Trillium Capital LLC Issues Open Letter To The Conduent Board Of Directors

BOSTON, June 8, 2020 /PRNewswire/ -- Today, Trillium Capital LLC released the following Open Letter to the Board of Directors of Conduent Incorporated – The Path to Unlock $3.9 Billion of Incremental Shareholder Value.

Trillium Capital LLC and its principals own over 2,500,000 shares of common stock of Conduent Incorporated (NASDAQ: CNDT) ("Conduent or the Company").  We believe that the Board of Directors of Conduent (the "Board") has not acted on obvious opportunities to increase shareholder value.  The share price of Conduent has declined by almost 70% since this time last year.  We have attempted to communicate our ideas several times to the Board.  Unfortunately, we have not as yet received a direct response from any Board member.  We now find ourselves in the reluctant position to try to share our ideas with them in an open letter.

We believe that there are a number of opportunities that the Board can take to unlock as much as $3.9 billion incremental Enterprise Value (before the effect of income taxes, restructuring and transaction costs) by pursuing the actions describe in our letter.

The Right Team

During the Annual Meeting of Shareholders, the CEO responded to a question as to whether he believed that he had the "Right Team".  He responded that he does have the "Right Team" (otherwise referred to as the "Team" herein) that has the turnaround skills, is not siloed and knows what good looks like.  We disagree.  The performance of Conduent over the last twelve months does not support the conclusion that the current Team has effectively led Conduent.  The Team has not created, much less preserved, shareholder value, nor has it articulated a strategy that is believable to all stakeholders.  If they had done even that, we believe that it would be reflected in the current stock price.  Both revenue and profits have declined during the past year under the leadership of this Team.

We believe that executive leadership should have significant "skin in the game" that demonstrates its commitment and confidence in the Company.  This is not the case for Conduent's senior leadership team.  Conduent's senior leadership team does not own enough stock that they have purchased in the open market and seems to only have been issued large stock option grants and RSU's.  Moreover, in a company such as Conduent that has such substantial unlocked shareholder value and a yet to be demonstrated restructuring plan, managements' compensation, especially the CEO's, should be highly leveraged to targets that are clearly aligned with shareholders' interests.  In Conduent, we have a CEO with a high base salary of $750,000 per year and a 200% bonus with targets that have not yet been disclosed to shareholders. We do not believe that there is sufficient alignment of management interests, particularly the CEO's, with the interests of shareholders to unlock the substantial value opportunity that we have identified in our letter. In fact, we may have the rare situation here where management's interests are diametrically opposed to those of the shareholders where they are more inclined to try to retain the conglomerate model, which would preserve their high compensation packages. We would have thought that the Board would have disclosed the CEO bonus targets prior to asking for a vote on an advisory basis of his 2020 compensation plan at the May 19, 2020 Annual Meeting of Shareholders rather than asking shareholders to wait until the 2021 proxy filing to find out the targets for these substantial bonus payments. The Board should disclose the bonus targets immediately.

Annual Corporate and Unallocated Costs

During the year ended December 31, 2019 and the Three Months Ended March 31, 2020, Conduent reported Corporate and Unallocated Costs at an annualized run rate of over $600 million.  During its Q1-2020 Earnings Call management indicated that it would embark on a program to reduce its Corporate and Unallocated Costs by at least $100 million per year.  There has been no significant progress to date that we can see as yet.  As a result, shareholders have no way to judge its progress and that lack of transparency seems to be reflected in the stock's poor performance.  Greater transparency would have already allowed shareholders to factor in the cost savings when projecting earnings of each its three Business segments on a stand-alone basis. 

Disclosing the Corporate and Unallocated Costs by Business segment would provide shareholders with valuable information to assess Conduent's financial performance and allow shareholders to calculate a market based valuation of each of the three separate Business segments on a stand-alone basis.  We would expect that an experienced CEO would demand this disclosure to promote transparency with its investors and regulators.

With the lack of information made available to the public shareholder by Conduent, we have been left to attempt to allocate the substantial Corporate and Unallocated Costs to each Business segment ourselves.  We have used a proportional share of each Business segments' revenues to total Company revenues for the Year ended December 31, 2019 to allocate the Corporate and Unallocated Costs and the net debt position to each Business segment.  While this may materially differ in the future, it is the only basis that is available to us at this point to allocate the substantial Corporate and Unallocated Costs of over $600 million per year.

