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Dilantha De Silva
Dilantha De Silva
Articles (182)  | Author's Website |

Carl Icahn Faces a Rare Defeat as Xerox Withdraws HP Bid

The guru's attempt to merge HP and Xerox failed on March 31, but this might be good for investors

April 01, 2020 | About:

Investors associate Carl Icahn (Trades, Portfolio) with activist moves that drive radical changes in companies that he takes an interest in. As recently as last week, I published an article outlining how the guru forced Occidental Petroleum to agree to his demands, including significant pay cuts.

Despite his stellar track record, Icahn lost a battle with HP Inc. (NYSE:HPQ) on March 31 as Xerox Holdings Corporation (NYSE:XRX) put an end to its takeover attempt of its larger rival. The guru has been pushing HP to accept the more than $30 billion tender offer for over five months, but the board of directors has been resilient to changes.

This, however, opens an opportunity for Icahn to bid for HP shares himself, which I think is a very real possibility going by his recent remarks, which I will discuss later in this analysis. On the other hand, the failure of this deal to go through might be beneficial to shareholders of both the companies as well.

The background

Xerox approached the board of HP in November 2019 with an offer of $33.5 billion, only to be firmly rejected. This triggered a proxy war between the two tech giants that went on until Tuesday. Carl Icahn (Trades, Portfolio) owns 11% of Xerox and 4.2% of HP and is the largest shareholder of the former. On December 4, the guru sent an open letter to HP shareholders urging them to vote in favor of the deal and pointed out that synergies could amount to as much as $2 billion as a result of this transaction. The guru wrote:

“Over the years, I have seen many obvious no-brainers that would greatly enhance value and have worked hard to facilitate these, but I can say without exaggeration that the combination of HP and Xerox is one of the most obvious no-brainers I have ever encountered in my career – one where activism should not even be necessary at all because the merits of the combination are so obvious to everybody involved.”

The $24 per share offer by Xerox, however, did not sit well with the HP management. The share price of both these companies, on the other hand, has declined significantly in the last five months, driven more recently by the broad market volatility created by the Covid-19 pandemic.

Source: GuruFocus

As the unsolicited bid by Xerox came to an end on March 31, the company released a statement, in which the CEO wrote:

“There remain compelling long-term financial and strategic benefits from combining Xerox and HP. The refusal of HP's Board to meaningfully engage over many months and its continued delay tactics have proven to be a great disservice to HP stockholders, who have shown tremendous support for the transaction.”

Now that the deal is history, investors need to get a measure of what to expect from both these companies in the future.

Mergers and acquisitions can fail too

More often than not, investors assume that business combinations always create value for shareholders, which is not true. There have been many instances where such deals erased billions of dollars in value, and a few noteworthy ones are listed below.

Companies involved

Year the deal was announced


New York Central and Pennsylvania Railroad


Just two years into the merger, Penn Central, the new business entity, filed for bankruptcy. This was the largest corporate bankruptcy in American history at the time.

Quaker Oats and Snapple


Quaker acquired Snapple for $1.7 billion in 1994, only to sell the entire stake for just $300 million two and a half years later.

Sprint and Nextel Communications


Soon after the merger, top-level executives of Nextel started leaving the combined entity citing cultural differences, and troubles continued for three more years until Sprint wrote off $30 billion in one-time losses due to impairment of goodwill.

Source: Company filings and Investopedia

This is not to claim that a merger between HP and Xerox would have eventually failed, but there’s reason to believe that there are a few discrepancies, mainly related to the companies’ business operations and the balance sheet structure.

First, the two companies operate in two different business segments. While HP generates the bulk of its revenue from the sale of personal computers (though the bulk of net income still comes from printers and related services), the sale of large printers accounts for the lion’s share of Xerox’s revenue, and Xerox does not have a PC business. This would have made it difficult for the combined entity, as different strategies and marketing campaigns are required to drive the revenue of these two business segments.

Second, Xerox had planned to fund part of the transaction through a credit facility of $24 billion. The company already has $3.2 billion in long-term debt, and the debt-to-equity ratio from this alone is already high.

Source: GuruFocus

If the deal went through, the ratio of debt-to-equity would have deteriorated considerably, and the combined entity would have had to bear the consequences. Even though PC sales might receive a boost from work-from-home policies due to quarantines around the world, sales would be impacted negatively if the U.S. enters a recession. Therefore, the merger of these two companies would have been very risky for investors as realizing synergies would be difficult if the global economy does not grow for a prolonged time.

Icahn might still consider buying HP

From the remarks made by the guru in his open letter to shareholders, it’s evident that he believes in the ability of HP to deliver attractive returns to investors in the long run. Icahn, reportedly, has already revealed his interest in bidding for HP shares himself if the Xerox deal fails, which it did.

On Feb. 27, HP filed a document with the Securities and Exchange Commission confirming this. According to the filing, Carl Icahn (Trades, Portfolio), in a phone call with then-chief executive officer Dion Weisler on Aug. 12, 2019, made remarks about bidding for HP shares on his own.

Now that the Xerox deal is off the table, the guru might consider other options to take control of HP.

Takeaway: it’s a loss for Icahn, but investors might be better without the deal

One of the most common mistakes investors commit when following legendary investors is assuming their investment objectives, investment time horizon and financial circumstances are similar to that of gurus. As an activist investor, Icahn might have had various plans in place to get the best out of the potential business combination between HP and Xerox. However, investors might do well even in the absence of a deal.

HP officials, on the other hand, believe that Xerox did not offer a fair price. In a letter sent to Xerox on November 24, 2019, HP's CEO Enrique Lores wrote:

“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.”

Enrique went on to highlight a few facts regarding the financial performance of Xerox that raise the doubts of a successful merger. The below is an excerpt from the letter.

“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."

These doubts raised by the HP CEO give reason to believe that the two companies might be better alone than together, which is a good outcome for shareholders. Chances are that both HP and Xerox will make headlines in the next couple of months, as Icahn might push for changes. I believe that long-term investors, on the other hand, should stay invested, as both these companies have the potential to deliver attractive long-term returns along with the increase in connectivity expected in the coming years.

Disclosure: I do not own shares of any company mentioned in this article.

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About the author:

Dilantha De Silva
I am an investment professional with 5-years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment-related content.

I\\\'m a CFA level 3 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). I am a registered candidate for the Chartered Wealth Manager program as well. During my free time, I enjoy reading.

Visit Dilantha De Silva's Website

Rating: 4.0/5 (1 vote)



Praveen Chawla
Praveen Chawla premium member - 1 year ago

It looks like a tactical retreat driven by the current bear market. Once this crisis is over Icahn may be back. Both these companies are selling at very low multiples.

Dilantha De Silva
Dilantha De Silva - 1 year ago    Report SPAM

Thanks for sharing your view, Praveen. I totally agree with you. I'm factoring in the possibility of a comeback by Icahn, either through a new bid from Xerox to acquire HP or maybe he will go solo. There's no doubt in my mind that both these companies will do really good in the long run, it's just that I don't feel so good about a business combination. For Icahn, being an activist investor, it's a different story. For me, as a retail investor looking for a negligible stake at either one of these companies, it's another story. I'd rather prefer the companies on their own rather than as one entity but Icahn is known to create value as well. Let's see where we get from here.

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