Proposal, Rejection, Retaliation – The Dynamic Exchanges Between Xerox and HP

In November 2019, Xerox launched a tender offer to buy HP shares at $22 per share. HP’s board of directors unanimously rejected the takeover, arguing that Xerox significantly undervalued HP’s assets and that the proposal did not align with shareholder interests – the deal would require a replacement of HP’s board of directors and burden the combined entity with debt. Three months later, Xerox returned with a new offer at $24 per HP share. 

 Xerox’s persistence reflects the challenges in a waning printing industry as consumers move away from printing toward digital documentation, the cost-efficient and environmentally responsible alternative. Xerox’s sales have contracted 6% annually since 2015, mirroring HP’s 5% decline in the printing division last year. With future revenue prospects looking grim, Xerox and HP have turned to cutting costs. Xerox has announced a $640 million reduction in 2019 expenses, and HP has implemented a $1.2 billion cost-saving program to shed 16% of its workforce, or approximately 9000 employees. Although cost restructuring could provide temporary relief, it appears as an unsustainable way to compensate for the sluggish top-line performance. The companies could exit the industry, but highly attractive profit margins make them reluctant. In 2019, HP generated 36% of sales from the printing division, while operating profit from the segment accounted for 63%of the company’s total operating profit. Convinced of the potential for a rebound, Xerox writes up new offer.

However, HP remains reluctant to accept the bid. While $24 per share represents a 9% increase from the previous proposal, HP expresses concerns about the consequences on shareholder and capital structure from the consolidation. A public company makes investors happy by returning cash in the forms of capital gains from price appreciation as well as cash dividends. HP’s relatively flat stock performance over the past year has led the company to ramp up dividends and share buybacks – the repurchase of outstanding shares on the open market – to drive up equity value. Yet despite the company paying out $970 million in dividends and repurchasing $2.4 billion shares, nearly 7% of its market value in 2019, key investors demand more. Further complicating the issue, Xerox wants to replace HP’s board of directors with its own nominees. Naturally, the replacement of the existing board in addition to a change of control could hinder HP from optimizing shareholder value and pursuing its own strategic objectives, especially during the early phases of integration where capital is constrained. 

A second complication underlying the proposal deals with the high levels of debt required to finance the deal. A cash-and-stock offer at $24 per share means that each HP shareholder would get $18.40 in cash and 0.149 Xerox shares. This arrangement entails two issues. First, low cash balance on Xerox’s side means it must resort to debt to finance a majority of the deal. Second, HP’s market capitalization of $31 billion trumps Xerox’s market capitalization of $7 billion. Absorbing a company over four times its size would disrupt the natural equilibrium between the acquirer and the target, but it moreover would increase the amount of debt needed. Cash illiquidity and size disconnect would require Xerox to lever up by $24 billion, raising its current debt level by 561% from $4.3 billion. The new capital structure would saddle the combined company with debt, resulting in a possible credit downgrade and potentially financial distress.

In view of these issues, HP hits Xerox with a second public rejection on February 24, 2020. Not only does HP dismiss Xerox but it also fires back with a poison pill plan –  a defensive strategy to protect businesses from hostile takeovers by creating barriers to closing the deal. The company has promised a massive $16 billioncash-return plan to investors including $15 billion in share repurchases, up from the $5 billion announced the year prior. In addition, HP has revealed a shareholder rights plan to prevent investors from owning more than 20% stake in the company, in which case other investors can buy additional shares at discounted prices, boost their voting power and dividends. This defensive tactic allows HP to lock in shareholders and discourages them from siding with Xerox. 

Yet Xerox’s second failed attempt only heightens its desire to conquer HP. One week following the defeat, Xerox launches a tender offer in a hostile takeover bid to buy all of HP at $24 per share. The back-and-forth exchanges have only escalated the tension between the two, leaving both more convicted in their own stance and disapproving of the other’s. With the broad stock market down nearly 15% amid fears of a global recession driven by the coronavirus outbreak and an overall economic slowdown – would HP be better off accepting the deal?

Although HP shows no interest Xerox' offer, the company's extensive resources and market power provide the potential for HP to propose a deal as the acquirer itself. Xerox’s largest shareholder with holdings in both companies – activist investor Carl Icahn – has been driving interesting discussions between the two and pushing for a tie-up since last year. In November, the activist investor unsuccessfully pitched for HP to acquire Xerox at $45 a share in a private phone-call, a price which HP believed overvalued Xerox. In HP’s most recent earnings call however, CEO Enrique Lores shares that the company is “reaching out to Xerox to explore if there is a combination that creates value for HP shareholders”. With higher cash on its balance sheet, an exchange of roles certainly would certainly seem appropriate.  

We credit Carl Icahn for the complex dynamic between Xerox and HP – but he may have a point. Perhaps Xerox and HP could stand to gain from consolidation. Since they operate in complementary segments, merging could lead to value creation through supply chain integration, growing market share and margins. Indeed, Xerox’s merger thesis includes an estimated $2 billion in cost synergies and up to $1.5 billion in revenue synergies through cross-selling and streamlining operations. However, Xerox’s initiation has instead resulted in two public rejections, provoked HP to retaliate with a poison pill plan, and Xerox to start a hostile takeover. For Xerox and HP to reach a deal, they must agree on purchase price, organizational control, and capital structure. If each would compromise, then merging would not be a question of if, but how. If the relationship continues to sour, then the next major headline would not be about a collaboration but a rivalry. 

Note: All values are in US dollars, unless stated otherwise.