There's something amusing about the idea of Xerox (XRX) -- a company whose researchers once came up with major innovations that would help underpin the PC industry, but largely failed to monetize them -- making a buyout offer for one of the world's biggest PC makers several years after PC sales peaked.
There's also, arguably, something desperate about such a move, given Xerox's performance over the last 20 or so years, HP's recent struggles and the giant financial hurdles a buyout attempt would have to clear.
According to The Wall Street Journal, the struggling copier and printer maker is thinking about making a cash-and-stock bid for HP Inc. (HPQ) -- owner of the old Hewlett-Packard's PC and printing businesses -- at some kind of premium to HP's Tuesday close. The paper added that Xerox has received an "informal funding commitment" from an unnamed major bank, albeit while also saying that no formal bid has yet been made.
HP's shares, which were battered in early October after the company announced major job cuts shared downbeat commentary about demand at an analyst meeting, are up around 7% in Wednesday trading. Xerox's shares are up about 4%.
As many others have noted, financing a bid for HP could be far from easy for Xerox, even if a portion of the offer is in stock. Excluding debt held by its hardware-financing arm, Xerox has an enterprise value (market cap plus net debt) of just $9 billion. HP, by contrast, currently has an enterprise value of $31 billion.
Xerox is (as noted by the WSJ) set to receive $2.3 billion from the sale of a 25% stake in a joint venture with Fujifilm. And with Xerox and HP producing more than $4 billion in annual free cash flow (FCF) between them -- a number that Xerox would undoubtedly try to grow with the help of cost savings -- Xerox is likely wagering that it can use the substantial cash flows the post-merger company would produce to pay down the debt it would need to raise to finance an HP deal.
However, once the initial cost synergies provided by an HP deal have run their course, keeping the post-merger company's free cash flow steady (never mind growing it) could prove a tall order. The integration challenges posed by combining two companies of this size are bound to be an issue. So are product overlap in the corporate printer and A3 copier markets, and (importantly) the top-line pressures that both HP and Xerox are facing.
HP is five weeks removed from forecasting fiscal 2020 (ends in Oct. 2020) FCF of "at least $3 billion." Even after accounting for restructuring costs forecast to impact FCF by up to $400 million, the outlook suggests fiscal 2020's FCF will be well below an estimated fiscal 2019 level of $4.29 billion.
The secular pressures faced by HP's printing business, which produces the lion's share of its operating profit, remain a major headwind, as digital document and photo-sharing continue eating into demand for both printers and printing supplies. HP noted at its analyst meeting that it expects its lucrative printing supplies revenue to drop in fiscal 2020, and (against a backdrop of diminishing supplies consumption) it will only offer subsidized prices for printers that can't use third-party ink.
HP's PC business is in somewhat better shape: Like Dell Technologies (DELL) and Lenovo, HP has been taking share from smaller PC OEMs and has gotten a lift this year from a business PC upgrade cycle. But PCs account for less than a third of HP's operating profit, and a look at industry sales over the last decade shows why one can't count on meaningful growth from this market over the long run.
Xerox, meanwhile, hasn't delivered a year of positive revenue growth since 2011, thanks to both secular and competitive headwinds in its copier and printer businesses. And though Xerox's stock has rallied this year with the help of improved financial execution under new CEO John Visentin, it's still roughly flat over the last five years and below where it was back in 2007.
All of this helps explain why Xerox -- presumably with the blessing of Carl Icahn, who owns a 10.6% stake in the company -- is reportedly mulling a go-for-broke bid for a much larger rival. While there's a long list of reasons why a Xerox-HP pairing could flounder, Xerox's leadership might feel that attempting such a move is a better option than resigning their company to a continued, long-term decline.