On November 24th, HP Inc. blasted Xerox’s “aggressive” and “hostile” actions, referring to a letter sent last week from Xerox CEO and Vice President John Visentin that essentially threatened a Xerox hostile takeover of HP, with Xerox appealing directly to HP shareholders. The letter specified that HP must respond by November 25th.
The new HP letter, which was published on November 24th, and is signed by HP CEO Enrique Lores and HP Chairman of the Board Chip Bergh, states: “We will not let aggressive tactics or hostile gestures distract us from our responsibility to pursue the most value-creating path.”
The two HP executives again state that they believe Xerox’s offer for HP “significantly undervalues HP.” Xerox has proposed purchasing HP for $33.5 billion or $22 per share (said to be a 20-percent premium on HP’s current share price).
The letter also states that HP believes Xerox is “intent on forcing a potential combination on opportunistic terms and without providing adequate information.”
In note that in August and September 2019, HP repeatedly raised questions about Xerox finances, but that Xerox failed to address them and “instead walked away, choosing to pursue a hostile approach rather than continue down a more productive path.”
The letter also emphasizes that HP is not dependent on a Xerox combination.”
HP again noted its concerns with with what it calls a “resulting out-sized debt burden on the value of the combined company’s stock even if the financing were obtained.” Xerox would likely have to borrow some $20 billion to purchase HP. It says it’s obtained a financing commitment from Citigroup.
Nevertheless, HP says: “Consequently, your proposal does not constitute a basis for due diligence or negotiation.”
Xerox Revenue Declines
HP again notes that Xerox’s revenues have been declining and that Xerox management has stated it expects them to continue to decline.
HP notes that ‘Xerox’s revenue has fallen from $10.2 billion to $9.2 billion (on a trailing 12-month basis) since June 2018, and this is expected to continue – Xerox management projects revenue declines of 6 percent in fiscal 2019.”
HP also expressed concerns with Xerox’s contractual revenue, noting its decline in customer Total Contract Value (TCV) “which suggests your revenues may decline even faster in future years.”
HP noted that Xerox TCV of enterprise signings (including renewals) in 2018 was down 13.9 percent, and “churn” for 2018 was 18 percent, “both data points which Xerox has stopped providing publicly since the end of 2018.”
Fuji Xerox Sale – Xerox “Mortgaged its Future for a Short-Term Cash Infusion
HP also remarked on Xerox’s recent sale of its 25-percent stake in Fuji Xerox to Fujifilm for $2.3 billion. Xerox has had a stake in Fuji Xerox with Fujifilm for decades, and has sourced much of its printers and copiers from Fuji Xerox, enhancing the equipment for customer use in North America and Europe.
HP had harsh words for Xerox’s sale of Fuji Xerox: “It appears to us that when Xerox exited the Fujifilm joint venture, Xerox essentially mortgaged its future for a short-term cash infusion. We fear that the exit has left a sizeable strategic hole in Xerox’s portfolio.”
Finally, we note that Xerox’s sale of its stake in Fuji Xerox means Xerox “will have to get access to the fastest growing Asia Pacific region.”
Nevertheless, HP is still leaving the possibility – however small – of some kind of merger, noting “We remain prepared to study the potential value of a combination.
While HP is still leaving open the possibility for an HP-Xerox combination, that possibility is appearing smaller and smaller, as the possibility of a proxy war looms ahead.
As we’ve noted previously, the driving force behind Xerox is now likely activist investor Carl Icahn, who has a 10.6-percent stake in Xerox, 4.25-percent stake interest in HP, and has overseen the appointment of a Xerox board friendly to his interests. He has been strongly urging an HP sale to Xerox, stating recently that “It’s a no-brainer.”
We’re now at a place where a proxy between Ichan and HP is a distinct possibility.
Icahn is notorious for strong-armed tactics when bending companies to his will. However, HP appears to come well-armed to the battlefield. As noted previously, in its initial letter announcing it was rejecting Xerox’s offer, HP included the name of the law firm advising it, Wachtell, Lipton, Rosen & Katz. This law firm has helped various companies, including Dell, push back against Icahn’s strong-arm tactics – and may be if push-comes-to-shove – which increasingly looks like may be the case.
Text of November 24, 2019 HP Letter
The full text of the letter, which was signed by HP Inc. CEO Enrique Lores and HP Inc. Chairman of the Board Chip Bergh, is as follows:
The HP Board of Directors has reviewed and considered your November 21 letter, which has provided no new information beyond your November 5 letter. We reiterate that we reject Xerox’s proposal as it significantly undervalues HP. Additionally, it is highly conditional and uncertain. In particular, there continues to be uncertainty regarding Xerox’s ability to raise the cash portion of the proposed consideration and concerns regarding the prudence of the resulting outsized debt burden on the value of the combined company’s stock even if the financing were obtained. Consequently, your proposal does not constitute a basis for due diligence or negotiation.
We believe it is important to emphasize that we are not dependent on a Xerox combination. We have great confidence in our strategy and the numerous opportunities available to HP to drive sustainable long-term value, including the deployment of our strong balance sheet for increased share repurchases of our significantly undervalued stock and for value-creating M&A.
It is clear in your aggressive words and actions that Xerox is intent on forcing a potential combination on opportunistic terms and without providing adequate information. When we were in private discussions with you in August and September, we repeatedly raised our questions; you failed to address them and instead walked away, choosing to pursue a hostile approach rather than continue down a more productive path. But these fundamental issues have not gone away, and your now-public urgency to accelerate toward a deal, still without addressing these questions, only heightens our concern about your business and prospects. Accordingly, we must have due diligence to determine whether a Xerox combination has any merit.
We remain prepared to study the potential value of a combination and to work quickly to learn more about your business trajectory. However, there are significant concerns about both the near-term health and longterm viability of your business that have a significant impact on Xerox’s value. The question of whether there is a path to turn around your business is a threshold issue. In addition to the visible and substantial declines at Xerox, our specific concerns include:
- Xerox has missed consensus revenue estimates in four of the last five quarters;
- Xerox’s revenue has fallen from $10.2 billion to $9.2 billion (on a trailing 12-month basis) since June 2018, and this is expected to continue – Xerox management projects revenue declines of 6% in fiscal 2019;
- Given how much of your business is based on contractual revenue, we are concerned about the decline in customer Total Contract Value (TCV) in excess of revenue declines, which suggests your revenues may decline even faster in future years. We note that the TCV of enterprise signings (including renewals) in 2018 was down 13.9% in constant currency and your churn for 2018 was 18%, both data points which Xerox has stopped providing publicly since the end of 2018;
Our review of synergies based on public information and the limited information you have shared does not support achievable synergies of the scale you suggest, and it appears that your assumptions include significant savings that are already included in each company’s independently announced cost reduction plans; and
It appears to us that when Xerox exited the Fujifilm joint venture, Xerox essentially mortgaged its future for a short-term cash infusion. We fear that the exit has left a sizeable strategic hole in Xerox’s portfolio. In addition, we have concerns as to the state of Xerox’s technology resources, research and development pipeline, future product programs, and supply continuity and capability. Finally, we note that Xerox will have to get access to the fastest growing Asia Pacific region.
The HP Board of Directors is committed to serving the best interests of HP shareholders, not Xerox and its shareholders. HP has numerous opportunities to create value for HP shareholders on a standalone basis. We will not let aggressive tactics or hostile gestures distract us from our responsibility to pursue the most value-creating path.”