Xerox (XRX) is acquiring the outsourcing giant Affiliated Computer Services (ACS). The deal marks Ursula Burns' first big move since she became the CEO of Xerox on July 1. Although still profitable, Xerox has been hurt by the slowdown in business spending during the recession.
As per the terms of the deal, ACS shareholders will receive a total of $18.60 per share in cash plus 4.935 Xerox shares for each ACS share they own. In addition, Xerox will assume ACS's debt of $2 billion and issue $300 million of convertible preferred stock to ACS's Class B shareholder. The transaction, which has been approved by the Xerox and ACS boards of directors and ACS special committee, is expected to close in the first quarter of 2010.
Xerox's offer amounted to a 33% premium over ACS's closing stock price on Friday, although the value fell as Xerox shares lost $1.34, or 14.86%, to $7.68 on Monday, while ACS shares jumped $6.61, or 14%, to $53.86. Xerox's estimated cost savings of $300 million to $400 million from ACS deal were more than wiped out in market capitalization loss on Monday.
The reasons for investor bearish outlook are pretty much clear – high price ($5.7 billion cash and stock offer), increased debt on books ($3 billion), and bloated employee count (Xerox's employee headcount doubles from 54,000 to 128,000). These are perfectly valid reasons. But will the acquisition overcompensate for these shortcomings? I do think so.
The Xerox once known for copiers, printers and paper has greatly expanded its footprint over the last few years. New technology and services offerings are generating billions of dollars in recurring revenue for the company – thanks to 15 acquisitions done during 2006-2008. The company has been gradually transforming into a document management player. ACS would transform Xerox from a seller of printing equipment and print services with $17.6 billion in revenues into a $22 billion specialist in gathering, analyzing and sharing information. This acquisition enables Xerox to triple its revenue from services from $3.5 billion in 2008 to an estimated $10 billion in 2010. Without this bold services move, Xerox faces stagnating revenue in its core product business as it matures.
ACS specializes in business process outsourcing (Business process outsourcing is estimated to be a $150 billion market, growing at a rate of 5% per year), the paper-intensive, back-office work like payroll and benefits, auto and mortgage loan processing and Medicaid claims. With ACS in the portfolio, Xerox sales team could expand its business to Europe, where its brand is strong and ACS has almost no presence today. And Xerox could boost ACS margins by offering its technology to eliminate paper and automate more processes. Moreover, ACS deal looks relatively cheaper than Dell's acquisition of Perot Systems (Dell is paying 29 times estimated 2010 earnings for Perot, while Xerox would get ACS for about 14 times its estimated 2010 earnings). Additionally, many of the information analysis problems ACS tackles every day are precisely the ones Xerox scientists are trying to solve. For example, ACS, which runs the E-ZPass electronic toll collection system in some areas on the East Coast, could use Xerox character recognition technology to digitally read the license plates of toll lane violators and issue tickets. ACS acquisition would also help Xerox increase its revenue from federal, state, county and local governments, as ACS is the largest provider of managed services to government entities in the US.
Difficult job of convincing the Wall Street
Ms. Burns now has the difficult job of convincing investors that ACS acquisition would enhance shareholder return in the medium term. Shareholders had been expecting stock buyback announcement from Xerox. With the deal signed, I guess, there won't be any share buyback program in the next few months. May be once the management secures favorable refinancing for its debt, they could look at share buyback.
