3 Reasons Xerox Corp's Stock Could Rise

Though it's hard to imagine now, Xerox (XRX) was once one of America's hottest stocks. The machines that made "Xerox" synonymous with copying minted a phalanx of Xerox millionaires in the 1960s, but the company's shares plummeted as that era's optimism gave way to stagflation and oil price shocks. Over the past four decades (with the exception of a dot-com era surge that, despite its notable peak on the chart below, actually underperformed relative to many other tech companies) Xerox's beleaguered shareholders have seen virtually no growth. In real terms, after accounting for inflation, their shares have actually lost value:

XRX data by YCharts

Source: Wikimedia Commons.

But there is hope. In the past year, Xerox has gained 30% as investors have slowly realized that this dirt cheap stock is no longer tied to a straightforward copy-machine maker. Can Xerox keep rising and rewarding its loyal shareholders into 2015 and beyond? It's certainly possible, but it's better to invest in facts than flights of fancy. With that in mind, here are three of the biggest reasons why Xerox might continue to post market-beating gains in the future.

Xerox isn't just a copier company anymore
Long-term investors should be well aware of the shift, but those newer to the stock or who might be kicking the tires today may not realize that the majority of Xerox's revenue now comes from services:

Sources: Xerox annual reports.

Numbers do not add up to 100% due to revenue recorded in "other" segment.
* Technology refers to all hardware, supplies, and services relating to document copying.
** 2009 results do not include acquisition of Affiliated Computer Services.

Since acquiring Affiliated Computer Services in 2010, Xerox's services segment has been the driving force for its overall growth, with year-over-year growth rates of 12.5% in 2011, 6.4% in 2012, and 2.9% in 2013. The company has been gobbling up a number of smaller service companies since its big buy in 2010, with four acquired in 2013 and two announced so far through 2014. Most of these acquisitions are of companies headquartered in other countries, which will help further globalize Xerox's revenue base.

In its latest quarter, Xerox's services segment made up 57% of total revenue, and CEO Ursula Burns noted that the company is on track to generate two-thirds of its revenue from services by 2017. Contrast that with the company's technology segment, which has actually seen its revenues shrink in each of the past three fiscal years, and you get a picture of a company transitioning toward a business model that more closely resembles the model IBM (IBM 0.06%) follows today than what IBM followed in the mid-1990s. This comparison is apt, because Xerox has been making a conscious effort to emulate IBM's services-first strategy over the past few years.

Xerox's turnaround is modeled on the most successful tech revival in 30 years
IBM languished throughout the 90s, but its decision to divest low-margin hardware business to focus on services has paid off. Since it installed turnaround whiz Lou Gerstner at the helm in 1993, IBM's earnings and share price have soared, with shares up more than 1,200% in the past decade as EPS has risen over 2,500% from a brief but abysmal stretch of losses in the early 90s. Xerox CEO Ursula Burns has publicly highlighted IBM's turnaround as a model for her company, particularly in a BusinessWeek interview last year:

We looked at IBM primarily because its transformation, while different in the specifics, was very similar in the general theme -- going from hardware and technology offerings only to expanding to higher engagement with clients. We had to be clear about what we were moving from and to. We had to make sure that we weren't running away from something that we could do well to something that we weren't sure that we could do well.

Xerox has gone so far as to appoint IBM veterans to key executive roles -- Robert Zapafel, IBM's former head of strategy, is now in charge of Xerox's services segment, and former IBM global business services VP John Kennedy  is now the company's CMO.

Xerox is far from alone in its shift toward services, but the services it focuses on have not been flooded by other well-capitalized hardware companies. Xerox's contract renewal rate was 92% for the two sub-segments it tracked in its last fiscal year, driven by a focus on health care, a $2 billion business for Xerox that serves government agencies, health care providers, employers, and pharmaceutical companies. Xerox is well-positioned to capitalize as Obamacare expands its reach, since the company notes that it serves 37 states and two-thirds of all insured patients in the United States.

Xerox continues its legacy of innovation at PARC
Xerox is legendary for its technological breakthroughs, but it's been more notable for letting trillion-dollar innovations slip through its grasp than it has been for capitalizing on emerging trends. Take the PC, which was first developed at Xerox's PARC labs before both Steve Jobs and Bill Gates made off with the idea and made billions in the process.

PARC's Alto, the first PC.
Source: Wikimedia Commons. 

That legacy of missed opportunities haunts Xerox today, and the company is making sure that it doesn't make similar mistakes again. Last year, Xerox was granted 1,013 patents, placing 32nd out of all companies that earned any patents in the United States in 2013. The company has earned at least 500 patents every year since 2008, and 2013 was the second year in a row it obtained at least 1,000 new patents.

But patents alone don't mean much if Xerox isn't developing technologies the future needs. PARC has announced a number of breakthroughs and developmental efforts in the past few years, including printed flexible electronic chiplets, printable lithium-ion batteries, extreme-temperature sensors, and "vanishing electronics," which could be very useful in military and privacy applications. Printable electronic circuitry in particular holds incredible promise, as it could be paired with 3-D printers to create a vast array of functional and fully customizable smart products. PARC has estimated that this field could be worth $45 billion by 2016, and a mere 10% slice of that pie would boost Xerox's annual revenue by 21% over current levels.

Three good reasons?
Xerox shareholders have waited a long time to see signs of life in this stock. The past year has been one of Xerox's best this century, but if the reasons I've highlighted here hold true, 2014 could be only the starting point for a long-term Xerox revival. Do you think Xerox has a chance to succeed for years to come? No stock is perfect, but for many shareholders, Xerox's turnaround has been the right move at the right time.