Fitch Expects to Affirm Xerox at 'BBB-' Upon Separation; Outlook Negative

CHICAGO--()--Fitch Ratings expects to resolve the Watch Negative and affirm Xerox Corporation's (Xerox) ratings, including the Long- and Short-Term Issuer Default Ratings (IDR), at 'BBB-/F3' upon its separation of Conduent Incorporated (Conduent). Fitch expects the Rating Outlook will be Negative.

Fitch's expected affirmation follows an Amendment to Conduent's Registration Statement on Form 10, which discloses Conduent's anticipated capital structure, liquidity and cash transfer to Xerox upon separation. Conduent will transfer approximately $2 billion to Xerox prior to separation, which we expect Xerox will use for near-term debt reduction, resulting in core leverage (which excludes profitability and debt associated with the equipment financing business) below 1x.

Xerox will separate Conduent, which will be comprised of the Business Process Outsourcing (BPO) businesses within Xerox's Services segment (excluding the Document Outsourcing business, which will remain at Xerox) through a spin-off transaction intended to be tax-free for Xerox shareholders for federal income tax purposes. The separation unwinds legacy Xerox's 2010 acquisition of Affiliated Computer Services Inc. (ACS) for $6 billion and is expected to be completed at the end of calendar 2016.

The expected affirmation and Negative Outlook reflect Fitch's expectations for:

Secular Top-Line Headwinds: Fitch expects continued headwinds through the intermediate term with pockets of growth in core markets insufficient to offset the anticipation of mid- and low-teens rates of decline in core mid-range A3 and MFP and high-end mono printers, respectively. Longer term, packaging, workflow automation, printed electronics and 3D printing opportunities could be significant but should require meaningful investments, including acquisitions.

Solid Free Cash Flow: Fitch expects annual pre-dividend FCF (excluding changes in financing assets) will remain solid from 75% annuity-based revenue, despite top-line pressures. Pre-dividend FCF should range from $500 million to $1 billion beyond the near term, and will include separation-related charges and cash restructuring. Fitch expects pension contributions and cash restructuring could be $500 million over the next two years. Xerox continues generating the majority of its revenue in the U.S., so Fitch expects longer-term domestic FCF will be more than sufficient to support modest tuck-in acquisitions and debt reduction or shareholder returns.

Conservative Financial Policies: Fitch expects Xerox's financial policies will remain conservative over the longer term, driven by the company's strategic focus on maintaining an investment-grade rating to support the financing business. In conjunction with the spin-off, Xerox plans to use the $2 billion cash transfer from Conduent to repay near-term debt maturities, which Fitch estimates would result in $4.5 billion to $5 billion of nominal debt, or $900 million to $1 billion of core debt. As a result, Fitch expects core leverage, which excludes debt and profitability associated with the financing business, will be 0.5x-1x post-separation.

Reduced Scale and Diversification: The separation reduces Xerox's scale, revenue diversification and organic growth prospects. The BPO business represented approximately 40% of 2015 revenue with minimal customer overlap and we believe it is poised for low-single-digit positive organic revenue growth over the longer term with profit margin expansion from restructuring. Pro forma for the separation, Xerox will consist of Document Technologies (DT; two-thirds of revenue), declining by mid-single digits with low double-digit profit margins, and Document Outsourcing (DO; one-third), which is growing in the low- to mid-single digits with profit margins in-line with DT.

Cost Reduction Roadmap: Fitch expects Xerox's cost reduction roadmap will be significant and ongoing in light of expectations for continued top-line pressures. Still, the company will restructure aggressively and, as a consequence, should maintain profit margin through the intermediate term and position Xerox for profit margin expansion upon improved revenue performance. Fitch estimates Xerox could take out more than $250 million of costs annually through the intermediate term, largely through headcount reductions and footprint optimization.

A3 and DO Market Leadership: Fitch expects Xerox will continue to benefit from market leadership in core markets, including A3 Mid-Range, High-End Color, and Mono and Document Outsourcing.

Additional information is available on www.fitchratings.com

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Contacts

Fitch Ratings
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Senior Director
+1-312-368-3210
Fitch Ratings, Inc.
70 West Madison Street
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or
Secondary Analyst
David Peterson
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+1-312-368-3177
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
Email: alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jason Pompeii
Senior Director
+1-312-368-3210
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
David Peterson
Senior Director
+1-312-368-3177
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
Email: alyssa.castelli@fitchratings.com