Conduent Continued

Last week’s post looked at the spinoff from Xerox called Conduent.  The new company trades as CNDT.  Since last week’s post, CNDT rose 48 cents representing a 3.4% increase in value over the week.  If you want to see the first post look here.  This week’s post will look at the cash flows for the company and consider some of the motivations of those in charge of the company.  This post will attempt to determine the appropriate value of the company per share.

I sit on a lot of boards…I don’t have to watch Saturday Night Live anymore, I just sit at the board meetings. I will tell you it’s a sad commentary that we have an inability to compete. You can blame unions to some extent. But the real problem is that boards – there’s a symbiotic relationship between boards and CEOs today. And as a result, there is no way to hold these guys accountable except when someone like myself comes along or some other person who is really well to challenge them. But you have to go through contortions. There is no corporate democracy. –Carl Icahn

According to ValueLine, the business represented in CNDT for the spinoff is the growth business for Xerox (XRX).  Icahn is one of the main shareholders at XRX, and as a result, he cares that the company makes its shareholders money.  Icahn and another major shareholder Darwin Deason are the main beneficiaries of the CNDT spinoff.  Before looking at the price, let us see what kind of deals Icahn and Deason received from this spinoff.

Icahn’s Interests

Vincent Intrieri, Courtney Mather, and Michael Nevin are all connected to the Icahn Group.  This means that on the eleven member board, Icahn has three individuals placed in order to protect his interests.  The Form 10 filing also notes that Icahn will maintain one seat on the board at XRX post spinoff.  His interests represented 9.8% of XRX pre-spinoff.  In the Form 10 filing, he required XRX to spinoff CNDT no later than March 2017.  He also requires special benefits to individuals holding more than

Darwin Deason

Deason, like Icahn is a self made billionaire.  In October, he filed a complaint with the courts alleging that the spinoff would violate certain provisions of Xerox’s Certificate of Incorporation.  His stake in XRX represented 6.1% pre-spinoff.  Deason dropped his charges against XRX with an exchange agreement where he relinquishes 300,000 shares of preferred stock in XRX for 180,000 shares of XRX preferred and 120,000 shares of CNDT preferred after the spinoff. The payout of these shares is 8%.  These preferred shares have a conversion right at any time to get 44.9438 common shares per one preferred share of CNDT.  This reflects a conversion price of approximately $22.25.  Mr Deason has given himself a beautiful golden parachute in this spinoff. He is probably trying to protect his cash flow from the preferred shares that he had with the XRX preferred investment.  His actions indicate that the real value is in CNDT’s business, not XRX.  Why else would he insist on a 40% stake in his preferred holdings when everyone else gets 20%?  It is possible that he wants to use the conversion rate which is much higher than the current price-considerably higher, like almost 50%.

Deason and Icahn both appear to be jumping on the CNDT bandwagon.  It appears that this is where the money is to be made.  This, coupled with the statement by ValueLine that the company represents the growth segment of XRX’s business pre-spinoff, does make it that much more attractive.


There are many places to look for value on a stock.  Price to earnings ratios are one.  Personally, the best pulse on a company comes from operating cash flows.  This is typically an erratic number, but it has less to do with taxes and more to do with actual cash coming into a company.  In the case of CNDT, the company’s net income according to Form 10 was (414)M in 2015, (81)M in 2014, and 182M.  The company therefore has started its life with a negative earnings track record.  However, the company’s operating cash flows over the past three years has been 493M, 665M, and 379M-all positive numbers even with a 216M charge for recent litigation in 2015.  On a per share (anticipated number of 202.8M shares) basis this means CNDT’s current price to past cash flow was between 4.4 and 7.7 over the past three years.  CNDT’s most recent price to cash flow is 5.9.  Even at the high end of this range, the company trades in the bottom 10% of the market on a per share valuation with the average valuation over 16 times cash flow.

Reasons for Buying

The market’s reaction to CNDT is weak, it appears to have little interest in this next generation growth stock.  The thing that makes me interested is that 9.77% of its shares are owned by institutional investors however Darwin Deason, Carl Icahn, and the CEO Ashok Vemuri all have vested interest in its success.  When the institutions begin purchasing the company’s shares it should rise dramatically.  After this analysis, I plan on investing in CNDT.  I am looking at about 1/8th of my portfolio to be exposed to this stock at less than $15/share.  This is with an expected 2-4 year holding time.

