What Does Xerox Bid Mean for HP Stock Approaching Earnings?

Younger investors may not realize this, but HP (NYSE:HPQ) stock was once a high-flier. The company, which launched its initial public offering in 1978, was one of the beneficiaries of the 1990’s tech boom. Anyone buying HP stock in 1990 would make as much as 20 times their money by the 2000 peak.

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The magic is long gone, however. HPQ stock has essentially gone sideways for the past 20 years. Furthermore, it split up a few years ago, making Hewlett Packard Enterprise (NYSE:HPE) a separate business. Hewlett Packard Enterprise got much of the more glamorous businesses such as consulting and cloud operations, while the original HP stuck with more traditional businesses such as computer printers.

While HP’s products business is a cash cow, there’s not much growth there, and so the HP stock price has languished. HPQ stock looked like a classic value trap, as it traded at a low price-to-earnings ratio and offered a strong dividend yield, yet the share price kept going down. Now, however, Xerox (NYSE:XRX) has shaken things up with a shocking offer to buy out HP. What does that mean for HP stock?

Will They Or Won’t They Merge?

Any discussion of Hewlett Packard’s upcoming earnings has to be viewed in light of the potential merger with Xerox. It’s unlikely that the next earnings report will make a big difference to HP stock one way or the other unless results are dramatically off from expectations.

The bigger question will be any updates on the potential merger process. The proposed merger is quite controversial. For one thing, it’s highly unusual for a firm as small as Xerox to take a run at HP. Xerox has a less than $9 billion market capitalization compared to HP at nearly $30 billion.

It’s not clear whether HP stock owners would want equity in a combined firm either. In some ways, this looks like a desperate effort from Xerox. That firm’s revenues have been down every year since 2011 despite a great economy. Hewlett Packard, by contrast, has grown revenues in recent years and appears to have more business lines that have future growth potential.

HP Rebuffs First Offer, But Is Open to a Higher Bid

On Nov. 17, HP’s board announced that it had unanimously voted down the Xerox takeover offer at $22 per share. It said that the $22 per share offer did not adequately compensate HP stock owners. Further, the board felt that the deal was not concrete enough, writing:

“In reaching this determination, the Board also considered the highly conditional and uncertain nature of the proposal, including the potential impact of outsized debt levels on the combined company’s stock,” the board wrote in a letter to Xerox’s CEO.

However, it’s clear that HP isn’t opposed to a deal altogether. And there’s a good reason why it can’t say no to Xerox entirely, but more on that in a second. In any case, HP left a clear opportunity for Xerox to make something happen if the parties continue looking into a potential partnership. The board added that:

“In addition, we believe it is critical to engage in a rigorous analysis of the achievable synergies from a potential combination. … With substantive engagement from Xerox management and access to diligence information on Xerox, we believe that we can quickly evaluate the merits of a potential transaction.”

Icahn Pushing for a Deal

Famed activist investor and billionaire Carl Icahn is angling to make sure that the deal does in fact go off. The Wall Street Journal reported that Icahn recently bought more than 4% of Hewlett Packard’s outstanding stock in an effort to help promote the potential deal. That’s on top of the more than 10% of Xerox that Icahn already owns.

As such Icahn will be able to influence events fairly dramatically, as he now owns a meaningful chunk of both companies in the potential merger. Hewlett Packard noted the Icahn purchase with a lack of enthusiasm, stating that: “We are aware of Carl Icahn’s investment and are committed to doing what is in the best interests of all HP shareholders.”

Regardless, Icahn is excited for a potential deal. Icahn gave his rationale, saying that in many cases, companies in declining industries, such as printing, don’t see their results fall off as quickly as the market expects. With that in mind, a merger of two rivals to cut costs and maximize profit margins would be ideal.

Regarding the structure of a merger, he is open to different types of deals, including HP being the buyer rather than Xerox. And while he’d prefer equity in the combined firm, he didn’t oppose a cash deal. In any case, he says the two merging is a “no-brainer.” This is particularly notable since Icahn doesn’t support all potential Xerox deals; last year, Icahn helped shoot down a potential merger of Xerox with Fujifilm.

HP Stock Verdict

There’s a lot to like about buying HP stock here as a potential trade. HP looks outright cheap here on a value basis. At around 9 times forward earnings and paying a 3.6% dividend, the company certainly rewards it shareholders. And HP was already planning another huge round of spending cuts to help maximize profits even more. While the company has struggled to grow as its traditional product lines slowly fade, there’s plenty of cash flow left to come for a good number of years.

So if there’s no deal, HP won’t sink like a rock. In fact HP stock had been trading around $20 for most of 2019 anyway, so the current price just under $20 seems most reasonable. And any sort of second offer from Xerox should send HP stock much higher. For example, Evercore’s Amit Daryanani gave Hewlett Packard a $24 price target Thursday, and suggested that Xerox may be able to pay as much as $26 per share to make a deal happen. Given that downside is modest, odds favor taking a long position here, though keep in mind that earnings are right around the corner.

At the time of this writing, Ian Bezek held no position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

Article printed from InvestorPlace Media, https://investorplace.com/2019/11/earnings-takeover-xerox-hp-stock/.

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