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HP Investors Should See Xerox’s Bid as a Selling Opportunity

By Leo Sun - Nov 8, 2019 at 10:52AM

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The proposed $33 billion merger won’t breathe new life into either aging tech brand.

Xerox ( XRX ) recently made a $33 billion cash-and-stock offer to acquire HP ( HPQ 0.97% ) for $22-$23 per share. That offer was stunning, since HP's market cap is roughly triple the size of Xerox's, and Xerox would need to take on significant debt to finance the deal, which will reportedly consist of 77% cash and 23% stock.

HP confirmed Xerox's bid but didn't confirm the price. In a statement, HP declared that it would approach the offer "with an eye toward what is in the best interest of all our shareholders."

I personally doubt that Xerox can pull this deal off since its initial offer only values HP at 10 times next year's earnings and it doesn't have much room to raise its bid. However, I think Xerox's bid might represent an exit opportunity for HP's investors.

Two figures push together two jigsaw pieces.

Image source: Getty Images.

What happened to HP?

Last quarter, HP generated two-thirds of its revenue from its personal systems business, which sells PCs and workstations, and the rest from its printers business, which sells hardware and supplies. The growth of both businesses slowed to a crawl over the past year.

YOY revenue growth

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Personal Systems


















YOY = Year-over-year. Source: HP quarterly reports.

Its PC sales decelerated due to longer upgrade cycles, competition from mobile devices, sluggish enterprise spending, and a CPU shortage at Intel. The printer business also struggled with longer upgrade cycles, weaker enterprise spending amid macro challenges, and lower sales of ink and toner.

The personal systems unit's operating margin rose 170 basis points annually to 5.6% last quarter, thanks to tighter cost controls and lower costs for certain components like hard drives and memory chips. However, the printing unit's operating margin contracted 40 basis points to 15.6% as sales of its higher-margin supplies declined amid tougher competition from generic ink and toner suppliers.

HP is struggling to counter those competitors with its Instant Ink subscription program, but that effort hasn't moved the needle yet. Meanwhile, its efforts to scale up the printing unit -- via its acquisitions of Samsung's printing unit and the office equipment dealer Apogee, along with its development of new industrial 3D and textile printers -- are causing its expenses to rise.

An industrial 3D printer.

Image source: Getty Images.

HP's recent moves also don't inspire much confidence in its future. CEO Dion Weisler, who led the company since its split with Hewlett Packard Enterprise in late 2015, stepped down earlier this month to attend to a "family health matter."

HP also announced that it would cut up to 9,000 jobs -- or 16% of its global workforce -- over the next three years to cut its annual costs by $1 billion. The company's new CEO, Enrique Lores, was previously the head of the printer division, so it's doubtful that he'll bring any fresh ideas to the table.

Instead, it's likely that HP will focus on boosting its EPS with buybacks instead of meaningful revenue growth. That's why analysts expect its revenue to dip 1% next year but for its EPS to improve 1%.

I don't want to own shares of Xerox, either

HP's growth rates are anemic, but Xerox's revenue and earnings are both expected to decline next year. Xerox believes that buying HP will create a printing behemoth that can generate up to $2 billion in cost synergies -- but it's unlikely that merger will generate organic growth for either tech giant.

I personally own shares of HP, but I don't want any shares of Xerox. The company has admittedly improved under new CEO John Visentin, who recently resolved its lengthy legal disputes with its joint venture partner Fujifilm and finally dumped its 25% stake in the JV for $2.3 billion. But Xerox's core businesses (sales; services, maintenances, and rentals; and financing) all remain weak, and it's too heavily dependent on cost-cutting measures to drive its earnings growth.

HP's investors would also end up owning less than half of the combined company, which leaves its core PC business -- which was meticulously revived by Weisler -- at the mercy of Visentin's cost-cutting strategies.

The key takeaway

I'm not saying investors should sell their shares of HP right away. However, its printing supply business is still festering like an open wound, and Xerox's takeover bid might temporarily lift the stock and give investors a rare opportunity to sell the stock.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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