Corporate spin off opportunity from Xerox: Conduent

This week will look at a corporate spin off.  Earlier this month, Xerox (XRX) spun off their Business Process arm into a new company called Conduent (CNDT).  The interest in this particular situation is partly from reading a book by Joel Greenblatt, a value investor and hedge fund manager who is also an adjunct professor at Columbia University’s Graduate School of Business.

(Some investment areas are) surprisingly unappetizing. (One such) area of discarded corporate refuse is usually referred to as “spinoffs.” – Joel Greenblatt

Companies sometimes grow so much that they realize that they have business arms that are no longer part of their core business.  The business leaders realize that they need to get back to their roots and find that they need to rid themselves of the business that is not part of their core business.  When this happens, they can sell that portion of the business to another company or they can spin it off into its own entity.  Hewlett Packard did this a couple of years ago and plans to do so again on April 1st. Since they split Hewlett Packard, the company has done well as management has been able to focus on their core business.  The spinoff is usually out of favor with institutional investors when it is first created primarily because it could be too small of a company for the mutual fund or in a different sector than that of the parent company.  The company may also have few analysts covering it making an opportunity to purchase it at a lower price than normal.  The interesting fact is that these situations typically create opportunity for superior returns.

Let us apply this thought process to CNDT.

CNDT is the world’s largest provider of diversified business process services.  When looking at the SEC Form 10 (the SEC form a company files when it creates a spinoff), it is surprising to find that this company serves 19 of the 20 top commercial healthcare payers in the United States.  They also have contracts with 49 of the 50 states for regulatory compliance and data needs. They provide services to government healthcare programs in 29 states, and services for 9 of the top 10 global pharmaceutical and life science companies in the world. In the public sector segment, CNDT provides services for 25 countries for transportation.  In their commercial industries segment, they provide end-to-end business-to-business and business-to-customer services in order to optimize their processes.

These contracts provide recurring revenue to CNDT.  The Form 10 talked about the company’s target renewal rate of 85-90% which was met for the past two years.  The company consistently generates cash flow according to its Cash Flow Sheet.  The company seems to have been put into a precarious position with a very low current ratio.  This appears to be XRX’s path to success-to unload it’s debt onto the spinoff so that XRX can return to profitability a normal action by many companies participating in spinoffs.  The most recent quarterly filing with the SEC indicates that the company is reducing its debt load improving the current ratio.  The quarterly statement does show that the company is heading for a cash flow loss in this first year of existence with a $38M loss in the nine months ended September 30, 2016.  In short the company should begin its life struggling to exist.

This is reflected in the number of institutional investors: 9.77% of the company’s stock is held by them.  The company’s first year results (due around the 10th of next month) should help determine if this will change.  This presents an opportunity to get into this company at a very low relative price.

The company’s new CEO should be considered, his name is Ashok Vemuri.  Vemuri’s experience is with Infosys and IGATE. At IGATE, Vemuri kept the company afloat when the prior CEO was embroiled in a sexual harassment lawsuit. When he worked at Infosys, he had mixed results, some say that he was successful, others state he was not a star player and contributed to Infosys’ weak results when a member of the board.  The question to ask is, “Will Vemuri be motivated to make CNDT a successful organization?” His fortunes are tied to the success of the company amounting for approximately $5M in recompense over the next two years if he makes the company profitable.  Vemuri appears to be a multi millionaire already, he is probably worth around $30M, so the $5M appears sufficient to keep him focused.

Another person to consider is Carl Icahn, he has control over three of the board seats in this new company.  The activist investor is finding a way to get his money’s worth out of his investment in XRX.  Icahn’s investment style should be considered to see what he is doing.  It is important to know that he orchestrated this spinoff to have three seats on the board the investor should want to know why he wanted so much control over the new company.

Annual results next month should help identify what the company is worth. $14/share may or may not be the best price for the company.  Is this corporate refuse or a diamond in the rough?  The company’s first annual statement should help determine this.

