Could Rising PC Sales Force Xerox to Raise Its Bid for HP?

Global shipments of PCs grew 2.7% in 2019, according to IDC, marking the industry's first full year of growth since 2011. Microsoft's decision to end support for Windows 7 this January sparked enterprise upgrades to Windows 10 PCs, CPU shortage concerns eased as AMD picked up Intel's slack, and new convertible and gaming PCs gained momentum.

That growth sounds promising for top American PC maker HP (HPQ -0.46%). However, investors should recall that HP has been trying to fend off a hostile bid by Xerox (XRX) since last November. Could rising PC sales force Xerox to raise its bid?

Previously on Xerox vs. HP...

Xerox approached HP with an unsolicited takeover bid at $22 per share in late November. The proposed $33 billion offer would give HP investors $17 in cash and 0.137 shares of Xerox per HP share.

Image source: Getty Images.

The bid was surprising, since Xerox was smaller and would need to shoulder a lot of debt to close the deal. HP's board unanimously rejected Xerox's offer on Nov. 17, stating that it "significantly undervalues HP and is not in the best interests of HP shareholders."

Analysts also questioned Xerox's ability to secure enough capital to close the deal. But on Jan. 6, Xerox announced that it had secured $24 billion in funding from Citi, Mizuho, and Bank of America.

On Jan. 23, Xerox announced that it would nominate eleven independent candidates to replace HP's board of directors at its annual meeting. HP dismissed the move as a "self-serving tactic" that "creates meaningful risk to the detriment of HP shareholders."

HP also claimed that Xerox's decisions were "being driven" by activist investor Carl Icahn, who owns a 10.6% stake in Xerox and a 4.2% stake in HP, according to The Wall Street Journal. HP claims that Icahn would "disproportionately benefit from an acquisition of HP by Xerox at a price that undervalues HP."

Reviewing HP's core business

HP's personal systems (notebooks, desktops, and workstations) generated 68% of its revenue last quarter. The rest came from the printer business, which sells hardware and supplies. Both units struggled over the past year, but the printing unit grew at much slower pace than its PC business.

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

HP's notebook and desktop shipments both grew during the fourth quarter, and lower component prices and tighter cost controls boosted the unit's operating margin year-over-year. Its consumer revenue dipped 4%, but that decline was offset by its 8% growth in commercial revenue -- which supports IDC's comments about enterprise upgrades.

HP's printing business, however, remains in dire shape, with tumbling shipments of commercial and consumer units, sliding supplies revenue, and declining operating margins. Long upgrade cycles are curbing sales of new printers, while competition from generic suppliers is crushing demand for its higher-margin ink and toner.

Image source: Getty Images.

The bears claim that that ongoing decline, which HP is trying to reverse with its Instant Ink subscription service, will flatten the company's growth and overwhelm its PC division. Proponents of Xerox's takeover of HP, including Icahn, believe that merging the two companies' printing businesses would offset their ongoing declines with economies of scale and cut costs. The merger could also accelerate the development of new 3D printing technologies.

Could rising PC sales make HP more attractive?

Stabilizing PC sales don't really give HP a better hand, for two simple reasons.

First, HP expects its personal systems revenue to decline "above the normal seasonal patterns" in the first quarter on a sequential basis. It also warned that its CPU supply would remain "constrained" in the first half of 2020, and that commodities would be "significantly less of a tailwind" in 2020 than 2019. Those warnings indicate that the momentum from Windows 10 upgrades will likely fade over the next few quarters.

Second, Xerox isn't really focusing on HP's PC business. It wants to merge its printing business with HP's, and believes that HP -- which hasn't offered any solid turnaround plans for the printing business beyond Instant Ink and price hikes -- also needs to strike a deal.

Therefore, Xerox will likely keep pursuing HP, but IDC's latest report on PC sales probably won't force it to raise its offer. But if the stalemate continues, Xerox might consider alternatives -- like pivoting toward an all-cash offer -- to ramp up the pressure.