DXC Technology Company’s (DXC Quick QuoteDXC - Free Report) shares soared 11.5% on Monday as the IT services and solutions provider garnered attention as a potential acquisition target. Citing people familiar with the matter, Reuters on Monday revealed that Apollo Global Management and Kyndryl Holdings, Inc. (KD Quick QuoteKD - Free Report) are considering a joint bid for DXC.

Apollo Global Management is an asset management firm, while Kyndryl Holdings is an IT services provider that was created from the spin-off of International Business Machines Corporation’s (IBM Quick QuoteIBM - Free Report) infrastructure services business in 2021. Upon spin-off, International Business Machines held a 19.9% stake in Kyndryl Holdings, which it later sold in November 2022.

This is not the first time when DXC has attracted takeover interest. In October 2023, it was approached by a financial sponsor regarding the potential acquisition of the company. In early 2021, it received an unsolicited, preliminary and non-binding proposal to acquire all its shares from the French technology services provider Atos SE. However, both talks didn’t materialize for different reasons.

DXC's current valuation plays a crucial role in its appeal as an acquisition target. The company's stock has been trading at a one-year forward P/E multiple of 6.30X, significantly lower than the Zacks Computer - IT Services industry’s 33.21X, making it a potentially lucrative investment for acquirers.

This attractive valuation multiple is a result of a 20.4% year-to-date (YTD) decline in DXC’s share price. At the closing price of $18.34 as of Jun 11, the stock traded 36.5% lower than the 52-week high of $28.89.

Transformation Efforts Attract Suitors

We believe that DXC’s sustained efforts toward transforming itself from a struggling, highly leveraged company to a high-growth, business-oriented firm have made it a lucrative takeover target.

DXC was formed by the merger of Computer Sciences Corporation (“CSC”) and the Enterprise Services Division of Hewlett Packard Enterprise (HPE Quick QuoteHPE - Free Report) , which was completed on Apr 1, 2017. CSC, prior to the completion of the merger, took an additional debt. This amplified DXC’s total long-term liability, thereby increasing its interest cost burden while limiting its scope for investing in growth opportunities.

To overcome this situation, DXC resorted to debt refinancing and divestment, as well as a spin-off of non-core assets. The strategy significantly reduced its outstanding debt level to $3.82 billion as of Mar 31, 2024 from $10.33 billion as of Jun 30, 2020.

Divestment and spinning off non-core assets have improved DXC’s focus on its core businesses. Also, it enhances the firm’s ability to execute acquisition strategies across high-growth businesses, including enterprise software-as-a-service, technology security solutions and autonomous driving.

The trimmed business is likely to help DXC focus on reviving its financial performance, which has been hurt by a slowdown in IT spending. Additionally, a low-leverage balance sheet will provide it with financial flexibility in investing in growth areas.

What Should Investors Do Now?

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

During its recently reported financial results, the company provided dismal revenue and earnings guidance for the first quarter of fiscal 2025. It hinted that cautious spending by clients in a challenging macroeconomic environment would hurt its fiscal 2025 top-line performance.

The Zacks Consensus Estimate for first-quarter revenues is pegged at $3.14 billion, which indicates a year-over-year decline of 8.8%. The consensus mark for earnings has been revised 25% downward to 60 cents per share over the past 30 days, which calls for a 4.8% decline from the year-ago quarter.

The potential for an acquisition does not necessarily translate into guaranteed gains for current shareholders, and the associated speculation can often lead to increased volatility and risk. Also, like previous takeover talks, if the acquisition does not materialize, the stock could suffer a significant decline.

Considering the ongoing challenges faced by DXC, along with a risk of speculated bid failure, it is wise to wait to invest in the stock until we see some clarity on its growth prospects. DXC currently carries a Zacks Rank #4 (Sell).

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

(We are reissuing this article to correct a mistake. The original article, issued onJune 11, 2024, should no longer be relied upon.)