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Icahn backs Xerox to acquire HP

Xerox offer to buy HP

The markets were in for a shock today when Wall street journal reported that Xerox Holding is intending to acquire HP through cash and stock bid. This development took place after the activist investor Carl Icahn backs Xerox to acquire HP. Icahn holds stake in both the companies. This is one of the very few occasions where a company with market share of $8.8 billion and that makes photocopiers is interested to acquire a $27 billion company which is three times its size and that makes printers and laptops. Although such deals are often difficult to believe, one cannot rule out the possibility of such a deal to get closed.
In my view Xerox would definitely not be interested in growth prospects of HP because HP itself is struggling. HP has struggled to find a viable model to move beyond its printing business as customers shift towards digitization. Last month it terminated 7000-10000 employees through a combination of layoffs and voluntarily retirements. Xerox like HP is relying on a dying business for its sales. It sells and services copiers and printers primarily for corporations.
What Xerox is focusing is on HPs cashflow and the ability to reduce costs through consolidation of systems, processes and job cuts. Xerox itself was looking to exit its business a few quarters back but was unable to get a buyer. Meanwhile HP had a very tough year with its stock declining 25% since its last year peak. Hence there is a chance that it might have received buyout offers.
HP also had few leadership exits recently when its Chief executive Dion Weisler stepped down last month due to personal reasons. He is replaced by his successor Enrique Lores. This vaccum in leadership along with HP’s low debt and its strong ability to generate cashflows makes it a good target for buyout. Hence Xerox bid to acquire HP is entirely feasible.
From deal synergies perspective, Xerox gets access to HP cashflows. It is very difficult for HP to function independently as global printer shipments market declining by 2% annually according to Gartner. Hence this merger can reduce costs and strengthen their market share in areas where there is an overlap. When we look at the printers market, HP has a higher market share for smaller printers where as Xerox holds the lead in larger ones. Hence this merger can boost margins even though the revenues will stagnate.

Icahn backs Xerox to acquire HP

Going to be the HP’s stock run in the last year, the maximum premium that Xerox would be contemplating at this point would be around 30-40% premium to the HP’s average share price in last 3 months. This would put the deal value between $40-45 billion which might be realistic.
To fund such a large deal, Xerox would go for debt in addition to stock. The debt required should be around 20 billion which would be a lot for Xerox to digest. To make the deal attractive, xerox would need to realize cost synergies which should atleast cover the cost of capital for the transaction. Xerox might need to arrange for the debt financing for this deal and it will mostly go to leading banks like Citi or BoFA.
It is also need to be noted that Xerox second largest shareholder is an activist investor Carl Icahn. Ever since Carl Icahn has acquired a stake, xerox had a good run in its stock price and have also recently divested its stake in its Joint venture with Fuji Film holdings for $2.3 billion.

Final Thoughts

Xerox bid to acquire HP does not have any strategic sense as both their businesses in printing and copier segments are aging and in decline. At best, this transaction is masterstroke of financial engineering.