HP CEO Lores on Coronavirus, the Future of the PC Business, and the Xerox Bid That Won’t Die

And, of course, Lores has been at the forefront as HP (ticker: HPQ) battles a hostile tender offer and proxy fight by Xerox Holdings(XRX), a company a fraction of HP’s size.

A native of Madrid with a bachelor’s degree in electrical engineering from the Polytechnic University of Valencia and an M.B.A. from Esade Business School in Barcelona, Lores has been with HP since joining as an intern in 1989. Before his recent ascent to the top spot, he ran the company’s printing business, steering the company’s 2017 acquisition of Samsung Electronics’ (005930.Korea) printing business. He also played a key role in the separation of the old Hewlett-Packard into two separate companies: HP Inc. and Hewlett Packard Enterprise(HPE).

Barron’s recently sat down for a chat with Lores in the company’s historic HP Laboratories building in Palo Alto, Calif., where the old offices of founders Bill Hewlett and David Packard are still preserved for posterity—and where the company’s engineers continue to develop new tech printing and PC technologies. Among other things, Lores discussed why HP is so opposed to the Xerox bid—and why HP might want to turn around and buy Xerox.

Barron’s: Enrique, let’s start with Xerox. You’ve repeatedly rejected their takeover bid as too low. But you’ve also said you see value in consolidating the printing business and that you’re willing to talk to Xerox about potential deals. Given they’re unlikely to raise their offer, that suggests you might want to buy Xerox. Can you explain your thinking?

Lores: When we look at the print market, especially in the office space, we don’t see significant growth going forward. But there are many competitors—and there is going to be consolidation. And when you drive consolidation by reducing costs, you create value. Three years ago, we bought the Samsung printing business. We drove consolidation and created value. It was a money-losing unit before we bought it and profitable the first year after the deal closed.

That deal helped accelerate our growth in managed print services. With Xerox, the problem we have is with the deal on the table. It doesn’t create value for our shareholders.

Remind us why you said no.

First, the price they’re offering doesn’t recognize the stand-alone value this company has. The second problem is the high leverage the combined company would have, which we consider extremely risky. Third is that the synergies they’re using to calculate the value of the deal are unrealistic. They count cost savings we’re already finding as a stand-alone company.

So what if HP turned around and bought Xerox?

Hold on. There are three questions that need to be addressed first. How do we get to the right value exchange between the two companies? How do we create an entity with the right capital structure? And how do we align on a realistic set of assumptions for synergies? That’s the first conversation. How the companies get together, who buys whom—there are many ways of doing that, but we don’t think it should be the first conversation.

You don’t actually compete with Xerox much, do you?

The overlap is small. We’re a $60 billion company. About $40 billion of that is PCs, with zero overlap. Of the remaining $20 billion, about half is consumer printers, with zero overlap. Of the rest, we do about $2.8 billion in managed print services, which is where we compete. They’re about a $9 billion business. That’s why when they say there are $2 billion in synergies, out of a combined $12 billion in business—well, that would be a miracle.

If you bought them, where would the value be?

We see an opportunity to drive costs down. We are investing in R&D, we both invest in marketing. We estimate the cost synergies are around $1 billion. It would also give us a larger presence in managed print services.

But you repeatedly have said you have other options.

Our priority is to execute our plan, which is going to create a lot of value for shareholders. We are open to exploring consolidation, but there are other opportunities we’re considering from an M&A perspective.

When you say other opportunities, are you talking about other printing deals? Or might you do something on the PC side?

Both. There are opportunities in the print market. There are opportunities in the personal systems market. Some might involve consolidation, others might be about expanding into other segments. There are opportunities in graphics printing and industrial printing. There are opportunities in 3-D printing.

Is Xerox open to the possibility of you buying them?

We have talked, but I don’t see value in sharing the discussions we’ve had in public.

What are you hearing from your institutional holders about the Xerox offer and about your own plan, which includes a large stock buyback and cost-cutting measures?

We presented our plan a few weeks ago, and since then we’ve spent a lot of time sharing, discussing, and explaining the plan. The response has been very positive. Investors understand how we plan to manage the company, and they like the amount of capital to be returned.

Have you also been in contact with Carl Icahn, who is the largest Xerox holder and also holds a 4% stake in HP?

We regularly talk to all of our key shareholders. He’s one. But we won’t talk about the specific conversations, not with him or with any others.

One of your biggest operating issues in recent quarters has been decreasing revenue from ink and toner. What are you doing to fix that issue?

It’s an opportunity to become more profitable. If you look at our installed base, we lose money with 25% of our customers who buy a printer and either don’t print enough or don’t use HP supplies. We have a plan in place to address the issue.

What’s the plan?

The first thing is to shift from a transactional model to a subscription model. With the new model, we monitor the amount of ink in your printer and before you run out, we send you a new cartridge. You pay us a fixed fee per month. The model is very attractive for consumers—it addresses the two big problems consumers have. The first problem is running out of ink. The second is printing is too expensive. Your cost per page goes down by up to 70%.

Is that program fully rolled out?

We already have 6 million subscribers, and the program is growing fast. In the U.S., 20% of customers who buy a printer end up as subscribers.

How are the third-party suppliers fighting back?

