Icahn, Deason Slam Proposed Fujifilm Takeover of Xerox

As perhaps expected, billionaire activist investor Carl Icahn and fellow investor Darwin Deason issued a public letter slamming the proposed Xerox-Fuji Xerox merger, under which Fujifilm of Japan would have a 50.1 percent controlling interest in the new combined Xerox-Fuji Xerox. The two also urged other Xerox stockholders to vote against that proposed deal.

In the letter, Icahn and Deason say the “scheme” dramatically undervalues Xerox and disproportionately favors Fujifilm. The transaction, they state, “has a tortured, convoluted structure, but it was best summarized by Shigetaka Komori, Fuji’s Chairman and CEO, when he boasted to the Nikkei Asian Review that the ‘scheme will allow us to take control of Xerox without spending a penny.'”

Fujifilm wouldn’t be paying cash for its controlling 50.1 percent interest in the new combined company – instead it would  make make the purchase by using the unrealized profit on its 75-percent interest in Fuji Xerox.

According to Icahn and Deason, they are “the first and third largest shareholders of Xerox, beneficially owning collectively over 40 million shares of the company’s common stock, constituting over 15 percent of the outstanding shares.”

The letter notes that Fujifilm will take over Xerox without putting up any cash to acquire majority interest in the “venerable American icon.” In exchange, they state existing Xerox shareholders “will receive (1) an additional, indirect 25 percent interest in a Fuji subsidiary that just last year disclosed a $360 million accounting scandal caused by a ‘culture of concealment’ and Fuji(film)’s failure to have adequate management systems and (2) a one-time special dividend financed with our own assets.”

The letter states that if the deal goes through as expected, existing Xerox shareholders will be “virtually powerless with respect to the future direction of our investment, with no opportunity to ever receive a true control premium for our shares.”

It also states that under the deal, “we are similarly being asked to hope against hope that the meager minority protections negotiated by the Xerox Board of Directors will be sufficient to protect us against tyranny and abuse by our new controlling stockholder Fuji(film). It states that: “we believe the history of interactions between Fuji and Xerox – until recently shrouded in mystery – should make all Xerox shareholders extremely skeptical that oppression of the minority will not occur in the future. Additionally, last year’s massive accounting scandal at Fuji Xerox should make us all extremely nervous (to say the least) about trusting Fuji with our capital.”

Deal Disproportionately Favors Fujifilm

Icahn and Deason argue that the proposed deal “disproportionately favors” Fujifilm at the expense of Xerox shareholders: “When we sketch out the financials of the deal, this is our conclusion: we – the existing Xerox shareholders – are selling approximately $535 million of normalized annual recurring cash flow for about $1.25 billion. In other words, we are selling control of Xerox for a cash flow multiple barely exceeding 2.3x. In addition, we are also surrendering half of all potential future dividend growth. When considered with these economics in mind, the transaction looks like another depressing display of incompetence by a Xerox Board of Directors with no real skin in the game.”

The two also argue that in order for any projected synergies to be realized, Fujifilm “will need to smoothly integrate Xerox, and if history is any guide, that integration will be anything but smooth (as the Nikkei Asian Review pointed out after interviewing Fujifilm CEO Komori: ‘Japan’s corporate history is littered with stories about foreign takeovers going awry.’)”.

The two also state: “Xerox itself acknowledges in the press release announcing the deal that we should not assume that the projected synergies will ever be achieved, and the reality is that the most readily achievable synergies – the ones we can actually be confident will be realized – are cost savings that could and should be achieved without consummating this transaction. To wit, it is common knowledge that the Fuji Xerox joint venture has yet to undergo any sort of significant restructuring (which, in and of itself, casts further doubt on Fuji’s management capabilities), and as a result, there is substantial low hanging fruit that could be captured with a thorough cost cutting program at that level, which would benefit both Fuji and Xerox independently without this transaction. But even if you assume we are 100% wrong about the projected synergies – even if you assume that all of the purported synergies will be achieved and would not otherwise be possible in the absence of this transaction – that still cannot possibly justify giving away control (which we cannot emphasize enough, can only happen once) without receiving a premium.”

Urges Xerox to End Fuji Xerox Agreement

Citing accounting scandals at Fuji Xerox, Icahn and Deason also urge Xerox to “get rid of this albatross (Fuji Xerox),” and state that the “massive accounting scandal” at Fuji Xerox “almost certainly rise to the level of being a material breach of the joint venture agreements,” and that Xerox “could and should exercise its rights to terminate the agreements effective immediately, thereby gaining for itself unfettered access to a $36 billion Asia-Pacific market, including sole right to use the Xerox name and intellectual property in the region. It would be catastrophic for Fuji’s printing business and a fantastic opportunity for Xerox to expand for its own benefit.”

Icahn and Deason also “demand complete and detailed disclosure of the advice given to the (Xerox) Board of Directors regarding terminating the joint venture, including copies and detailed explanations of all financial models and projections contemplating Xerox operating independently in a growing Asia-Pacific market. We demand complete and detailed disclosure of the efforts taken by Xerox to terminate (or even renegotiate) the terms of the joint venture as a result of last year’s massive accounting scandal at Fuji Xerox. We demand complete and detailed disclosure of the steps taken by Xerox and its advisors to solicit and evaluate indications of interest from parties other than Fuji during the 46 days they spent negotiating this transaction, including a description of the feedback received from each contacted party regarding the change of control provisions in the joint venture agreements.”

Despite its market-leading share “in an $85 billion addressable market, including large enterprise Managed Print Services (MPS) and Centralized Print Services, A3 Multi-Function Printers (MFPs) and Production Cut Sheet (Color and B&W),” poor Xerox management, and a “do nothing” (Xerox) Board of Directors, Icahn and Deason state that “Xerox has failed to keep pace with the market.” This “complacency” has provided “an opening for competitors to eat away at its market share in A3 MFPs and high-end production, while Xerox chased the A4 MFP market, where it had to play catch-up to stronger and more established competitors. That critical error has been evident over the past three years as revenue and margins have continued to decline.”

The two however state that “there is still great opportunity for Xerox to create enormous value for shareholders, and it does not involve selling control to Fuji without a premium. Rather, it entails freeing the company from the shackles of the Fuji Xerox joint venture and bringing in leadership with the vision and operational expertise to revive the company – leadership that will, among other things, reinvigorate the portfolio towards software, security and services while maintaining the existing dominant market share position by leveraging the company’s strong position in the higher-end enterprise market,  focus the distribution and channel networks to target and grow sales to small and medium sized businesses (the current model creates channel conflict with competing sellers, thereby diluting their differentiation, incurring duplicative operating expenses and sacrificing margin), and (iii) optimize the organizational and operating structure to be more competitive.”

Icahn and Deason also state that “Xerox desperately needs… leadership that can develop a strategy to commercialize and monetize the intellectual property developed at PARC. Xerox PARC scientists have been responsible for some of the world’s most notable technological innovations, including the modern personal computer, the graphical user interface (featuring windows and icons) and the mouse. Yet Xerox squandered those opportunities, even as the innovations themselves spawned entire new platforms and industries – turning people like Steve Jobs and Bill Gates into household names. New leadership, both in the C-suite and on the Board of Directors, could ensure that those types of opportunities never get squandered again.”

The two conclude by stating that the current Xerox Board of Directors “has overseen the systematic destruction of Xerox, and, unless we do something, this latest Fuji scheme will be the company’s final death knell, and urge other Xerox shareholders to vote against the Fujifilm “scheme to send a clear message that we will not be fooled into giving up control of our company for $9.80 in cash.”

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