DXC Technology: Undervalued Margin Growth Opportunity

Formed through the merger of CSC and HPE Enterprise Services in March 2017, DXC Technology aims to be the world’s leading independent, end-to-end IT services company by partnering with companies to develop world-class digital offerings that enable technology driven business transformation.

The new company has a highly diversified customer base across public and private sectors as outlined in the table below.

Sector % of Revenue
Manufacturing 16%
Banking 14%
US Public Sector 12%
Energy 12%
Global Public Sector 11%
Healthcare 11%
Retail 8%
Insurance 7%
Travel & Transportation 6%
Other 3%

The recent merger of these two companies will unlock a wide range of synergies laying the foundation for slow but stable revenue growth of 1%-4% per annum alongside improving operating margins by 7%-8%.

If achieved, these synergies will generate significant shareholder value over the next 2-3 years. This article provides further detail of the company’s plan to achieve these synergies along with outlining an attractive buy price of $88.55 per share.

1. Stable Revenue Growth of 1%-4% per Annum by 2020.

While revenues at DXC Technology’s traditional IT services business are forecasted to decline annually in the low single digits, the company plans to shift its business mix to higher growth offerings by redeploying capital and resources to developing IP for key industry sectors, providing business process solutions and scaling it’s digital transformation proposition. This will enable clients to re-invest productivity gains to accelerate their digital transformation.

DXC Technology forecasts that developing it’s Industry IP and Business Process Solutions segments will grow revenues at 7%-10% per annum while scaling it’s Digital offering alongside making selected strategic acquisitions will result in digital revenues increasing annually at 25%-30%.

2. Operating Margin Expansion of 7%-8%

In addition to a steady increase in revenues, DXC Technology has identified a number of sizeable opportunities to reduce costs and improve operating profits including:

  • Harmonising Policies and Benefits
  • Optimising Workforce and Delivery
  • Leveraging Scale in Supply Chain
  • Rationalising Facilities and Data Centres

DXC Technology believes that these opportunities will increase operating profit margins by 7%-8% by 2020. A breakdown of targeted savings is provided below.

Business Area By 2017 By 2020
Delivery Optimisation $275m/1.3% $800m/2.8%
Facilities Rationalisation $75m/0.4% $125m/0.4%
Supply Chain Efficiency $225m/1.1% $650m/2.2%
Total $575m/2.8% $1,600m/5.4%

Financial Forecasts

Stable revenue growth combined with a significant increase in margins should unlock a meaningful improvement in financial performance. In addition, DXC Technology is planning to return c. 30% of cash flow to shareholders on an annual basis through share repurchases and dividends.

DXC Technology is aiming to increase EPS from an estimated $3.85 in 2017 to between $9.25-$10.00 in 2020. A breakdown of the improved performance is provided below.

 Area EPS Improvement
Estimated 2017 EPS $3.85
1%-4% Revenue Growth +$0.40
Policies Alignment +$0.40
Workforce Optimisation +$2.40
Supply Chain Efficiency +$1.50
Facilities Rationalisation +$0.40
Share Repurchases +$0.70
Estimated 2020 EPS $9.25-$10.00

Company Valuation

DXC Technology will achieve a CAGR of 36.31% if it grows its EPS from $3.85 to $9.75 between 2017-2020.

Assuming a more conservative growth rate of 20% per annum we believe that a conservative PE multiple would be 23x forecasted 2017 EPS of $3.85 providing a Buy Price of $88.55 or lower per share.

Legal Information and Disclosures

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This memorandum is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Elenchus Capital Management Limited believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.

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