By Dee Gill
Business managers rarely use "Xerox" as a verb any more, and Xerox (NYSE:XRX) shareholders are particularly pleased about that. Xerox's success as a corporate accounts manager is finally overshadowing its fame as copier king, and this ongoing shift from machines to services has nearly reversed a two-year slide in the share price, as seen in a stock chart.
So has Xerox finally found a formula for long-term shareholder returns? The experiences of other major tech companies suggest there's still a long hard slog ahead. Dell (NASDAQ:DELL), Nokia (NYSE:NOK), IBM (NYSE:IBM), Cisco Systems (NASDAQ:CSCO), Intel (NASDAQ:INTC) and Hewlett-Packard (NYSE:HPQ) have each made concerted efforts to improve performance by adding more higher-margin services to their mainly hardware businesses. For investors, the results of those strategies have been rather mixed. Consider:
In 2008, PC maker Dell set out to expand its IT services in a big way, which is why it took over Perot Systems in 2009. The markets were at first encouraged but grew worried as demand on the PC side fell off faster than expected. The share price was in a steep decline until Michael Dell began fighting to take the company private, a buyout that was approved in September.
Nokia tried to add services earlier this decade to offset its weakened position in the cellphone market. It didn't really help shareholders until Nokia sold that phone business to Microsoft (NASDAQ:MSFT) earlier this month.
IBM is considered the big success in this changeover, having pulled up its software and services sales to about 75% of revenues from 50% in 2000. It helped that IBM began the hunt for services company acquisitions before such takeovers were in vogue. Ten years later, IBM's share price was only marginally higher, although it's up more than 40% since 2010.
Cisco, Intel, and Hewlett-Packard also adopted similar services expansions in recent years.
Perhaps Xerox has a couple of advantages in its quest. First, many of the services it pursues are stickier and not nearly as competitive as the businesses Dell and others chose to enter, like cloud computing. Xerox now gets most of its revenues from services like managing employee benefits, accounts payable and customer care services. It also sets up Health Insurance Exchanges under the Affordable Care Act, processes insurance claims for hospitals, and reads license plate photos for tollbooth operations. Its customers are huge entities that renew their contracts at rates exceeding 80%.
Secondly, demand for Xerox's high-end machines hasn't dropped as fast as demand for PCs, servers and non-mobile tech generally. Xerox expects its move from 40% document production to 33% by 2017 to be driven more by growing service revenues.
Yet Xerox is in the early days of this transition. Overall revenues are still declining and are expected to be up a mere 1% in 2014. Profit margins haven't materially widened yet. The move toward paperless offices may yet intensify.
Consider critically the buy signs Xerox shares are flashing. Xerox trades at a forward PE ratio of less than 10, its dividend yield is 2.2% and strong free cash flow fuels speculation about generosity toward shareholders. But there's no history of steady dividend increases here, which will become important to investors if interest rates rise.
Xerox investors are hoping it can do better than so many other companies that have been down this road before, and maybe it can. But they might want to prepare for a long, painstaking process to get there.
Disclosure: I am long CSCO, IBM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.