CHICAGO--(BUSINESS WIRE)--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
Copyright © 2016 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch's factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch's ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.
The information in this report is provided "as is" without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.
For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.