Moody’s Downgrades Xerox Debt Rating, But Outlook is Stable

Credit-rating agency Moody’s has downgraded Xerox’s Corporate Family Rating (CFR) to Ba2 from Ba1 and the Probability of Default Rating (PDR) to Ba2-PD from Ba1-PD, driven by Moody’s expectation that Xerox’s revenue growth in 2022 will remain challenged by supply-chain disruptions and the slowdown in return to office trends.

Moody’s also stated that Xerox’s willingness to fund significant share buybacks in fourth-quarter 2021 “evidences aggressive financial policies in light of weak fourth-quarter (2021) operating results, elevated debt to EBITDA (Moody’s adjusted), and the company’s decision to increase growth investments in 2022.”

As part of the rating actions, Moody’s downgraded Xerox’s senior unsecured credit facility and senior unsecured notes ratings to Ba2 from Ba1. The Speculative Grade Liquidity (SGL) rating of SGL-1 is unchanged, and the outlook was revised to stable from negative.

Reasons Behind Changes

Moody’s downgrade to Ba2 is said to reflect the ongoing challenges Xerox faces to grow overall revenues and maintain profit margins. Supply-chain disruptions contributed to a greater than expected decline in the number of Xerox’s equipment installations in fourth-quarter 2021 and will continue through at least mid-2022. Moody’s also stated that Xerox’s operating performance will continue to be hindered by delays in the return to office trends, as a result of the lingering pandemic. The downgrade also considers Xerox’s aggressive financial policies that favor shareholder interests. Xerox funded $388 million of share buybacks in fourth-quarter 2021, bringing total 2021 repurchases to just under $890 million, despite weaker than expected operating results in fourth-quarter 2021, elevated leverage, and guidance for tepid operating performance in 2022.

Over the next year, Moody’s expects organic revenue growth for Xerox will be pressured due to ongoing supply-chain disruptions that contributed to equipment shortages and the remaining impact of the COVID-19 pandemic. Revenues for fiscal-year 2021 increased only modestly to $7.04 billion, as a 7.9-percent revenue decline for fourth-quarter 2021 offset gains through the first half of 2021, due to supply-chain issues.

For 2022, Moody’s expects only modest overall revenue growth for Xerox, given pressures from declining print demand combined with only partial recovery in the percentage of workers returning to their offices.

Moody’s also noted that the downgrade reflects higher financial leverage for Xerox, with debt to EBITDA (earnings before interest, tax, depreciation, and amortization) exceeding 3.5-times.

Moodys noted that Xerox has gained market share in the past year, particularly for office-focused offerings, but its competition remains intense in this mature industry with new equipment and service offerings from other providers, a few of whom have deeper financial pockets, more stable top lines due to significant revenue diversification, or better penetration in certain higher-growth Asian and other emerging markets.

Xerox’s ratings are supported by the company’s good market position in its core mid-range print and document-outsourcing markets, as well as very good liquidity. Excluding the impact of COVID-19, more than 70 percent of Xerox’s revenue is typically derived from post-sale activities that include document outsourcing, managed print services, maintenance service, supplies (toner and paper), and finance income. These elements come with higher operating margins and often provide recurring revenue streams. Moody’s noted that Xerox engages in customer financing as part of its overall selling proposition to provide a competitive advantage and greater flexibility in structuring large technology purchases. However, financing equipment receivables weigh on the company’s risk assessment due to the ongoing need to manage sizable debt maturities and cost of funding.

Lower Office MFP/Copier and Printer Demand

Moody’s noted that demand for office copiers and printers remains in decline driven by the substitution of traditional physical copies with digital documents and the social trend to go paperless. Corporate governance is also a key consideration given the company’s aggressive financial policies including Xerox’s debt-financed proposal to acquire HP Inc. in November 2019 and funding over $1 billion of dividends and share buybacks in 2021.

Xerox Holdings

In addition, Moody’s noted that Xerox established a new holding company, Xerox Holdings Corporation, with the intent of providing strategic, operational, and financial flexibility. Xerox guarantees the credit facility of Xerox Corporation but does not guarantee the senior notes of Xerox Corporation, which could favor shareholders, debt investors of Xerox, and revolver lenders at the expense of Xerox Corporation note holders.

Icahn Associates Remains Majority Shareholder

Moody’s also noted that Xerox’s board is comprised of 10 members, of which nine are considered independent. Xerox’s shareholder base includes Icahn Associates, which owns roughly 20.5 percent of outstanding shares as of the end of January 2022, followed by Vanguard and Blackrock owning 6 percent to  8 percent, and other investment firms owning less than 5 percent.

Factors that Could Lead to an Upgrade or Downgrade of Moody’s Ratings

Moody’s stable outlook for Xerox reflects its expectation that Xerox’s top-line gains over the next year will be modest with revenues from newer growth businesses, such as 3D Printing, CareAR, and Xerox Financial Services, largely offsetting potential revenue declines for Xerox’s core copier and printing operations.

The outlook also incorporates Moody’s expectation that debt to EBITDA will improve over the next year from current elevated levels through growth in adjusted EBITDA, or debt reduction and liquidity will remain very good with ample cash balances and revolver availability.

Although Xerox intends to increase investments in growth businesses by roughly 50 percent to $200 million in 2022, Moody’s expects adjusted free cash flow to debt will be in the low double-digit percentage range. The stable outlook does not contemplate further share repurchases beyond the remaining authorization for an additional $113 million.

Possible Upgrade

Moody’s ratings could be upgraded if Xerox demonstrates consistent revenue growth, stable to improving operating margins, and growing free cash flow. An upgrade would also require conservative financial discipline, ensuring classes of unsecured debt at Xerox and Xerox Corporation will have similar instrument ratings, and maintaining the asset quality of its expanded finance operations to non-Xerox offerings. These results would be evidenced by achieving and maintaining adjusted operating margins in the low double-digit percentage range, adjusted total debt to EBITDA approaching 2.5 times, and improving free cash flow generation.

Possible Downgrade

Moody’s ratings could be downgraded if Xerox is unable to stabilize total revenues, or if operating margins weaken. Downward rating actions could also occur if liquidity deteriorates, including cash balances approaching $500 million or revolver availability declining to less than $800 million, or if Moody’s expects adjusted debt to EBITDA will be sustained above 3.5-times after 2022 or adjusted free cash flow to debt will fall below 10 percent. Ratings could also be downgraded if the company funds share buybacks beyond the remaining $113 million currently authorized, classes of unsecured debt at Xerox or Xerox Corporation have different instrument ratings reflecting asymmetric credit metrics, or the asset quality of the finance operations erodes.