Why is DXC technology (DXC) back on the acquisition radar?

DXC technology companyDXC shares rose 11.5% on Monday as the IT services and solutions provider gained attention as a potential takeover target. Citing people familiar with the matter, Reuters revealed on Monday that Apollo Global Management i Kyndryl Holdings, Inc. KD is considering submitting a joint bid for DXC.

Apollo Global Management is an asset management company, while Kyndryl Holdings is an IT services provider that was created from the spin-off of the company International Business Machine CorporationIBM’s infrastructure services business in 2021. International Business Machines holds a 19.9% stake in Kyndryl Holdings.

This isn’t the first time DXC has received takeover interest. In October 2023, she was approached by a financial sponsor about a potential acquisition of the company. In early 2021, it received an unsolicited, preliminary and non-binding proposal to acquire all of its shares from French technology services provider Atos SE. However, both talks did not take place for various reasons.

DXC’s current valuation plays a key role in the company’s attractiveness as a takeover target. The company’s stock is trading at a one-year P/E multiple of 6.34X, much lower than the 32.86X of the Zacks Computer – IT Services industry, making it a potentially lucrative investment for buyers.

This attractive valuation multiple is the result of DXC’s share price decline of 19.3% year-to-date (YTD). At a closing price of $18.45 as of June 10, the stock is 36% below its 52-week high of $28.89.

DXC technology company. Price and consensus

DXC technology company. price consensus chart | DXC technology company. Quote

Transformation efforts attract suitors

We believe that DXC’s continued efforts to transform itself from a struggling, highly leveraged company to a rapidly growing, business-oriented company have made it a lucrative acquisition target.

DXC was formed through the merger of Computer Sciences Corporation (“CSC”) and its Enterprise Services Division Hewlett Packard Company HPE, which ended on April 1, 2017. CSC incurred additional debt before the merger was completed. This increased DXC’s total long-term liability, thereby increasing its interest expense burden while limiting its ability to invest in growth opportunities.

To overcome this situation, DXC resorted to debt refinancing and divestitures, as well as spin-off of non-core assets. The strategy significantly reduced outstanding debt to $3.82 billion as of March 31, 2024 from $10.33 billion as of June 30, 2020.

The divestiture and spin-off of non-core assets increased DXC’s focus on its core business. It also enhances the company’s ability to execute acquisition strategies in high-growth businesses, including enterprise software-as-a-service, technology security solutions and autonomous vehicles.

Reduced operations will likely help DXC focus on reviving its financial results, which have been hit by a slowdown in IT spending. Additionally, its low leverage balance sheet will give it the financial flexibility to invest in growth areas.

What should investors do now?

While the prospect of an acquisition may create confusion around DXC Technology, it is important for investors to look beyond the headlines and consider the company’s underlying fundamentals. DXC’s deteriorating financial performance, high debt levels, competitive pressures and limited growth prospects paint a challenging picture.

In its recently released earnings results, the company provided dismal revenue and earnings guidance for the first quarter of fiscal 2025. It signaled that cautious customer spending in a challenging macroeconomic environment is hurting its top-line performance in fiscal 2025.

The Zacks Consensus Estimate for first-quarter revenues is $3.14 billion, down 8.8% year-over-year. The earnings consensus estimate has been revised 25% down to 60 cents per share over the past 30 days, down 4.8% from the year-ago quarter.

The potential for a takeover does not necessarily translate into guaranteed returns for existing shareholders, and the speculation involved can often lead to increased volatility and risk. Moreover, as with previous takeover talks, if the takeover does not materialize, the company’s stock could suffer a significant decline.

Given the ongoing challenges facing DXC, as well as the risk of a speculative bid failing, it may be wise to wait to invest in the stock until we see some clarity on the company’s growth prospects. DXC is currently sporting a Zacks Rank of 4 (Sell).

While Kyndryl Holdings carries a Zacks Rank #1 (Strong Buy), International Business Machines and Hewlett Packard Enterprise carry a Zacks Rank #3 (Hold). You can see complete list of today’s Zacks #1 ranked stocks here.

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