HP Rejects Xerox Offer, But Remains Open To Persuasion

Hewlett-Packard’s (NYSE:HPQ) board rejected Xerox’s (NYSE:XRX) offer of $22 a share, of which it would like to pay 77% in cash and the rest in Xerox shares.

What HP basically said is that Xerox hasn’t adequately explained its financial situation and the reason its revenue slipped 9.8% on a trailing twelve months (TTM) basis. So on the face of it, the deal didn’t look great for its shareholders, particularly when Xerox’s balance sheet didn’t look much better than HP’s.

The two companies hold total debt of $9.89 billion (HP $5.058 billion, Xerox $4.832 billion) and cash of $5.84 billion (HP $4.919 billion and Xerox $922 million). Moreover, they generated operating cash of $3.049 billion and $1.032 billion, respectively on a year-to-date basis.

The board also said that the offer undervalues HP, which was trading at $18.40 on November 5, before the offer became public. On Nov 15, the shares closed at $20.18, reflecting positive sentiment on the value of a shrinking business. It was however still below the offer price, which seems to indicate that investors are perhaps not as hopeful as HP’s board.

But there could be some real advantages to getting together because these two companies lack certain capabilities that could be useful in a shrinking market. Labels, packaging and signage for instance are fast growing areas of the market where Xerox doesn’t have any offering. Similarly, the corporate copier business is where Xerox shines and an area where HP has no presence.

Together, they can bring customers the full range of paper-based solutions their clients need. Although this entire pie is shrinking, it helps to remain relevant as long as possible to generate strong cash flows that can support any refocus of the business.

HP is already in the middle of a massive restructuring that will help it slash headcount by 9,000 and generate annual cost savings of $1 billion. Xerox claims that the merger will also generate a billion dollars in savings.

Activist investor Carl Icahn seems to think the deal makes sense. He owns a 10.6% stake in Xerox, a 4.24% stake in HP and has been pushing for a merger of the two companies. And that’s because he thinks shrinking markets like this can continue to generate strong cash flows far longer than investors probably expect.

So it all boils down to the extent of gains to be had from the deal and whether the price makes sense, as HP’s letter to the Xerox CEO said:

“We believe it is critical to engage in a rigorous analysis of the achievable synergies from a potential combination… With substantive engagement from Xerox management and access to diligence information on Xerox, we believe that we can quickly evaluate the merits of a potential transaction...”

And also,

“We recognize the potential benefits of consolidation, and we are open to exploring whether there is value to be created for HP shareholders through a potential combination with Xerox.”

Here's a quick glimpse at the share prices over the past month-

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