HP Inc.'s Decline Is Years in the Making as it Weighs Xerox Bid

HP Inc.’s printing division was once the envy of Silicon Valley for its billions of dollars in annual revenue and supersized profits. But in the increasingly digital world, consumers and companies are printing less, causing HP’s printing business to fade.

Last week, HP Inc. confirmed getting an acquisition offer from copy machine giant Xerox worth over $30 billion, a premium to HP’s market valuation. The massive deal would combine two venerable but troubled names in tech, in the hopes that they would be stronger together.

The takeover bid highlights the difficult position HP Inc. is in. If it rebuffs the deal, or any rival offer, it risks continued decline, while combining with another troubled company is also dangerous.

HP Inc. has “done the best they can” with its printing business, said Stephen Baker, an analyst at and vice president of NPD Group. “But they are pushing the rock up the hill.”

Until four years ago, HP Inc. was part of technology powerhouse Hewlett Packard, which sold everything from corporate servers to laptops to printers. The rise of cloud computing and the decline of the overall PC and printing market, in the end, took its toll.

Ultimately, Hewlett Packard executives decided to split their company into two smaller businesses under the theory they would be more nimble and therefore better able to compete in a changing technology landscape. Hewlett Packard Enterprise would be focused on selling corporate data center technology while HP Inc. would sell printers and PCs.

Dion Weisler, who led HP Inc. during most of its ensuing independence, managed to weather the rough market relatively well. Overall annual sales increased 13% to $58.5 billion over the three years ending in fiscal 2018.

Under Weisler’s leadership, sales in HP Inc.’s PC business rose 19% over that three-year-period to $37.7 billion. The company is currently the world’s second largest shipper of personal computers, ahead of Dell Technologies and Apple, but behind Lenovo, according to IDC. Meanwhile, prominent gadget reviewers said HP laptops have significantly improved in quality in recent years.

In a nod to investors, Weisler also cut costs, including firing thousands of workers.

Shares in the company, initially considered a lost cause, rose during Weisler’s tenure. Just before Xerox’s proposed bid earlier last week, HP Inc.’s shares had gained 26% since debuting in 2015.

Weisler also pushed HP Inc. into possible growth areas like 3D printing while also taking on ambitious graphic design projects for clients like Coca-Cola. However, it’s too soon to know when those initiatives will offset the declines in traditional printing.

In August, HP acknowledged trouble ahead by saying that third quarter sales in its printing unit had dropped 5% year-over-year to $4.9 billion and that declines would continue into the next year. Additionally, it said that printing supplies sales had fallen 7% in the quarter to $3.2 billion.

Analysts feared that the decline in printing supplies signaled that customers were increasingly buying cheaper ink from third-parties, potentially the kickoff to a painful long-term trend. HP’s printing unit, which makes most of its money from selling supplies like ink, has a higher profit margin than its PC division.

“So, the highest-margin part of this business, which has higher margins than the PC business, is now under siege.” Argus Research analyst Jim Kelleher told Fortune in October.

At the same time that HP Inc. announced its printing unit problems, Weisler said he planned to step down as CEO, citing a family health matter. Enrique Lores, HP’s printing chief, took over his role in November.

Enter Xerox with its surprise takeover bid, first reported by the Wall Street Journal. Xerox, which declined to comment to Fortune, has previously said that the printing “industry is long overdue for consolidation, and those who move first will have a distinct advantage.”

In a recent research note, Bernstein analyst Toni Sacconaghi, Jr. voiced skepticism about Xerox’s proposed acquisition. A deal centered on printing does little to change its downward spiral, he argued, nor does it eliminate the threat of Chinese companies supplying cheaper ink.

“The traditional printing and copying business is slowly collapsing,” Sacconaghi said in his note, which he ominously titled, “Xerox buying HPQ: Brilliance? A Dare? ‘Two Garbage Trucks Colliding?’”

Like HP Inc., Xerox is also in decline, with little investments in potential growth areas like 3D printing. From 2016 to 2018, Xerox’s sales fell 9% to $9.8 billion.

Sacconaghi also raised questions about whether Xerox could swallow a company of HP Inc.’s size. Xerox has a $8 billion market capitalization, making it difficult to secure enough financing to buy HP Inc., which has a market value of $31 billion.

Instead, Sacconaghi speculates that Xerox may be prodding HP Inc. to instead buy Xerox. Such a “deal would make A LOT more financial sense,” he said, because HP Inc. is healthier financially and wouldn’t need to raise a significant amount debt for an acquisition.

HP Inc. declined to comment to Fortune about Xerox’s proposed acquisition. Instead, it pointed to its original statement that said, “We have a record of taking action if there is a better path forward and will continue to act with deliberation, discipline and an eye towards what is in the best interest of all our shareholders.”

HP’s board has yet to make a decision about the Xerox deal, a source familiar with the matter told Fortune. That person added that HP is evaluating multiple business combinations, and won’t necessarily accept the one floated by Xerox.

Kristin Von Manowski, a senior research director at Gartner, said that a Xerox-HP Inc. merger would have a huge impact on the printing industry. The combined company would dominate while also increasing competition from many smaller players. In her view, the proposed acquisition would result in other smaller printing companies lowering their prices to compete with the larger HP-Xerox entity.

The result, Von Manowski said, would be “a new wave of price discounting.” If so, it would be bad news for the combined company, which would have to lower its prices, and for those small companies.

In the end, a merger “does not alter the very somber reality that the total addressable market for both PCs and print is in decline,” Von Manowski said.