The Path to Unlocking Value Buried Within Conduent

Conduent currently has about a $1.9 billion enterprise value based on the closing stock price on June 5, 2020 of $2.92 per share less its net debt position of $1.26 billion as reported in its Form 10-Q for the Three Months Ended March 31, 2020 as filed with the United States Securities & Exchange Commission (the "SEC").  We believe that there is a path to significant value creation of about $3.9 billion incremental shareholder value locked in Conduent (before the effect of income taxes, restructuring and transaction costs) that has not yet been unlocked by the Team. This could result in over a 200% increase in Enterprise Value of Conduent and would likely result in a much higher stock price.

As much as we wish the COVID-19 issue did not exist, it has created opportunities for many companies including Conduent.  We believe the Government Services Business segment has been growing recently due to Conduent's COVID-19 service offering to track incidents with its Maven Software program that provides disease surveillance to track COVID-19 cases using Microsoft Azure.  Conduent recently announced changes to its Benefit Wallet and a re-design of its COVID-19 microsite to help its members understand the new rules around Health Savings Accounts, Flexible Spending Accounts and Health Reimbursement.  Conduent announced expansion of its on-line Supplemental Nutritional Assistance Program ("SNAP") in response to the COVID-19 pandemic.  Conduent mentioned that its Women, Infants and Children ("WIC") program and especially its Unemployment Benefits program was showing significant volume increases during its most recent Q1-2020 Earnings Conference Call.  Also, on its most recent Q1-2020 Earnings Conference Call Conduent announced expansion of its "Work-from-Home" employee program that involved over 50,000 or about 75% of its total employees.  We believe that these factors should be a strong tailwind for the foreseeable future for the Government Services Business segment to grow both its top and bottom line. 

Now that the world is starting to return to work, we believe that the Transportation Service Business segment should experience an increase in its business volume in the next few months.  The growth opportunity in the Transportation Service Business is described in the Advanced Market Analytics released on May 26, 2020 on the electronic toll collection ("ETC") market.  Among other things, this most recent industry report stated; "The world is going through industrial revolution and road transportation is required in every aspect of economy growth thus giving ETC system an edge which will keep on expanding irrespective of slight niggle on the way. Some of the key players profiled in the study are Conduent Business Services [United States], 3M [United States], Kapsch Trafficcom Ag [Austria], Cubic Transportation Systems, Inc. [United States], Siemens Ag [Germany], Thales Group [France], Sanef ITS [France], Transurban Limited [Australia], International Road Dynamics [Canada], Raytheon Company [United States] and Denso Corporation [Japan] and predicted that the ETC market would reach a market size of USD11.2 Billion by 2024." 

We believe that the Transportation Service Business segment could further benefit from implementing artificial intelligence, including deep machine learning and encryption algorithms, that enables the creation of more powerful vehicle recognition systems that can be deployed at a fraction of the cost of traditional vehicle recognition systems.  We believe that Conduent's Transportation Service Business segment could experience significant tailwinds from the evolution in the ETC market size in places such as South America, India and China to name a few growth areas and implementation of new technology solutions that might reduce costs and improve service effectiveness.

We believe that the Commercial Business segment of Conduent should continue to see growth from its new business contracts announced during the Q1-2020 Earnings Conference Call and an increase in earnings potential from continued expansion of its Work-from-Home initiatives. Recently, Conduent announced expansion of its innovative solution to transform legal invoice and review validation using its new Legal Invoice Analytics cloud based invoice review technology.  According to Conduent, this new service provides in-house legal departments the ability to drive more efficient and accurate invoice reconciliation.  Conduent predicted that this could help reduce in-house legal departments spending by up to 10% and improve review time by as much as 80%.  Conduent also recently announced an enhancement to its Loan Manager servicing platform to allow for an end-to-end solution to help banks digitally transform loan servicing and collections in the automobile industry.  The Commercial Service Business segment is also most likely benefiting from  the expansion of the Work-from-Home model.  We believe that these business service offerings and cost saving initiatives should provide a substantial tailwind for growth and increased profitability in the Commercial Business segment.  

We believe that the $21 billion sales pipeline, 93% customer renewal rate and TCV of $324 million new business contracts that were announced by management during the Q1-2020 Earnings Conference Call should convert into significant new revenue growth opportunities in the near future for Conduent.  If implemented properly, we believe that conversion of the new business contracts should result in higher revenue and higher profitability for Conduent.  Conduent also announced during its Q1-2020 Earnings Conference Call that its senior leadership team and Board would take compensation reductions, although these reductions have not yet been disclosed to shareholders.  We encourage the Board to disclose the extent and timing of these reductions in compensation immediately.

