UPDATE: Xerox Confirms It Will Launch Hostile Bid Attempt After HP Board Rejects Offer

Enrique Lores

HP Inc.'s board of directors didn't wait until the Monday, Nov. 25, 5 p.m. EST deadline imposed by Xerox Vice Chairman and CEO John Visentin, whereby Xerox threatened to bypass HP's board and mount a hostile takeover bid proxy targeting HP shareholders directly to endorse Xerox's $33.5 billion cash-and-stock ($22 per share, including $17 in cash) acquisition offer.

Instead, it issued the following public letter on Sunday, Nov. 24, which also cc'd Keith Cozza, who serves as chairman of Xerox Holdings and president and CEO of Icahn Enterprises L.P. :

Dear John,

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.

John Visentin

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 long-term 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.

On behalf of the Board of Directors,

 Enrique Lores                       Chip Bergh

Battle Between Xerox, HP Boards Continues to Heat Up

Here are some takeaways from HP's most recent, sharply worded, response:

Aside from its previous claims that Xerox's offer undervalues HP; that Xerox might be unable to raise the necessary cash; that a combined firm would be too highly leveraged from a debt standpoint, even if the financing were obtained; as well as pointing to Xerox's $1 billion in revenue declines during the June 2018-June 2019 period, the HP board of directors also raised some new concerns:

• The HP board indicated that the two companies had been in private discussions in August and September about the possibility of a merger, but that Xerox walked away. Not ruling out further merger discussion due diligence, the HP board countered that "there are significant concerns about both the near-term health and long-term 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."
• Given how much it says Xerox's business is based on contractual revenue, HP is concerned about the decline in customer Total Contract Value (TCV) in excess of revenue declines, which, the HP board noted, suggests Xerox's 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," the letter said.
• The HP board questioned Xerox's calculation of $2 billion in cost-saving synergies that Xerox says could be achieved by a merger during the next 24-month period. HP's board pointed out that each company had already announced cost reduction plans independently. On Oct. 3, HP Inc. announced a restructuring plan that it predicts will result in about $1 billion in annualized savings by the end of fiscal year 2022. As part of the plan, HP is reducing its global headcount of about 55,000 employees by 7,000 to 9,000 workers (13% to 16%), through a combination of layoffs and voluntary early retirement, during the next three years.
• When Xerox exited its long-standing Fuji Xerox joint venture in Asia with Fujifilm in a $2.3 billion agreement on Nov. 5, giving Fujifilm full ownership, the HP board contends that "Xerox essentially mortgaged its future for a short-term cash infusion. We fear that the exit has left a sizable strategic hole in Xerox's portfolio," the letter noted. "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."

Xerox Says It Now Plans to Follow Through on Its Hostile Bid

It only took two days for Xerox to issue a written response to HP's board, confirming that it intends to mount a hostile bid attempt, while also addressing what it considers to be misleading and inaccurate statements made by HP in its response.

Here is the letter John Visentin sent on Tuesday, Nov. 26:

Dear Chip and Enrique,

Your refusal to engage in mutual due diligence with Xerox defies logic.

We have put forth a compelling proposal – one that would allow HP shareholders to both realize immediate cash value and enjoy equal participation in the substantial upside expected to result from a combination. Our offer is neither “highly conditional” nor “uncertain” as you claim. It does not contain a financing contingency, and the combined company is expected to have an investment grade credit rating.

The potential benefits of a combination between HP and Xerox are self-evident. Together, we could create an industry leader – with enhanced scale and best-in-class offerings across a complete product portfolio – that will be positioned to invest more in innovation and generate greater returns for shareholders.

The market clearly understands the industrial logic of this transaction. HP and Xerox shares are up 9.5% and 6.6%, respectively, since the date our proposal was first made public. We have already received inquiries from several HP shareholders and are encouraged by their interest in our offer.

Nevertheless, rather than engage with us in three weeks of customary mutual due diligence, HP continues to obfuscate and make misleading statements. It is important that we correct, for your benefit and that of HP’s shareholders, a few of the mischaracterizations from your last letter.

• On February 5, 2019, Xerox announced a three-year strategic plan that was built on four initiatives: (i) optimizing operations, (ii) driving revenue, (iii) reenergizing innovation and (iv) focusing on cash flow and capital returns. We are already outperforming this plan. Through the first nine months of 2019, we have increased our guidance for adjusted earnings per share and free cash flow while also increasing investments in innovation and our core business, which is why our stock is up 96% year-to-date.
• Your comment regarding total contract value is little more than a diversion. Your own public disclosure states that backlog information is “not a meaningful indicator of future business prospects” or “material to an understanding of our overall business.”
• It is possible that the modest, expensive and time-consuming cost savings included in the restructuring plan you announced on October 3, 2019 (only $1 billion over three years at a cost of $1 billion in restructuring charges), has resulted in a lack of confidence in HP’s ability to realize the $2+ billion of synergies your team previously agreed could be achieved in a combination.
• We monetized our illiquid interest in Fuji Xerox at over 20 times 2019 expected aggregate cash flow while favorably restructuring the terms of our sourcing relationship with Fuji Xerox to ensure continuity of supply, protect our high-value intellectual property and provide strategic flexibility. There is no “hole in Xerox’s portfolio” as a result of those transactions – just significantly more cash to support growth and greater flexibility in our sourcing terms.

While you may not appreciate our “aggressive” tactics, we will not apologize for them. The most efficient way to prove out the scope of this opportunity with certainty is through mutual due diligence, which you continue to refuse, and we are obligated to require.

We plan to engage directly with HP shareholders to solicit their support in urging the HP Board to do the right thing and pursue this compelling opportunity.

Sincerely,

John Visentin
Vice Chairman and CEO
Xerox Holdings Corporation

Silent, for now, is activist investor Carl Icahn, who owns a 10.6% controlling stake in Xerox and, more recently, who acquired a 4.24% stake in HP Inc., worth $1.2 billion. Icahn has been quoted earlier that a combination between the two companies in any form is a "no-brainer." But, given his behind-the-scenes power within Xerox, one can be sure that Icahn approves of Xerox's latest aggressive move.