Xerox: So Far, So Good


By Olga Kharif For Anne Mulcahy, carrying the Utah-bound Olympic torch over a half-mile stretch near her Connecticut home on Dec. 26 was a piece of cake. After all, the CEO and chairman of Xerox (XRX), who runs daily on a treadmill, is in great shape. And her jaunt with the flame just can't compare to the treacherous trail she has traversed for the past two years at the troubled copier outfit. The greatest challenge of her career has been spearheading a restructuring of a behemoth that many analysts were writing off just two years ago.

In the fall of 2000, the 25-year Xerox veteran proposed a multibillion-dollar turnaround plan that included massive job cuts and selling off unprofitable operations. Xerox, Mulcahy said, would focus on its high-end businesses, such as color and commercial copying and printing, and exit low-end lines like inkjet printers. Xerox would also expand into services, she promised, offering consulting deals to corporations on how to improve their document flow.

Most important, Mulcahy swore she would staunch a steady decline in market share and reform an ossified corporate culture. All in all, she set herself a Olympian task.

TAKING NOTICE. Today, the copier and document company's financials are certainly looking cleaner, say analysts. As of Dec. 31, 2001, Xerox had about $3.9 billion in cash and $11 billion in debt still outstanding. True, Moody's recently downgraded its bonds to one notch above junk status. But compare last year's numbers to yearend 2000's, when Xerox had $1.7 billion in cash and $16.4 billion in debt.

Investors have certainly taken notice. From about $6.50 in mid-November, Xerox shares are up to around $10 today. The question for 2002: Can Mulcahy restore vigorous, top-line improvement to a company in what has traditionally been a slow-growth business?

So far, Mulcahy has been true to her vows -- in some cases delivering more savings than she promised. She said she would sell at least $2 billion worth of the company's nonperforming assets. As of October, 2001, she had already dumped $2.5 billion worth. In December, 2000, Xerox sold its China operations for $550 million. In March, 2001, it sold half its stake in Fuji Xerox for about $1.3 billion.

RED-INK INKJETS. The selloff hasn't been confined to big chunks. On Dec. 3, Xerox announced it would sell the assets of Delphax Systems to printer maker Check Technology (CTCQ) for $14 million in cash. Then, on Dec. 21, Xerox completed the first $118 million tranche in a series of asset sales to manufacturing outsourcer Flextronics (FLEX).

Mulcahy has also reduced Xerox's workforce by some 14,200 employees over the past 14 months, slicing it to around 80,000 and cutting $1 billion in annual costs. In addition, the company shuttered its unprofitable inkjet printers business last June. According to analysts, she should beat her $1 billion cost-cutting target by $200 million when fourth-quarter 2001 results are announced in the coming weeks. Says Jim Firestone, president of Xerox corporate operations group: "We are back, stronger than ever, with a powerful value proposition for our customers and shareholders."

As promised, Xerox has outsourced many of its noncore functions, such as international information-technology services. On Nov. 28, Xerox signed a $1.5 billion, five-year contract extension that will see Electronic Data Systems (EDS) continue to run Xerox' computer and telecommunications networks. That move ended a potentially costly lawsuit with EDS over a portion of their original 10-year agreeement.

And since Xerox' credit rating has been downgraded, it has become more costly for it to borrow money. As a result, Xerox can't profitably finance its customers' purchases itself. So, it's also looking for companies to provide up to $10 billion in financing for its customers.

DELAYED PROFITABILITY? Those moves and others have earned Mulcahy strong marks. Says Julianne Mehegan, analyst with printing consultancy Lyra Research: "They have pretty much achieved the objectives they set out."

Next comes the hard part -- reversing the slide in sales and profits. Most analysts think Xerox will post earnings that return it to at least operational profitability for the fourth quarter of 2001, although some think the economic downturn will delay that. Yet Xerox continues to lose market share in its core businesses, say analysts who cover the company. Its share of the black-and-white printer market slid from 12.6% in 2000 to 9.3% in 2001, according to tech consultancy IDC. Xerox' share in color printers fell from 23.2% of all U.S. shipments in 2000 to 22.8% in 2001. Company spokespeople say the primary focus is on restoring profitability rather than market share.

Some of the problem may come from a sales force unable to get the message across. For example, Xerox' high-speed printers can churn out as many as 185 pages per minute, while competitors' products reach speeds only in the low teens, says IDC analyst Riley McNulty. This year, Xerox will put out five new copiers, most of which it claims will be cheaper to operate and outperform those of rivals. And it's looking for new revenues in the document-consulting business.

ALL-IN-ONE TECHNOLOGY. A wild card is the Internet. While copiers and paper documents are hardly going away, corporations have began sending much of their internal correspondence electronically instead of printing it out and distributing it among employees. Bulky procedure manuals are now routinely posted on company Web sites. For that reason, Xerox "will never be as much of a juggernaut as they were in the '90s," predicts Mehegan.

Mulcahy aims to create a more lucrative future for Xerox by producing big machines for corporations -- machines that can copy, fax, print, and broadcast documents electronically. While the traditional printer market could grow just a few percentage points annually, all-in-one devices might expand as much as 15% this year, believes Keith Kmetz of IDC. That means it could one day eclipse the $131 billion copy-and-document market of today.

For now, however, copiers and document machines remain some of the last things companies buy during an economic slowdown. If that wisdom continues to hold true, sluggish sales could push Xerox' revenues down a few percentage points in 2002, according to Goldman Sachs. As it stands now, Xerox sees little growth until 2003.

"RISKY STORY." For the first time in a long time, though, Mulcahy and Xerox are raising cash. In September, 2001, the company signed a $1 billion loan agreement with GE Capital. In November, 2001, it raised more than $1 billion through a private debt offering, one of the year's most successful, according to analysts.

More recently, on Jan. 7, Xerox announced it would seek an additional $500 million through private placements. Xerox still needs to renegotiate the terms of its $7 billion credit line, which is coming up for renewal in October. But Merrill Lynch analyst Shannon Cross figures that by next fall, Xerox will have hoarded enough cash to pay off about half of the $7 billion sum. It could repay the rest through short-term loans, she says. And Xerox could implement further cost-cutting measures. Analyst Mehegan, for one, sees the possibility of an additional 5,000 middle managers being cut.

While investors seem to be buying the turnaround tale, "it's still a risky story," says Cross. Witness a Jan. 7 announcement from Xerox that the Securities & Exchange Commission was reviewing its accounting for certain types of leases. But he adds: "It's a company you need to watch." And for now, Mulcahy appears at least to have Xerox on the right track. Kharif covers technology from Portland, Ore.


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