By Christopher Gvenetadze and Alessandro Carleo (Bocconi University), Gustaf Baavhammar and Chris Leung (University of Warwick) | 09/02/2020
Overview of the deal
Acquirer: Xerox Holdings Corp.
Target: HP Inc
Estimated Value: $31.7 billion
Proposal date: 6th November 2019
Acquirer Adviser: Citi
Target Adviser: Goldman Sachs
The merger will enable the two companies to combine their resources and consequently support their strong presence in the future with the creation of an unprecedented corporate IT empire on a market where the demand for printers and related products such as ink has decreased in the recent years. For Xerox, the most attractive element of the deal must be the resulting combined sales from print supplies and services, which will exceed $20 billion where HP carries an operating margin above 16%. Furthermore, following the 19% decline of HP’s stocks in the past 12 months, leading to a market cap of $29.97 billion, the timing for an acquisition by Xerox seems reasonable. In contrast to HP, Xerox had a positive run during this time period by showing a 29% lift of its stock resulting in a market capitalization of $8.20 billion.
“Our industry is long overdue for consolidation, and those who move first will have a distinct advantage. We look forward to expeditiously moving this process forward and creating additional value for shareholders.” - Caroline Gransee-Linsey, Xerox Director of Corporate Communications.
The strategic rationale for a deal is largely to cut costs for two companies struggling to navigate the accelerating erosion of the traditional printing business. Analysts estimate that the savings from a merger could be $1.5 billion a year or more. Over the years, HP’s business model for its desktop consumer and corporate printing business has been to sell printers at no profit or a loss, but make money on selling a steady stream of replacement cartridges, called aftermarket supplies.
Company Details (Acquirer: Xerox Holdings Corp)
Xerox Holdings Corporation operates as a holding company. The Company, through its subsidiaries provides printers, scanners, supplies, and accessories. Xerox Holdings serves health care, insurance, government and retail sectors worldwide.
- Founded in 1906, Rochester, NY, USA
- CEO: Giovanni Visentin
- Number of Employees: 40,000
- Market Cap: $8.2 billion - EV: $10.3 billion
- LTM Revenue: $9.1 billion - LTM EBITDA: $1.7 billion
- LTM EV/Revenue: 1.13x - LTM EV/EBITDA: 6.1x
Company Details (Target: HP Inc)
HP Inc. provides imaging and printing systems, computing systems, mobile devices, solutions, and services for business and home. The Company offers products which include laser and inkjet printers, scanners, copiers and faxes, personal computers, workstations, storage solutions, and other computing and printing systems. HP sells its products worldwide.
- Founded in 1939, Palo Alto, CA, USA
- President/CEO: Enrique Lores
- Number of Employees: 40,000
- Market Cap: $31.7 billion - EV: $32.3 billion
- LTM Revenue: $58.8 billion - LTM EBITDA: $4.9 billion
- LTM EV/Revenue: 0.55x - LTM EV/EBITDA: 6.6x
Projections and Assumptions
Shares of HP Inc. rallied 9.5% in midday reaching $21.67 but ultimately pared earlier gains of as much as 18%, after The Wall Street Journal reported that the potential buyout bid from Xerox Holdings Corp. would be below $23 a share.
Xerox's potential purchase of HP would be highly accretive, even with the higher cost of capital associated with roughly $20 billion of additional debt. The companies' savings programs total almost $1.7 billion, and the combination will result in further cost synergies. HP's low net debt and $4.9 billion EBITDA, coupled with Xerox's $1.8 billion EBITDA, could possibly support the higher debt load, even with the higher cost of capital and with a more conservative $2 billion in synergies. The subsequent debt load could be less than 4x EBITDA of the combined companies, presuming a portion of the capital was raised through stock.
Long Term Upsides
HP and Xerox both operate in a business segment suffering from declining paper demand as we move into an era of digital transformation. Where the pair of once-hailed giants have spun off from their money-making ventures (Hewlett Packard Enterprises and Conduent), what remains is an aging printing business with diminishing earnings.
There is certainly merit for consolidation considering the large number of competitors in the space. Combining with HP would not only allow Xerox to undergo rapid scaling, but also acquire the business and technology for them to diversify and adopt a more balanced portfolio that covers a wider spectrum. This ultimately means that Xerox is being able to position itself amongst the leading PC vendors rather than a reselling partner and assist in expanding into Asia, where HP already boasts a strong presence.
Although HP dominates 40% of desktop printing, it lacks ground in networked enterprise printing, where Xerox has a 15% market share by revenue (still behind Canon and Ricoh). A merger on this level would give rise to $2 billion in cost synergies alongside up to $1.5 billion in “potential growth opportunities” over the next 3 years. To highlight the outcome of this merger, the combined printing business of NewCo would be $30 billion while total revenues sit at $70 billion.
However, just because a deal makes sense, it does not mean it will happen. It almost appears that there is a fundamental clash in strategic directions that invokes questions of whether an outcome could even work. For one, HP recently appointed Enrique Lores as President and CEO, taking over Dion Weisler’s tenure only in November as well as the fact that HP is targeting higher growth ventures such as 3D printing. This is in stark contrast to Xerox whose business operates predominantly around printers as a commodity, which is what HP is exactly diversifying away from. As means of financing the merger, Xerox has also sold various stakes in former parts of its business while exiting a joint venture with Fujifilm for a $2.3 billion cash injection. This move was criticised by HP, stating that “Xerox essentially mortgaged its future for a short-term cash infusion … leaving a sizable strategic hole”.
It is evident that both companies are seeking strategic solutions to improve their top-line growth and profit trajectory. But with PCs and printers becoming progressively redundant, it begs the question whether a merger would even help rescue them.
Risks and Uncertainties
The structural decline of the printing industry has seen smartphones rendering printers more redundant and likewise, sales for copy machines and printers, primarily for corporations, is falling - as has been the case for Xerox in the past 8 quarters. Xerox’s latest 4 quarters generated $9.23 billion in revenue, an 8% tumble from the $10.04 billion achieved in its prior 4 quarters. As Katy Huberty, Head of North American Technology Hardware Equity Research at Morgan Stanley states in a research note: “Xerox’s end-markets suggests that a near-term return to growth is unlikely, as growth investments in new and adjacent markets are unlikely to offset market declines in Xerox’s core end markets”, which seems to question the very foundation of their future prospects and business viability. The cards seem to stack in HP’s favour who, despite showing signs of residual deterioration from the wider market, still managed to increase revenue by 2.9% to $58.72 billion in the latest 4 quarters.
Furthermore, the impact of debt levels could be overpowering, considering the debt Xerox will need to finance, on top of the existing $5.15 billion in total debt as of its latest quarter. Contrastingly, HP has a lower amount of total debt at $5.06 billion, despite being more than 3 times larger. There is also significant risk in combining with a company whose primary revenue source is shrinking and the fact that a deal would not counter the prominence of Chinese companies selling alternatives at a steep discount.
“There are significant concerns about both the near-term health and long term viability of [Xerox’s] business” - Chip Bergh, HP Board Chairman