UPDATE 6-Xerox to buy ACS to expand back office services
* Xerox to pay $18.60 cash and 4.935 shares per ACS share
* Xerox shares fall 14 pct; deal value drops to $5.5 bln
* Analysts cite concerns about integration, share dilution
* ACS rivals like CSC seen as likely M&A targets
* ACS shares up 14 pct; analyst says deal price is fair (Adds shares of ACS's peers, termination fees, links to related stories)
By Franklin Paul
NEW YORK, Sept 28 (Reuters) - Xerox Corp (XRX.N) plans to buy Affiliated Computer Services Inc (ACS.N) for $5.5 billion to move into the outsourcing business, but shares of the printing company plunged on concerns that it was gambling on a major shift in strategy.
The cash-and-stock deal, Xerox's biggest ever and the first major move by new CEO Ursula Burns, is the latest in the technology services sector, where reliable revenue streams have attracted hardware vendors looking to diversify. Xerox rival Hewlett-Packard Co (HPQ.N) bought EDS last year, and Dell Inc (DELL.O) plans to buy Perot Systems Corp (PER.N).
Shares of Xerox fell 14.48 percent to $7.68 as some analysts questioned how quickly the acquisition will bear fruit and others cited concerns about the dilution of Xerox shares.
BMO Capital markets analyst Keith Bachman said Xerox is seeking to buy access to new markets for its copiers and printers through ACS, but their sales teams could struggle to sell each other's services.
"Xerox's (deal) appears more radical in scope than any deal contemplated by HP, Sun, or IBM -- more change at once, with less initial product overlap," Bachman wrote in a client note.
"To be fair, we believe that Xerox has proven with Global Imaging Services that it can effectively integrate companies, but we question the amount of current strategic overlap." Xerox acquired GIS in April 2007 for about $1.5 billion.
Xerox said it will pay 4.935 Xerox shares and $18.60 cash for each share of ACS, totaling $6.4 billion, or $63.11 a share based on Friday prices. That was a 33.6 percent premium -- and about the same as ACS's record share price of $63.66 in 2006.
But with the fall in Xerox shares on Monday, the deal value shrank to $56.60 per share. ACS rose 13.99 percent to $53.86.
Norwalk, Connecticut-based Xerox, which has about $1 billion in cash, said about $3 billion of the deal will be financed through capital markets. Its credit default swaps rose by 0.10 percentage point to 1.78 percentage points, indicating that the cost of protecting its debt has risen.
Xerox said that if its board terminates the deal, the company will have to pay ACS $235 million. If ACS's board terminates the deal, then the company will pay Xerox $194 million.
Despite Xerox's share fall, analyst Shannon Cross of Cross Research said the deal appeared to be fairly priced when compared to Dell's bid for Perot and HP's acquisition of EDS.
"The ACS acquisition will strengthen Xerox's enterprise business, allowing it to expand from a document management company ... into the (outsourcing) space with strongholds in government and healthcare," Cross said in a note to clients.
SERVICES REVENUE TO TRIPLE
While ACS would be the first big deal for Burns, Xerox has eyed the company for at least two years. Talks began in the first quarter of 2009, before Burns succeeded Anne Mulcahy on July 1, according to sources familiar with the matter.
Burns said Xerox's revenue from services will triple to $10 billion next year from $3.5 billion in 2008 after the deal, which is expected to add to earnings in the first year. Xerox said the deal will likely close in the first quarter of 2010.
"The reason why we pursued this is that our customers have been telling us that they need a ... deeper connection between back-office document infrastructures and front office business process services," Burns said on a conference call. "Putting our two companies together allows us to do this."
Roughly two-thirds of Dallas-based ACS' revenue comes from handling back office operations for companies, and the rest comes from providing technology services.
Some bankers said other services companies like Computer Sciences Corp (CSC.N), CGI Group Inc (GIBa.TO)(GIB.N), Cap Gemini (CAPP.PA) and Unisys Corp (UIS.N) are likely takeover targets. Accenture (ACN.N) is also a possibility, but its $23 billion market value makes it pricier than rivals.
Unisys shares jumped 14.58 percent, Accenture shares rose 4.9 percent and CSC shares rose 4.75 percent.
Potential buyers for IT services companies could include IBM (IBM.N), Cisco (CSCO.O), Microsoft (MSFT.O), Oracle (ORCL.O) and Fujitsu (6702.T), bankers said, as these firms seek new growth opportunities.
Xerox will assume $2 billion of ACS debt and issue $300 million of convertible stock to ACS founder Darwin Deason.
The companies expect annualized cost savings of $300 million to $400 million in the first three years. ACS CEO Lynn Blodgett said some jobs will be affected but gave no details.
Xerox derives some 70 percent of cash flow from the sale of supplies, financing and services to repeat customers. But the economic downturn has forced some of its customers to slow their plans to buy new equipment or order service.
"HP strengthened their position in terms of business services (in addition to) printing," said Gabelli & Co analyst Hendi Susanto. "Xerox may have to compete with HP, and this will strengthen their position."
J.P. Morgan and Blackstone Advisory Partners acted as financial advisers to Xerox for the deal, Citigroup Global Markets Inc was financial advisor to ACS and Evercore Partners was financial advisor to a special board committee at ACS.
COLUMN-Tech services deals count on more with less: Eric Auchard [ID:nN2898003]
FACTBOX-Tech companies swoop in on IT service providers [ID:nBNG430080]
Xerox-ACS: the back story (here) (Additional reporting by Anupreeta Das and Tiffany Wu; Editing by Derek Caney, Gary Hill)
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