UPDATE: HP Board Rejects Xerox Offer, for Now; Xerox Threatens Hostile Bid

John Visentin

Although not your typical "Dear John letter" announcing someone has found another, more well-suited, suitor, HP Inc. did issue a letter to Xerox Vice Chairman and CEO John Visentin on Sunday unanimously rejecting the unsolicited proposal from Xerox Holdings to acquire HP for approximately $33.5 billion in a combined cash-and-stock transaction. Here is HP's written response:

Dear John,

Our Board of Directors has reviewed and considered your unsolicited proposal dated November 5, 2019 at a meeting with our financial and legal advisors and has unanimously concluded that it significantly undervalues HP and is not in the best interests of HP shareholders. In reaching this determination, the Board also considered the highly conditional and uncertain nature of the proposal, including the potential impact of outsized debt levels on the combined company’s stock.

We have great confidence in our strategy and our ability to execute to continue driving sustainable long-term value at HP. In addition, the Board and management team continue to take actions to enhance shareholder value including the deployment of our strong balance sheet for increased repurchases of our significantly undervalued stock and for value-creating M&A.

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. However, as we have previously shared in connection with our prior requests for diligence, we have fundamental questions that need to be addressed in our diligence of Xerox. We note the decline of Xerox’s revenue from $10.2 billion to $9.2 billion (on a trailing 12-month basis) since June 2018, which raises significant questions for us regarding the trajectory of your business and future prospects. In addition, 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.

We remain ready to engage with you to better understand your business and any value to be created from a combination.

On behalf of the Board of Directors,

Enrique Lores   Chip Berg

The following day, HP Inc. shares dropped 5% on the news of the rejection of the bid from its much smaller rival. HP's board claimed the offer undervalued HP; would make the combined company too highly leveraged; and even questioned Xerox's future growth prognosis based on its trailing 12-month, $1 billion revenue decline.

At the same time, though, the response indicated that HP recognizes the cost benefits of consolidation (Xerox claims their merger could generate $2 billion in savings within 24 months) and is willing to remain engaged in further due diligence discussions. As some pundits had also predicted, the response also seemed to hint that HP might consider acquiring Xerox instead.

Carl Icahn | Credit: Twitter.com

HP has a reported market value of $29.7 billion, while Xerox is valued at $8.4 billion. And, as I reported last Friday, Xerox activist investor Carl Icahn — who already owns a 10.6% stake in Xerox — revealed that he has acquired a 4.24% stake in HP valued at about $1.2 billion.

And last week, Icahn told the Wall Street Journal that the rationale for the combination of Xerox and HP is a "no-brainer," no matter what type of structure it ultimately takes. I guess, like the expert billionaire M&A and hedge fund executive that Icahn is, Icahn has "hedged" his bet either way to still make money. And he also continues to conduct media interviews, which ultimately helps to keep HP institutional shareholder pressure focused at HP's board to maximize value.

A New York Times article published Monday also quoted a letter sent by Credit Suisse analysts to their clients, noting, "We continue to believe consolidation within the printing industry makes sense given a mature and secularly challenged end demand backdrop." Other financial analysts contend that HP Inc., instead, should do a major buyback of its own stock.

Somewhat surprisingly — although perhaps to help portray full transparency — HP also released the original offer letter from Xerox that outlined the terms with its response:

Ladies and Gentlemen:

I want to thank you for facilitating our recent discussions regarding a potential business combination between our two companies. The substantial synergies generated from a transaction are only the beginning of the unique value creation opportunity you and we identified together – enhanced capital allocation, revenue growth, diversification, balance sheet strength and best in class human capital all result from combining our two industry leading companies. Consequently, our Board of Directors fully supports the transaction outlined below. The nature of the opportunity and the moment, combined with the overwhelming support we believe your and our shareholders, employees and other stakeholders will extend to our coming together as one company, furthers our resolve to pursue a potential transaction with you.

Accordingly, we are providing you with the following definitive written proposal to effect the combination of Xerox Holdings Corporation (“Xerox”) and HP Inc. (“HP”):

The Proposal

1. Offer. We are prepared to offer HP shareholders $22.00 per share comprised of $17.00 in cash and 0.137 Xerox shares for each HP share¹, for a total transaction value of approximately $33.5 billion, assuming 1,515 million fully diluted shares outstanding and the balance sheet as of July 31, 2019. Our offer implies 77% cash consideration, with the balance comprised of Xerox shares, resulting in HP shareholders owning approximately 48% of the combined company – allowing your shareholders to both realize immediate cash value and enjoy equal participation in the substantial upside of synergies resulting from our combination.

Our compelling offer represents:

• a 20% premium to the closing share price of $18.40 as of November 5, 2019
• incremental value of at least $14 billion to our respective shareholders based on a 7x multiple of EBITDA
• a 29% premium to the 30-day volume weighted average trading price of $17.00, excluding the significant value of the shared synergies
• an implied transaction multiple of 6.9x HP’s LTM Adjusted EBITDA of $4.8 billion

2. Strategic Rationale and Potential Synergies. A combination between us is supported by strong industrial logic given our respective strengths in the A3 and A4 markets, complementary footprint, deep cultural fit and shared DNA of innovation. Our combined scale, product portfolio and global reach would allow us to compete effectively in the Production, Large Enterprise and SMB segments, while offering a truly differentiated Managed Services capability. It is difficult to conceive of a strategic alternative for either company that delivers superior value.

Our preliminary analysis shows a clear path to cost synergies of at least $2.0 billion within 24 months:

• $0.5 billion in cost savings by leveraging our scale, combined supply chain and distribution footprint, and
• $1.5 billion in cost savings from combining our world class R&D groups and streamlining corporate functions

Our Board of Directors strongly believes the industry is overdue for consolidation and that those who move first will have a distinct advantage in a secularly declining macro environment. By combining R&D capabilities and financial resources, together we can accelerate the transformation of our businesses and take a leadership role in key growth markets such as: 3D Printing, Digital Packaging and Labels, Graphics, Textile Printing, Workflow Software and IoT Enabled Services.

