Here's How Xerox Would Finance a Deal With the Much Larger Hewlett-Packard

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Xerox (XRX) - Get Report is reportedly buying Hewlett-Packard(HPQ) - Get Report and at first glance, the deal looks tough for the much smaller Xerox to pull off. 

Before we take a look at how Xerox would finance the acquisition, let's review the news first. 

Xerox is considering making an offer to Hewlett-Packard, according to a Wall Street Journal report. The Xerox board has apparently been kicking around the possibility, according to people familiar with the matter. 

Shares of HPQ rose 9.46% to $20.14 on the news Wednesday, while Xerox shares rose 2.53% to $37.28. 

But if Xerox's market capitalization is $8 billion, less than one-third the size of $29 billion HPQ, how would Zerox deliver more than $30 billion of dollar value to HPQ? Unsurprisingly, Xerox doesn't have even half the amount of cash of HPQ's equity value on its balance sheet. Xerox's cash pile, as reported in its latest earnings release, is $922 million. 

Well, making the cash situation slightly better is the reported sale of Xerox's stake in Fujifilm (FUJIY) , which would bring $2.3 billion of cash into Xerox. 

But this still leaves north of $20 billion of value to be delivered to HPQ. The transaction is reportedly cash and stock, which also lessens the cash burden on Xerox, but unless HPQ shareholders want to become major shareholders of Xerox, which would then own, Xerox can't use that much stock. 

The last leg of the transaction would be through debt. Hours after an Evercore analyst said Xerox could either issue debt or even some new equity to finance the purchase, Bloomberg news broke that Xerox has secured debt financing from Citigroup. 

So the acquisition now seems feasible. 

But this isn't without risk. Xerox, which has seen its stock move nowhere since 2014 when it traded at $37 in 2014 and decline from $50 in 2007, has a junk credit rating, according to Moody's. Xerox has seen its legacy business spiral over the decades, as the proliferation of the internet business has made the printer business close to obsolete.

Now, Xerox's roughly $4.8 billion in total debt is 40% of its total enterprise value (market cap plus debt minus cash). That's very high, which means the deal would have to be significantly value added to Xerox, or else the debt burden would worsen the credit profile. Fortunately, the Evercore analyst says the deal would be accretive to Xerox's earnings, but the question is how accretive? 

Xerox needs to grow its EBITDA (earnings-before-interest-tax-depreciation-amoritization) in order to cover its interest expense and right now, analysts polled by FactSet expected the company's EBITDA to decline from $1.62 billion in 2019 to $1.603 billion by 2021. 

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