We’re seeing some retailers offering “replenishment models.” The difference with our program is that we get data directly from the printer, so we know exactly what you need. We know exactly when the printer is going to run out of ink. Also, the cartridges we use are bigger. The overall cost of our model is significantly lower.

How does the hardware price vary if you pay for ink with a subscription?

No change. The difference is that we’ll send you ink cartridges before you run out. You can drop from the program at any point, but the retention rate is in the high 90s. Customers love the program because it addresses a key problem—they don’t need to buy cartridges anymore, and the cost of printing is cheaper.

Will most consumers adopt that model?

We think 40% to 50% of customers will subscribe. The percentages will grow because that’s the way more and more consumers want to buy.

But you are taking an alternative approach in emerging markets.

Right. In those markets, the printer comes with a very big reservoir of ink or toner, which, depending your consumption rate, could last a year, two years, three years. That’s a change in our model, and those printers are profitable. The average life of a printer is three to five years. In many cases, you might choose to buy a new printer. But we also have the ability to refill the ink.

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You’ve also announced a shift in your business model for retail customers.

Yes, we’re adopting a model that looks like the one mobile phones used to have. We’re going to offer two options. One we call an end-to-end system, which will only work with HP supplies. The price of the hardware will be similar to where it is today. We’ll also offer a flexible system, which will work with supplies from other companies, and the hardware price will be higher.

And you are going to start doing that at the end of 2020.

Yes. It will take almost two years to change the whole portfolio to this model. The important thing is the print business will be in much better shape as we drive these transitions.

For the personal-systems business—the PC business—there have been some positive dynamics over the past year. The Windows 10 refresh cycle has driven demand, and memory chip pricing has been soft. And then there has been a tight supply of microprocessors. In the January quarter, you had your highest operating margins in the PC business in many years. But that’s not sustainable, is it?

The PC business is more than 60% of revenue and close to 50% of profits. It’s a critical business for us. In recent years, we’ve been able to outgrow the market in revenue, units, and profits. We have been growing and improving profitability, driven by the innovation we bring to market, the experiences we create, and the scale we have.

But what happens with margins? And growth?

We’re confident in our ability to continue to grow the business at or above the market pace. When we look at the overall PC market, the expectation from analysts is that it will grow around 4% for the next three to five years in revenue. In the segments where we operate, which are not growing as fast, growth is 1% to 1.2%, and we should grow at or above that rate.

In terms of margins, you’re right that the margins we have now are the best in a long time. Our long-term projection is for margins between 3.5% and 5.5%. So in the latest quarter, we were one full point above the top of the long-term range. We think at the end of the year we will be within the target range.

Let’s discuss these component supply and demand issues.

The component issues are extending the life of the Windows refresh, by not having enough processors, and now because of the implications of the coronavirus. We expect to see very solid growth in this business just driven by these changes. On top of that, there is a large installed base of PCs that are older than four or five years, hundreds of millions of units that will eventually be replaced.

You raised this notion about M&A in personal systems. What’s your thinking there?

We’ve always said any transaction needs to be supported by three things. It needs to be aligned to the strategies we have explained. It needs to have a solid financial case. And we need to have an execution plan that will support the financial gains.

If I apply those filters to personal systems, we have said that we see opportunities to grow in certain verticals where margins are better—for example, retail point-of-sale systems, where we are the leaders in the market. We have said we want to grow in the services category. We have said we want to grow in the accessories category. We have said we want to grow in specific premium categories. There could open opportunities to use M&A to complement our position.

Give us a brief update on how 3-D printing is going.

It’s a fantastic opportunity. We are leveraging technologies that we have built for years. There are opportunities in automotive, in aeronautics, in the medical space. At the same time, though, we are talking about transforming large industries, and that takes time. But once it happens, it scales. And it is very sticky. That’s why we decided that this strategy for the company is to focus on real manufacturing opportunities. And we are actually making good progress in working with some of the largest manufacturing partners to use our technology to grow into this category.

I used to see the opportunity in printing replacement parts. But you see this as a primary production technology.

The value of 3-D printing is not only in aftermarket parts. It is in designing parts that will be created with 3-D printing, because you can create structures that are more complicated, structures that with traditional modern methods cannot be built, but that have better physical performance. For example, something really important for cars going forward is weight, especially as we go to electric cars. With 3-D printing you can create much lighter parts. You can design a part of that because the same physical performance but significantly less weight.

How far is this from being material to your financial results?

It’s a great long-term opportunity, but it won’t be material for a few years.

Finally, how has HP been affected by the coronavirus so far?

After the Chinese New Year, production didn’t restart at the pace it usually does. But it has been recovering. Clearly there has been an impact in terms of the products that we will have in the short term to sell. It’s a supply problem, not demand.

Are you through the worst of it?

In China, yes. But the situation is fluid. We have seen steady progress, with factories coming up to speed in alignment with a plan that we had two weeks ago. It has not gotten worse.

Is the impact spread across your business?

Yes. It’s an issue for print hardware, PCs, and printer suppliers. We were already having product shortages because of processors, and we have customers not getting the products they want. But that’s the situation we’ve already been in.

And what about demand?

If anything, PC demand is stronger than we were expecting. As many companies launch their business-continuity programs, they need their employees to have PCs to work from home. In many cases, they had desktops, and now companies are offering them notebooks.

Enrique, thanks so much.

Write to Eric J. Savitz at eric.savitz@barrons.com