Even with all of these new initiatives, capturing these opportunities requires a highly skilled Team.  We do not believe this Team has demonstrated that competence.  We do not understand that with all of these tailwinds, described above, why Conduent is not reporting better financial results as a stand-alone conglomerate of the three separate businesses.  Perhaps Conduent does not have the right Team after all to get the job done and to unlock the substantial shareholder value.

Value of the Sum of the Parts

During the May 19, 2020 Annual Meeting of Shareholders, Conduent stated that it was open to all ideas to unlock shareholder value as long as they made business sense and that the Company would consider them opportunistically.  We believe that Conduent should separate its three business segments and that individually they most likely will be more valuable to potential acquirers, especially if these separations can be affected on a tax free or reduced tax effect basis such as a Reverse Morris Trust transaction structure.  These suggestions make a lot of business sense to us and should be immediately pursued by the Board.

Here is a more detailed presentation of our strong belief that there is significant unlocked shareholder value buried within the conglomerate model of Conduent.  Our calculation of the sum of the parts of Conduent's three separate Business segments, Government, Transportation and Commercial, indicates that the Enterprise Value of Conduent could be about $5.8 billion after deducting its net debt of $1.26 billion as of March 31, 2020 as compared to the Enterprise Value of $1.9 billion using the stock price of $2.92 as of the close of business on June 5, 2020.  We believe that Conduent could unlock incremental shareholder value of about $3.9 billion (before the effect of income taxes, transaction and restructuring costs). This is over a 200% increase in Enterprise Value and would most likely result in a much higher stock price for shareholders.

Our Enterprise Value calculation has accepted the assumption from Conduent's management that it will be able to reduce annual Corporate and Unallocated Costs by at least $100 million.  We believe that Conduent could reduce its Corporate and Unallocated Costs by even more than $100 million on an annualized basis by expanding its Work-from-Home program, reducing or combining its real estate footprint of 150 site locations, selling some of its owned real estate, implementing artificial intelligence or machine learning and rationalizing its employee headcount to name just a few things that could improve earnings.  Another simple example of additional cost savings that might be possible is outsourcing Conduent's data centers to a cloud provider such as Microsoft or Amazon Web Services. This would not only reduce costs but would increase flexibility and security.

Although this is more of a disclosure issue than a cost reduction issue, we believe that if the Corporate and Unallocated Costs include any executive bonuses or Board related costs, (such as D&O insurance, SEC fees or Annual Meeting costs), they should be separated from the Business segment results and a summary of such costs should be separately provided in all future filings with the SEC and investor presentations.

As a measure of Conduent's unlocked value, we compared Conduent's EBITDA multiple to some of the peer group companies presented in Conduent's Investor NDR Presentation (page 9) published on Conduent's corporate website on May 15, 2020.  We have set out below those in the peer group that report sufficient information to calculate their EBITDA Multiples for the fiscal year ended 2019 plus a few other peers (denoted as "Other" in the chart below) that we believe should be taken into consideration in calculating the Enterprise Value of Conduent:

We note that DXC Technologies may no longer be an appropriate peer group comparison for Conduent since it announced in early March 2020 that it had entered into an agreement to sell its Government Services Business to Veritas for about 3.5 times revenue or $5 billion in cash.  We also note that DXC acquired the Molina government service business as announced in June 2018 that competed directly with Conduent and likely comprised most of the business that was recently sold to Veritas by DXC in March 2020 for $5 billion.  Accordingly, neither of these companies are good peer comparisons anymore and have been excluded from our calculation.  We are also confused as to why FIS is included as a peer in the group, but we have included it regardless.

Our calculation of the sum of the parts valuation of Conduent is as follows:

We note that Conduent has withdrawn its financial guidance for FY 2020.  Accordingly, the financial results for FY 2020 and beyond may be materially different than the above analysis.  Sure the FY2020 financial results will likely be lower than FY2019 due to Covid-19 and other factors but it is still relevant to understand the substantial unlocked value in the sum of the parts of Conduent that is available to shareholders should the Board act to unlock this substantial value creation opportunity before the Team drives the financial results even lower.

A leading sell side research analyst recently estimated that Conduent trades at about 4 times of his forecasted Adjusted EBITDA for the year ended December 31, 2021, which we believe is dramatically lower than the mean or average of its peer group.

We believe that there is significantly more value in Conduent using the sum of the parts valuation method than it is currently valued by the market as a conglomerate of its three businesses, Government, Transportation and Commercial.  We believe that the conglomerate business model results in Conduent trading at a significant discount to its peers.  We believe there should be much more value that could be returned to shareholders if each Business segment was separated and either sold or spun out as a separate public company.

