Value Investing

Icahn Opposes ‘Fuji’s Scheme to Take Control of Xerox “Without Spending a Penny”’




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Xerox’s Two Largest Individual Shareholders Oppose Fuji’s Scheme to Take Control of Xerox “Without Spending a Penny”

New York, New York, February 12, 2018 – Today Carl Icahn and Darwin Deason released the following open letter to the shareholders of Xerox Corporation (NYSE: XRX):


Fellow Shareholders:


Last week, Xerox and Fuji announced a scheme to transfer majority ownership and control of Xerox to Fuji in a transaction that dramatically undervalues Xerox and disproportionately favors Fuji. The transaction has a tortured, convoluted structure, but it was best summarized by Shigetaka Komori, Fuji’s Chairman and CEO, when he boasted to the Nikkei Asian Review that the “scheme will allow us to take control of Xerox without spending a penny.”


It really is a remarkable achievement by Fuji. Without putting up any cash, they will acquire majority control and ownership of a venerable American icon. In exchange, we – the existing Xerox shareholders – will receive (1) an additional, indirect 25% interest in a Fuji subsidiary that just last year disclosed a $360 million accounting scandal caused by a “culture of concealment”[i] and Fuji’s failure to have adequate management systems and (2) a one-time special dividend financed with our own assets.


There are a number of critical facts that we – the existing Xerox shareholders – must keep in mind as we evaluate this transaction. As a starting point, we must understand that if this deal is consummated we will no longer be Xerox shareholders. Rather, we will be passive minority owners of a Fuji subsidiary – virtually powerless with respect to the future direction of our investment, with no opportunity to ever receive a true control premium for our shares. The structure reminds us of a timeless anecdote about two brothers who are bequeathed a vast estate. The older brother receives a 50.1% controlling stake and an instruction to keep the interests of his younger brother in mind. The younger brother receives a 49.9% minority stake and assurance that his older brother has been directed not to abuse his controlling position. Fast forward a few years, and you’ll find the older brother living in a mansion and driving a Rolls-Royce while the younger brother lives in a shack and drives an old beat-up hatchback. Like the younger brother in that anecdote, we are similarly being asked to hope against hope that the meager minority protections negotiated by the Xerox Board of Directors will be sufficient to protect us against tyranny and abuse by our new controlling stockholder Fuji. However, we believe the history of interactions between Fuji and Xerox – until recently shrouded in mystery – should make all Xerox shareholders extremely skeptical that oppression of the minority will not occur in the future. Additionally, last year’s massive accounting scandal at Fuji Xerox should make us all extremely nervous (to say the least) about trusting Fuji with our capital.


Beyond the issues of control and governance of our investment going forward, the fundamental economics of this transaction also disproportionately favor Fuji at our expense. When we sketch out the financials of the deal, this is our conclusion: we – the existing Xerox shareholders – are selling approximately $535 million of normalized annual recurring cash flow[ii] for about $1.25 billion[iii]. In other words, we are selling control of Xerox for a cash flow multiple barely exceeding 2.3x. In addition, we are also surrendering half of all potential future dividend growth. When considered with these economics in mind, the transaction looks like another depressing display of incompetence by a Xerox Board of Directors with no real skin in the game.


The purported justification for the paltry (and downright offensive) cash flow multiple is $1.7 billion in projected total cost savings that we will supposedly realize as minority owners of a Fuji-controlled Xerox. However, as they sang in Porgy and Bess, “it ain’t necessarily so.” In order for the projected synergies to be realized, Fuji will need to smoothly integrate Xerox, and if history is any guide, that integration will be anything but smooth (as the Nikkei Asian Review pointed out after interviewing Komori, “Japan’s corporate history is littered with stories about foreign takeovers going awry.”). Xerox itself acknowledges in the press release announcing the deal that we should not assume that the projected synergies will ever be achieved,[iv] and the reality is that the most readily achievable synergies – the ones we can actually be confident will be realized – are cost savings that could and should be achieved without consummating this transaction. To wit, it is common knowledge that the Fuji Xerox joint venture has yet to undergo any sort of significant restructuring (which, in and of itself, casts further doubt on Fuji’s management capabilities), and as a result, there is substantial low hanging fruit that could be captured with a thorough cost cutting program at that level, which would benefit both Fuji and Xerox independently without this transaction. But even if you assume we are 100% wrong about the projected synergies – even if you assume that all of the purported synergies will be achieved and would not otherwise be possible in the absence of this transaction – that still cannot possibly justify giving away control (which we cannot emphasize enough, can only happen once) without receiving a premium.


Sadly, as we all know, this is not the first time Xerox has negotiated a dreadful deal with Fuji. In connection with the deal announcement, Xerox finally disclosed the agreements governing the Fuji Xerox joint venture – agreements we believe they have intentionally withheld from shareholders for years despite clear legal rules requiring disclosure.[v] Even a cursory review of these documents lays bare a critical fact that Xerox has hidden from its investors and the market for the last 17 years (yet, curiously enough, now uses to justify why we have no choice but to accept this deal) – the joint venture agreements severely limit Xerox’s ability to pursue transformative strategic transactions (both on the buy side and sell side). That critical fact is the primary reason why last year’s massive accounting scandal at Fuji Xerox is so significant – it presents by far the best opportunity to date (as far as we can tell) Xerox has ever had to get rid of this albatross. Because the myriad failures at Fuji that led to the massive accounting scandal almost certainly rise to the level of being a material breach of the joint venture agreements, Xerox could and should exercise its rights to terminate the agreements effective immediately, thereby gaining for itself unfettered access to a $36 billion Asia-Pacific market, including sole right to use the Xerox name and intellectual property in the region. It would be catastrophic for Fuji’s printing business and a fantastic opportunity for Xerox to expand for its own benefit.


