Fitch: Xerox's Ratings Unaffected by Sale of IT Outsourcing Unit; Outlook Stable

Fitch Ratings believes the ratings for Xerox Corp. (Xerox), including the 'BBB' Long-Term Issuer Default Rating (IDR), are unaffected by the sale of its Information Technology Outsourcing (ITO) business. The Rating Outlook is Stable. A full list of current ratings follows at the end of this release.

Fitch believes the sale is neutral to Xerox's credit profile, despite reducing revenue diversification and resulting in slightly higher core leverage, which excludes debt and operating EBITDA related to financing activities. Fitch estimates core leverage for the latest 12 months (LTM) ended Sept. 30, 2014 will increase to 1.4 times (x) from 1.3x, pro forma for the sale, and will remain under 1.5x through the intermediate term.

Fitch believes the sale enables greater focus on faster growing and less capital-intensive business process outsourcing (BPO) and document outsourcing (DO) markets. The deal also boosts efforts to expand Services segment profit margins, given Fitch's belief the operating EBITDA margin for the ITO business is lower than that of the overall Services segment.

Xerox announced this morning it reached a definitive agreement to sell its ITO business to France-based digital services provider, Atos, for a total cash consideration of approximately $1.1 billion. The transaction was approved by the board of directors for both companies and is expected to close in the first half of 2015, pending customary regulatory approvals.

Xerox will use net proceeds to bolster budgeted acquisitions and share repurchases in 2015. Prior to the announcement, Xerox budgeted $500 million for each of acquisitions and stock buybacks in 2015. Fitch expects $1.5 billion of free cash flow (FCF) in 2015 and that Xerox would moderate stock buybacks should FCF fall short of plan, as it has done historically.

KEY RATING DRIVERS

Xerox's ratings and Stable Outlook reflect:

--Fitch's expectations for improving operating results in Services to offset revenue declines in Document Technology (DT), primarily black-and-white (B&W) high-end production printing.

--Substantial recurring revenue from long-term services contracts, rentals and financing, and supplies (86% of total revenue for the year-to-date ended Sept. 30, 2014.

--Solid liquidity supported by $1 billion of cash at Sept. 30. 2014, an undrawn $2 billion RCF due 2019, staggered debt maturities and consistent annual free cash flow (FCF). Fitch believes FCF (post-dividends) will to exceed $1.3 billion annually.

--Fitch expectations for an increasingly diversified revenue mix from faster growth in the Services segment and with declining exposure to the slower-growing print industry. Services accounts for 57% of Xerox's total revenue but will decrease pro forma for the ITO business sale.

--Xerox's conservative financial policies. Fitch believes management remains committed to an investment grade rating and has a track record of reducing debt to offset declining financing assets, resulting in flat core leverage.

Fitch's credit concerns center on:

--Fitch expectations for ongoing revenue pressures in DT, which includes equipment and supplies bundled with DO contracts. Fitch forecasts mid-single digit revenue declines for DT through the intermediate term. Revenues fell 5.5% year-to-date (YTD) due to weakness in B&W. Benefits from restructuring resulting in higher DT operating margin will partially mitigate revenue declines. Operating profit margin will exceed 12.5% through the intermediate term, up from 10.8% in 2013.

--The aggregate $1.1 billion underfunding of worldwide defined benefit (DB) pension plans as of year-end 2013, down from $1.8 billion in the prior year. The higher funded status primarily reflects lower benefit obligations due to a 110- and 20-basis point increase in the U.S. and non-U.S. discount rate, respectively. Total contributions are expected to be $250 million in 2014 up from $230 million in 2013.

--Pressured operating margin in the Services business, although stronger pro forma for the transaction. Fitch expects operating margin to remain in the high-9% range through the near term but has greater confidence Xerox will reach and maintain 10% in the longer term, driven by higher BPO profit margin and greater contract bidding discipline. Fitch expects Xerox's Services segment operating margin to decrease for the fourth consecutive year in 2014 to just below 9% from 9.8% in 2013.

Cost overruns related to government healthcare contracts and the continued run-off of certain higher margin business process outsourcing contracts, consisting of student loan processing and customer care (CC) volume with a telecom client post acquisition drove operating profit margin compression.

RATING SENSITIVITIES

Negative:

--Fitch's expectations for Services operating profit margin sustained below 9%;

--Sustained declines in DT more than offsetting growth in Services, resulting in a material decline in financial performance and credit metrics.

Positive rating actions are unlikely in the absence of:

--A significant reduction in the funding shortfall for Xerox's worldwide defined benefit pension plan;

--DT revenues levels stabilize with expectations for sustained operating profit margin near current levels; and

--Revenue growth and margin expansion in Services results in expectations for FCF margin approaching 10%.

Xerox's liquidity is solid, supported by $1 billion of cash at Sept. 30, 2014 and an undrawn $2 billion RCF that matures in March 2019. Fitch's expectation for more than $1.5 billion of annual FCF also supports liquidity.

Total debt with equity credit was $7.8 billion on Sept. 30, 2014, consisting of approximately $7.5 billion of senior unsecured debt and $349 million of convertible preferred stock, which Fitch assigns 50% equity credit. As of Sept. 30, 2014, $4.2 billion, or 54%, of total debt, supported Xerox's financing business based on a debt-to-equity ratio of 7:1 for the financing assets. Xerox's net financing assets, consisting of receivables and equipment on operating leases, totaled $4.8 billion compared with $5.2 billion in the prior year.

Xerox's nearest debt maturities include $1 billion of senior notes due Feb. 15, 2015 and $250 million of senior notes due June 1, 2015.

Fitch currently rates Xerox as follows:

Xerox

--Long-term Issuer Default Rating (IDR) at 'BBB';

--Short-term IDR at 'F2';

--Revolving credit facility (RCF) at 'BBB';

--Senior unsecured debt at 'BBB';

--Commercial paper (CP) at 'F2'.

ACS

--IDR at 'BBB';

--Senior notes at 'BBB'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

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