Possible Investment: Mylan @ $40/share

Mylan NV is a large pharmaceutical company based in the United Kingdom.  The company has been featured in the news recently because of its EpiPen pricing.  This recent poor publicity has restricted the company’s share price.

“Drug pricing drama helped cause pharmaceuticals stocks to badly trail the market in 2016” – Charley Grant, Wall Street Journal, R12, 3 January 2017

The pricing drama Grant is talking about was centered on Mylan’s EpiPen, pharma fell last year when most of the industries had a banner return.  The company booked a $465 million charge last quarter to settle the ensuing Justice Department investigation.  This charge, combined with lower EpiPen volumes resulted in a loss last quarter.

This dramatic series of events presents a possible investment opportunity.  This post will analyze the company for such an investment.  In a disclosure up front, I have a personal interest on one call option in this company to purchase it at $60/share January, 2019.

Mylan NV

Company Profile (Adapted from TDAmeritrade’s website)

Mylan N.V. is a global pharmaceutical company. The Company develops, licenses, manufactures, markets and distributes generic and branded generic products for resale by others; specialty pharmaceuticals, and active pharmaceutical ingredients (APIs). It operates through two segments: Generics and Specialty.

Generics segment

Mylan’s Generics segment primarily develops, manufactures, sells and distributes generic or branded generic pharmaceutical products in tablet, capsule, injectable, transdermal patch, gel, cream or ointment form, as well as API.

Specialty segment

Mylan’s Specialty segment is focused on respiratory and allergy therapies. The EpiPen Auto-Injector, which is used in the treatment of severe allergic reactions, is an epinephrine auto-injector. The Company’s Perforomist Inhalation Solution is a long-acting beta2-adrenergic agonist indicated for the maintenance treatment of bronchoconstriction in chronic obstructive pulmonary disorder (COPD) patients.  The Specialty segment was bolstered by the recent acquisition of Meda.

Growth prospects

The 7 October 2016 Value Line review indicates that the company has two major blockbusters that it is pursuing in the generics business for Advair and Herceptin.  Just 20% of these two markets last year would represent $3 billion in revenue.

Market threat

Although government entities are up in arms over the pricing of products like EpiPen, the fact remains that until another company is able to make a generic the company will have the ability to maintain pricing power.  The company’s fortunes are not solely based on the EpiPen however, much of its recent price performance appears to be correlated with how this product is performing.

The recent settlement with the Department of Justice represents a significant blow to the company because it’s quarterly earnings that were to be significant, turned into a loss.  This settlement represented just over 100% of the company’s quarterly earnings.  The company’s share price suffered as a result and has hovered under $40/share  for the last two months.

The following table compares key information about the company compared to Pfizer, I find that comparing companies to industry leaders helps identify a company’s value.

Ticker MYL PFE
Top 1 or 2 in individual industry No 2
Positive annual Cash Flows since ’08 since ’00
P/E ratio 22.6 30.2
Invesment size ~2% of portfoli0 $330 NA
Management consistently
reduces shares (10 year change)
9% -2%
Consistent earnings growth, 10 year change Mylan posted earnings losses for two years ten years ago, it may not perform well in a recession -4% earnings growth rate negative
Year over year positive growth during the past 10 years 60% 60%
Interest and preferred dividend expense coverage 2.71 2.90
Earnings or cash flow
losses in the past 10 years
2 yrs’ earnings losses and one year cash loss during the financial crisis No losses
Dividend growth rate -100% 5%
Current Ratio 3.23 1.37
Debt to Capital 203% 263%
Price as a % of Net Tangible Assets 173% 304%
Number of superior elements 4 6

Mylan has better current ratio, debt to capital ratio, and P/E ratio.  Pfizer, an industry leader has better earnings history and interest coverage.  This places Mylan as a peer to one of the respected industry leaders and DJIA component.  The price of Mylan is what makes it a superior investment it has a P/E that is roughly 2/3 of Pfizer’s.  Value Line projects the share price to be 80-120 in three to five years’s time a double or triple its value. I want to see more on how the settlement may affect future earnings but I expect to add to my investment later this week.  My call purchase is anticipating over 50% return over the next two years.