Nevertheless, as has been the case at Xerox throughout the past two decades, rather than pursue something challenging that could yield tremendous returns, the Board of Directors appears to have taken the path of least resistance and acquiesced to Fuji based on the advice of self-interested executives and advisors. But we demand – as is our right – accountability for these decisions. We demand complete and detailed disclosure of the advice given to the Board of Directors regarding terminating the joint venture, including copies and detailed explanations of all financial models and projections contemplating Xerox operating independently in a growing Asia-Pacific market. We demand complete and detailed disclosure of the efforts taken by Xerox to terminate (or even renegotiate) the terms of the joint venture as a result of last year’s massive accounting scandal at Fuji Xerox. We demand complete and detailed disclosure of the steps taken by Xerox and its advisors to solicit and evaluate indications of interest from parties other than Fuji during the 46 days they spent negotiating this transaction, including a description of the feedback received from each contacted party regarding the change of control provisions in the joint venture agreements.


Despite decades of mismanagement, Xerox is still an iconic brand with a valuable portfolio of over 12,000 patents and an impressive list of loyal customers. As the original pioneer in the copier space, the Company has historically been #1 in terms of market share across multiple segments in an $85 billion addressable market, including large enterprise Managed Print Services (MPS) and Centralized Print Services, A3 Multi-Function Printers (MFPs) and Production Cut Sheet (Color and B&W). However, because of poor corporate management and a “do nothing” Board of Directors, Xerox has failed to keep pace with the market. Consumers and businesses have changed. Digital adoption has paved the way for increased collaboration between people and groups. The way we share information has evolved, and instead of leading the digital transformation, Xerox’s complacency has provided an opening for competitors to eat away at its market share in A3 MFPs and high-end production, while Xerox chased the A4 MFP market, where it had to play catch-up to stronger and more established competitors. That critical error has been evident over the past three years as revenue and margins have continued to decline.


Nonetheless, there is still great opportunity for Xerox to create enormous value for shareholders, and it does not involve selling control to Fuji without a premium. Rather, it entails freeing the company from the shackles of the Fuji Xerox joint venture and bringing in leadership with the vision and operational expertise to revive the company – leadership that will, among other things, (i) reinvigorate the portfolio towards software, security and services while maintaining the existing dominant market share position by leveraging the company’s strong position in the higher-end enterprise market, (ii) focus the distribution and channel networks to target and grow sales to small and medium sized businesses (the current model creates channel conflict with competing sellers, thereby diluting their differentiation, incurring duplicative operating expenses and sacrificing margin), and (iii) optimize the organizational and operating structure to be more competitive. While the current management team has presented cost-cutting measures to offset the current revenue trajectory of “mid-single digit” annual declines, so far that has not translated into improved operating margins. As a result, there’s likely significant potential for value creation simply by reevaluating the current cost structure and identifying cost savings that will actually impact the bottom line. But beyond portfolio reinvigoration, focused distribution and cost-cutting, Xerox desperately needs (and this is another point that cannot be emphasized enough) leadership that can develop a strategy to commercialize and monetize the intellectual property developed at PARC. Xerox PARC scientists have been responsible for some of the world’s most notable technological innovations, including the modern personal computer, the graphical user interface (featuring windows and icons) and the mouse. Yet Xerox squandered those opportunities, even as the innovations themselves spawned entire new platforms and industries – turning people like Steve Jobs and Bill Gates into household names. New leadership, both in the C-suite and on the Board of Directors, could ensure that those types of opportunities never get squandered again.


However, none of the above-described value creation will be possible if we – the existing Xerox shareholders – allow this Board of Directors to cede control of our company to Fuji. Nor will it be possible if we simply vote the deal down and allow this Board of Directors to remain in control of Xerox. They have proven time and time again to be nothing more than ostriches burying their heads in the sand while the world slowly falls apart around them. They kept Ursula Burns on as Chairman and CEO for years after it was obvious to everyone else that she was not up to the task (indeed in 2014 she was ranked number 4 on Time Magazine’s list of “9 CEOs With the Absolute Worst Reputations”). And when she finally agreed to retire the Board amazingly gave the job to Jeff Jacobson, one of her acolytes. Now, when it should be clear that Xerox must act quickly to remove and replace Jeff Jacobson and move away from Fuji, this Board of Directors has instead doubled-down on both.


To put it simply, the current Board of Directors has overseen the systematic destruction of Xerox, and, unless we do something, this latest Fuji scheme will be the company’s final death knell. We urge you – our fellow shareholders – do not let Fuji steal this company from us. There is still tremendous opportunity for us to realize value on our own if we bring in the right leadership.

Vote against the Fuji scheme to send a clear message that we will not be fooled into giving up control of our company for $9.80 in cash.

Sincerely yours,

Carl Icahn           Darwin Deason