We believe that Conduent must be split into at least three separate entities, Government, Transportation and Commercial Businesses, with their own separate and likely lower cost structures to maximize shareholder value making each segment a much more attractive acquisition target to a greater number of potential acquirers.  An acquirer could possibly achieve even greater cost efficiencies than we have estimated in our calculations from combination synergies. Conduent could minimize or even eliminate any material income taxes by using a Reverse Morris Trust transaction to consummate a transaction on or near a tax free basis.  However, we do not have sufficient information to determine this affect at this time.

We do not understand why the Board has been so reluctant to unlock the potential value opportunity of about $3.9 billion in incremental shareholder value (before the effect of income taxes, restructuring and transaction costs). This results in over a 200% increase in Adjusted EBITDA and would likely translate into a much higher stock price for Conduent.

As another "data point" in the destruction of shareholder value, we note that in 2009 Xerox paid $6.4 billion in cash and stock for Affiliated Computer Systems (ACS) that was primarily the predecessor company to Conduent before its spin-out from Xerox in 2016.  Most of this value has value has now been destroyed under the current Team and strategy of Conduent.

Finally, if the Board is not prepared to separate the three Business segments, restructure the cost base and deal with the management issues that we have described above to unlock the substantial untapped shareholder value, then we believe the Board has a fiduciary duty to put Conduent in its entirety up for sale.  We do not necessarily believe this will bring maximum value to shareholders, but we do believe that it is a better alternative than the current course of action.

We implore the Board to seriously review the various options that we have outlined to unlock the massive incremental shareholder value that we have identified in our letter and to inform shareholders of its plans for Conduent as soon as possible, but surely no later than during its Earnings Call for the Six Month Period Ended June 30, 2020. 

Sincerely,

R. Scott Murray
Managing Partner
Trillium Capital LLC.
[email protected]

SPECIAL NOTE REGARDING THIS LETTER:

THIS LETTER CONTAINS OUR CURRENT VIEWS ON THE VALUE OF SECURITIES CONDUENT INCORPORATED AND CERTAIN ACTIONS THAT THE BOARD OF DIRECTORS OF CONDUENT MIGHT TAKE TO ENHANCE THE VALUE OF ITS SECURITIES. OUR VIEWS ARE BASED ON OUR OWN ANALYSES OF PUBLICLY AVAILABLE INFORMATION AND ASSUMPTIONS WE BELIEVE TO BE REASONABLE. THERE CAN BE NO ASSURANCE THAT THE INFORMATION WE CONSIDERED AND ANALYZED IS ACCURATE OR COMPLETE. SIMILARLY, THERE CAN BE NO ASSURANCE THAT OUR ASSUMPTIONS ARE CORRECT. THE ACTUAL PERFORMANCE AND RESULTS OF CONDUENT MAY DIFFER MATERIALLY FROM OUR ASSUMPTIONS AND ANALYSES.

THIS LETTER ALSO REFERENCES THE SIZE OF OUR RESPECTIVE CURRENT HOLDINGS OF CONDUENT. OUR VIEWS AND OUR HOLDINGS COULD CHANGE AT ANY TIME. WE MAY SELL ANY OR ALL OF OUR HOLDINGS OR INCREASE OUR HOLDINGS BY PURCHASING ADDITIONAL SECURITIES. WE MAY TAKE ANY OF THESE OR OTHER ACTIONS REGARDING CONDUENT WITHOUT UPDATING THIS LETTER OR PROVIDING ANY NOTICE WHATSOEVER OF ANY SUCH CHANGES (EXCEPT AS OTHERWISE REQUIRED BY LAW).

FORWARD-LOOKING STATEMENTS:

Certain statements contained in this letter are forward-looking statements including, but not limited to, statements that are predications of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. The current COVID-19 Virus Crisis may and continue to have an material adverse effect on the Company's financial results and its stock price.  Forward-looking statements are not a guarantee of future performance or activities and are subject to many risks and uncertainties. Due to such risks and uncertainties, actual events or results or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. Forward-looking statements can be identified by the use of the future tense or other forward-looking words such as "believe," "might, "expect," "anticipate," "intend," "plan," "estimate," "should," "could," "may," "will," "objective," "projection," "forecast," "continue," "strategy," "position" or the negative of those terms or other variations of them or by comparable terminology. 

Important factors that could cause actual results to differ materially from the expectations set forth in this letter include, among other things, the factors identified in the public filings Conduent. Such forward-looking statements should therefore be construed in light of such factors, and the we are under no obligation, and expressly disclaim any intention or obligation, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

SOURCE Trillium Capital LLC

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