HP's shares, which popped two weeks ago after it was first learned that Xerox (with top shareholder Carl Icahn's blessing) was interested in buying the company, have dropped a little more than 1% to around $20 after the company rejected a $22.00-per-share, cash-and-stock offer on Sunday, while publishing Xerox's buyout offer in full.
In rejecting the offer, HP not only said -- as is typical in such rejection announcements -- that Xerox's offer "significantly undervalues" HP, but also noted that "the highly conditional and uncertain nature of [Xerox's] proposal, which depends on financing that Citi says it's confident it can arrange but hasn't yet been guaranteed." And understandably, HP also said it's worried about Xerox's revenue declines and "the potential impact of outsized debt levels on the combined company's stock."
As I noted after the first reports of Xerox's buyout interest emerged, Xerox hasn't seen a year of positive revenue growth since 2011. And given HP's own revenue growth challenges, as well as product overlap between the companies, potential integration challenges and the long-term, secular pressures facing the printer, copier and PC markets, it's fair to wonder how much the combined company will be able to grow its top line (if at all).
In addition, with Xerox's offer including $17 per share in cash, a deal would leave the combined company with about $32 billion in debt (not counting debt related to Xerox's financing operations), offset by just $6 billion or so in cash.
And between Xerox's current market cap (less than one-third of HP's current market cap) and the stock that would be issued as part of the deal, the combined company would (at Xerox's current stock price) only have an equity value of about $16.5 billion against that $26 billion or so in net debt.
Even with Xerox and HP currently throwing off more than $4 billion in annual free cash flow that could be used to pay down this debt over time, and Xerox saying it can achieve at least $2 billion worth of cost synergies within 24 months of a closing, this is a far-from-ideal net debt to equity ratio.
If everything goes swimmingly for the post-merger company -- i.e., if there aren't major execution issues, talent losses and/or share losses, if Xerox makes good on its cost synergy promises and its core printer and copier markets don't decline significantly -- then perhaps that debt load is a manageable one. But needless to say, there are quite a few "ifs" here, and HP's management, which has been executing pretty well from a product standpoint, is undoubtedly aware of this.
It's also possible that HP's management remembers all the issues that plagued the old Hewlett-Packard's acquisition of PC rival Compaq in the early 2000s. And how the biggest winner of this deal was arguably Dell, which gobbled PC market share at HP/Compaq's expense.
Notably, HP is still leaving the door open to striking some kind of deal with Xerox: The company says it recognizes "the potential benefits of consolidation, and...are open to exploring whether there is value to be created for HP shareholders through a potential combination with Xerox." HP has already signaled that it's open to a Xerox deal in which it would be the acquirer.
While such a deal would present many of the same execution, market share and revenue growth questions that a Xerox-led deal would, it would probably be on better financial footing, given how much more equity value there is for HP's stock compared with Xerox's.
And either way, HP certainly has a long list of reasons for saying "thanks, but no thanks" to Xerox's initial bid.