XEROX HAS $9.3B. IN DEBT

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XEROX HAS $9.3B. IN DEBT

 user 2010-05-17 at 1:22:48 pm Views: 77
  • #23950

    http://quicktake.morningstar.com/Stocknet/san.aspx?id=334325
    XEROX HAS $9.3B. IN DEBT
    New Credit Rating: Xerox
    Morningstar is initiating credit coverage of Xerox XRX with a BBB- rating. Most notably, the firm scores poorly on our Solvency Score measure, owing primarily to its large receivables financing program. The decision to provide customers with long-term financing, which has become a key part of Xerox’s relationship with many, adds a large dose of leverage to the balance sheet. More than one fourth of assets at the end of 2009 were tied to customer financing activities, and the firm finances the vast majority of these assets with debt. Of Xerox’s $9.3 billion in debt at year-end 2009, $6.6 billion was tied to customer financing. Return on invested capital and interest coverage, two additional components of the Solvency Score, also suffer as a result of the large financing operations, as the firm engages in this activity more to support equipment sales than to generate profit. We believe Xerox’s receivable book is well diversified and provides a solid asset base to borrow against. Historically, provisions for loan losses and actual write-offs have run at less than 1% of total receivables per quarter. We didn’t adjust our Solvency Score upward, however, as financing customer purchases does present more balance sheet risk than leaving this activity to a third party. In addition, any issue with Xerox’s ability to access the capital markets would probably hurt sales.
    We have given the firm credit for the quality of the collateral against which it borrows in our Cash Flow Cushion calculation. The firm faces about $1 billion in debt maturities each year for the next decade. In addition, the firm repaid $1.7 billion of Affiliated Computer Services’ debt after completing its acquisition of the company earlier in 2010. Most of Xerox’s debt not tied to receivables was issued in 2009 to prepare for the ACS acquisition, leaving the firm with $3.8 billion in cash at the end of 2009. Beyond 2010, we expect Xerox will generate about $1.5 billion in cash per year through our five-year explicit forecast period. At that level of cash generation, the firm will cover its obligations only once over during the next five years. However, we expect Xerox will be able to issue additional debt against new receivables created in the course of business. As a result, we assume that the firm refinances 70% of its debt that comes due between 2011 and 2014, roughly the same percentage of its current debt load tied to customer financing. This cash inflow provides a decent cushion against an unexpected downturn in the business, moving the Cash Flow Cushion into a range more typical for a BBB rated company. If the firm is unable to refinance debt, it would probably begin allow its receivable book to shrink, also boosting the cash cushion.

    Xerox’s rating benefits from a solid Business Risk score, which is the result of the firm’s size and narrow economic moat rating. We believe Xerox’s competitive position is on the weak side among firms with a narrow moat rating, though. Xerox has created an impressive recurring revenue stream around its large installed base of equipment, but competing on the merits of hardware is a daunting task, especially given the attitude that office machines are cost centers to minimize and not strategic differentiators. When it is time to upgrade, we do not believe there is enough complexity in the typical office machine to generate significant switching costs. On the other hand, while we question the strategic rationale behind the ACS acquisition, we do like the business. ACS outsources entire business processes that take time and effort to set up, creating stronger bonds with the clients and thereby making the supplier more difficult to replace.