3. Financing. We will fund the cash component of our offer with a combination of cash on hand and new financing to support the transaction and the new combined company. We have been engaged in ongoing discussions with Citi on the transaction financing and they have provided to us a highly confident letter evidencing their certainty in arranging financing for the transaction. Given the current status of the capital markets, we and they expect that we will be able to finance the transaction fully with investment grade rated notes. We will obtain a fully committed financing package before signing any final agreement, and closing of the transaction will not be subject to a financing contingency.

4. Fuji Xerox Relationship. Many of your diligence questions to our management team concerned our relationship with FUJIFILM Holdings Corporation (“Fujifilm”) and our ownership stake in Fuji Xerox Co. Ltd. (“Fuji Xerox”). The transactions with Fujifilm and Fuji Xerox that we announced this morning, through which we will divest our ownership stake in Fuji Xerox at an attractive valuation (over 20x annual cash flow), permanently resolve pending litigation without any monetary payment and achieve a more flexible strategic sourcing relationship, will greatly facilitate the speed and ease with which you and we could effect a timely transaction and successful integration of our operations. Fujifilm has already obtained the necessary regulatory approvals in Japan, and as a result we expect to close the transactions with Fujifilm and Fuji Xerox on Friday, November 8, 2019.

5. Due Diligence Timetable. We are prepared to devote all necessary resources to finalize our due diligence on an accelerated basis. Given our discussions to date and our familiarity with each other’s operations and business plans, we believe that you and we could complete our work and concurrently negotiate final documentation in 3 – 4 weeks. We have already engaged Citi as financial advisor and King & Spalding as legal advisor to assist us with completing the transaction.

6. Required Approvals and Closing Conditions. This proposal and potential business combination have been extensively reviewed and approved by Xerox’s Board of Directors – we have their full support. Completion of the proposed transaction would be subject to the approval of the Board of Directors of each of Xerox and HP, as well as our respective shareholders. As you know, we have been working diligently with our regulatory advisors and have a strong understanding of the regulatory framework for a transaction of this nature and do not anticipate any meaningful regulatory hurdles to its completion.

7. Governance. We anticipate that the parties will agree to a governance framework, including board representation, that is customary for a combination of this type.

8. Confidentiality/Definitive Agreement. This letter is submitted to you on a strictly confidential basis and is intended for the Board of Directors of HP only. The terms outlined here are subject to the completion of due diligence and the negotiation and execution of mutually acceptable definitive transaction documents.

Our Board of Directors and management are excited about the opportunity to create significant value for both of our shareholders, employees and other stakeholders through this unique combination of our two companies. Please do not hesitate to contact me with any questions. I look forward to hearing from you.

Our offer remains open until Wednesday, November 13, 2019.

Sincerely,

John Visentin
Vice Chairman and CEO
Xerox Holdings Corporation

This saga will continue in the days and weeks to come. But, unlike Carl Icahn, I'm not in a position to "hedge" any bets on what the ultimate outcome will be.

UPDATE: It didn't take long for another development. Xerox issued a written response to HP just this morning (Thursday, Nov. 21 ) emphasizing the need for a clear path forward to complete mutual due diligence toward a friendly combination by 5 pm EST Monday, Nov. 25. If that doesn't happen, Xerox threatened it will take its case directly to HP shareholders by waging a hostile bid:

Dear Chip and Enrique,

We were very surprised that HP’s Board of Directors summarily rejected our compelling proposal to acquire HP for $22.00 per share, comprising $17.00 in cash and 0.137 Xerox shares for each HP share, claiming our offer "significantly undervalues" HP.  Frankly, we are confused by this reasoning in that your own financial advisor, Goldman Sachs & Co., set a $14 price target with a "sell" rating for HP's stock after you announced your restructuring plan on October 3, 2019. Our offer represents a 57% premium to Goldman’s price target and a 29% premium to HP’s 30-day volume weighted average trading price of $17.

Moreover, our offer is neither "highly conditional" nor "uncertain" as you state. There will be NO financing condition to the completion of our acquisition of HP.

While we are glad to see that HP's Board of Directors acknowledges the substantial merits of a business combination between Xerox and HP and are open to exploring the value opportunity for our respective shareholders, your response lacks a clear path forward. You have requested customary due diligence, which we have accepted, but you have refused to agree to corresponding due diligence for Xerox. Any friendly process for a combination of this type requires mutual diligence — your proposal for one-way diligence is an unnecessary delay tactic. In light of favorable markets and terms, Xerox is determined to capture the compelling opportunity for our respective shareholders and strongly encourages HP’s Board of Directors not to sanction further delay in light of our extensive discussions to date.

Xerox remains willing to devote the resources necessary to complete mutual due diligence over the next three weeks and confirm the substantial cost and revenue synergies that we both believe could be achieved through a combination.

The Xerox Board of Directors is determined to expeditiously pursue our proposed acquisition of HP to completion — we see no cause for further delay. Accordingly, unless you and we agree on mutual confirmatory due diligence to support a friendly combination by 5:00 p.m. EST on Monday, November 25, 2019, Xerox will take its compelling case to create superior value for our respective shareholders directly to your shareholders. The overwhelming support our offer will receive from HP shareholders should resolve any further doubts you have regarding the wisdom of swiftly moving forward to complete the transaction.

We look forward to your prompt response.

Sincerely,

John Visentin
Vice Chairman and CEO
Xerox Holdings Corporation

Stay tuned. Things are really heating up now!