $45.28
Capitalization Rate $2.00 EPS/EV 4.5%
Cash Flow Cap Rate $3.50/EV 7.73%

ALTERNATIVE HYPOTHESIS

Xerox’s competitive advantage/franchise/product branding remains substantively intact and earnings growth will return to 50% to 100% of the historical earnings growth rate of 19% over the past 5 years (it was 8.5% over the past 10 years).

RESEARCH

A careful competitive advantage study needs to be effected along with a detailed replacement cost of assets vs. earnings power valuation.

What impact does technology have on this company?

VALUATION

Should earnings growth return to 50% to 100% of 5 year historical levels and the P/E returns to its historic level of 16x the at 2001 earnings of $2.20 to $2.40 per share the stock could be worth $35 to $38 in 2 years a total return of 67% to 80%.

The stock pays a dividend of $0.80 yielding 3.5% while we wait.

INTROSPECTION

Is this another IBM, AT&T or Apple?

Is it truly a value investment or simply an interesting speculation.

Catalyst

Recovery of earnings and multiple. Also large blue chip companies have tendency to recover.