Xerox continues to suffer declines in its BPO and DO service lines; weak annual compares will spur a return to growth by 1Q17, says Ryan Blanchard, analyst at TBR.
Despite modest inorganic contributions from its recent acquisition of Imagetek, Xerox’s document outsourcing (DO) revenues fell slightly in Q3 2016, down 1.2 percent year-to-year to $791 million following two consecutive quarters of expansion.
Xerox will recapture growth from the service line as the company accelerates investments in next-generation hardware and technology offerings, bolstering its value proposition when pursing contracts with large enterprise clients. Xerox will target the lion’s share of its remaining M&A budget ($30 million to $50 million in 2015) to augment its DO capabilities in advance of its split. Additionally, we expect 4Q16 DO revenues will benefit from the ramp up of the 10-year, $110 million managed print services (MPS) contract Xerox secured from the USDA in October.
Xerox suffered a year-to-year decline of 4.5 percent in its BPO service line, down to $1.61 billion during Q3 2016. We expect the decline is largely owed to a decrease in new client engagements, which failed to offset the negative impacts of low-margin contract runoffs. TBR anticipates a rebound from the segment by 1Q17 as the company benefits from a relatively weak compare and increasing traction for digital back-office solutions, particularly among state-level and healthcare clients.
Xerox continues to appoint Conduent leadership in advance of its split while outlining its brand identity and go-to-market strategies.
Conduent leadership appointments continued in Q3 2016, as the company announced the appointment of Brian Webb-Walsh as CFO effective Jan. 1, 2016. TBR believes Webb-Walsh’s deep knowledge of Xerox’s services business and its financial operations stemming from his tenure as the firm’s current CFO will enable a seamless transition through the split, and will ease any investor concerns of shareholder value erosion.
Conversely, Sophie Vandebroek announced she would be retiring from her position as Xerox’s CTO at the end of the year. Replacing Vandebroek will be a top priority for Xerox, as the company continues its climb up market and invests heavily in innovative technologies and managed print services. During the quarter Xerox continued to outline Conduent’s brand identity, unveiling its official logo and branding. To align with its new posturing, the company is revamping its portfolio to capture demand for improved customer engagement and transactional data analysis.
During its Q3 2016 earnings Xerox announced the two independent firms would be reporting as separate entities for the 4Q16 and full-year earnings release.
Xerox encounters headwinds across verticals as its focus on protecting margins drove a decline in new client engagements during Q3 2016.
TBR estimates Xerox’s public sector vertical fell 5.5 percent in Q3 2016, despite traction at the state level, evidenced by recently secured contracts including its engagement with the Oakland County Clerk’s Office in Pontiac, Mich., for an automated fraudulent deed alert system.
Financial services revenue fell 0.5 percent from the year-ago compare in Q3 2016 per TBR estimates, which we believe was driven in part by efforts to protect segment margins during the quarter. Modest pricing increases and a selective bidding strategy limited the volume of new client wins in the vertical. TBR expects Xerox’s efforts to leverage partnerships to expand its financial services expertise such as its engagement with Atos will regain traction in the sector in 4Q16.
TBR estimates, Xerox’s Industrial, Retail & Hospitality vertical fell 4.7 percent year-to-year in Q3 2016. We believe traction in retail markets for mobile app development and customer engagement solutions such as its recently launched Shop and Ride application will support a return to growth in 2017.