There has to be some joke about two of America’s oldest technology giants thinking about a merger. The news was confirmed during the week of November 8 that Xerox Corp. (NYSE: XRX) has made a proposal to combine with HP Inc. (NYSE: HPQ). Xerox was ready to offer more than $30 billion for HP. Needless to say, how the smaller Xerox would do a Pac-Man gobble up of HP comes with some serious questions.

These two companies have been involved in other acquisitions over time, as well as divesting, cost cuts and restructurings. The latest move would have an impact on the PC and printer markets, and it might come with a massive debt load.

The investing public has a simple and fair question to ask: To save all this trouble and to prevent a massive debt-load from being forced, if there is so much merit here, why doesn’t HP just bite the bullet and buy Xerox?

Credit ratings agencies and Wall Street analysts are not the last word when it comes to getting a merger done, and companies often are willing to take a short-term credit downgrade for a better position in the future.

A transaction of this sort would be complicated further by the notion that activist investor Carl Icahn owns an 11% stake in Xerox and has a board seat. One issue that might help a transaction along at least a little is that Xerox is expected to receive a check for $2.3 billion from the sale of its 25% stake in its Fuji Xerox joint venture. Reports also indicated that Xerox had an informal funding commitment for the potential HP acquisition.

As far as what the future company might look like to future investors, Xerox and HP’s combined print business would have close to $30 billion in annualized revenues and total revenues of about $70 billion.

A UBS report indicated that consolidation in the printing industry makes sense considering the pressure and the relatively large number of players competing for it. HP was noted as having 40% of the desktop printing, but a much smaller share in networked enterprise printing. Xerox is said to have roughly 15% of the networked printing share by revenues, but still behind Canon and Ricoh.

Toni Sacconaghi, an analyst for Bernstein, opined that perhaps Xerox is actually just trying to force HP into making an offer to acquire the company. Xerox is not investment grade, but HP is, and Xerox likely would have $25 billion or so in net debt. Still, he thinks the $2 billion in combined synergies under a deal that was touted in reports may be a bit high and the deleveraging could take five years or more.

Standard & Poor’s did not take any credit ratings action on the news, but it did issue a note on Friday, indicating that a Xerox move to acquire HP would come with significant debt and would bring downward credit rating pressure on the ratings for both companies.

There already was some evidence that the merger would damage the credit ratings as the deal’s structure looked during the week. The Wall Street Journal reported on Thursday that HP’s bond issue due in 2041 fell about 6% in price, and that Xerox’s maturity in 2039 fell about 5% on the news. HP’s current BBB investment-grade rating is better than Xerox’s BB speculative (junk) rating.

HP’s shares closed up 0.67% at $19.52 on Friday, almost 10% higher than the $17.78 close the prior Friday. Refinitiv’s consensus analyst target price on HP is $19.62, and the shares have a 52-week trading range of $15.93 to $25.49.

Xerox closed up 4.1% at $38.85 a share on Friday, for a gain of 16% from the prior Friday’s close of $33.48. The consensus target price is just $38.00, and shares have traded in a 52-week range of $18.58 to $39.38.

At the heart of the matter, perhaps more than anything else in this equation, is that size does matter. HP’s market cap is about $31.5 billion, and Xerox has a market cap of about $8.6 billion.

Rather than a weaker credit-rating company having to take on $20 billion or so in debt, HP already had close to $5 billion in cash and long-term liabilities of close to $9 billion at the end of its last quarter. With Xerox shares already up close to 90% in 2019 alone, HP might not even have to pay much of a premium since the shares rallied on the news. There is an obvious answer here, and that’s that if the combination really has so much merit, then perhaps HP should leave the future combined company less riddled with debt.

If HP acquired Xerox you would still have two value companies combined, but if Xerox takes on this much debt to do a deal, you would just have a relatively low price-to-earnings ratio and a massively bloated balance sheet.

Fitch Ratings had already downgraded Xerox’s long-term and senior unsecured ratings by one notch to BB back in March of this year. Fitch Ratings issued a note on Friday warning about significant debt funding to get this deal done, and it noted disruption and secular change in their industries:

Xerox’s confirmed buyout offer for HP could provide strategic benefits for both companies due to challenging secular trends in commercial printing and personal computers, but any potential transaction would likely require significant debt funding given HP’s large size, says Fitch Ratings. HP is more than three times larger on an enterprise value basis. Rating implications would depend on deal structure, assumed revenue and cost synergies, intermediate-term leverage expectations, financial policy and the business risk profile of the combined entity.

Consolidation in declining markets is not unusual, particularly when emerging technology disrupts traditional business models. Therefore, M&A event risk is elevated in sectors experiencing disruption and secular change as companies look to transform business models and remain competitive. Transactions are often leveraging with long-term value creation that is uncertain. Rarely do smaller entities acquire larger companies but, if financing is available, it is not inconceivable, as evidenced by Dell’s purchase of EMC in 2015. Xerox is expected to receive $2.3 billion of proceeds from the sale of its 25% stake in it Fuji Xerox JV and, according to media reports, has an informal funding commitment for the potential HP acquisition.

Assuming Xerox offered $17 per share in cash and $5 per share in stock, as reported by the media, incremental debt financing could be about $20 billion and pro forma core leverage between 3.4x and 4.2x, depending on synergy capture. HP and Xerox have relatively low stand-alone leverage of around 1.5x and 1.8x, respectively, but have different revenue growth, profitability and FCF prospects. HP is solidly investment grade while Xerox is speculative grade. Investor appetite for such a sizable debt issuance in a secularly challenged industry is an open question.

HP’s confirmation statement earlier in the week said:

As reviewed at HP’s most recent Securities Analyst Meeting, we have great confidence in our multi-year strategy and our ability to position the company for continued success in an evolving industry, particularly given the multiple levers available to drive value creation.

Against this backdrop, we have had conversations with Xerox Holdings Corporation (NYSE: XRX) from time to time about a potential business combination. We have considered, among other things, what would be required to merit a transaction. Most recently, we received a proposal transmitted yesterday.

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.

By combining two dinosaurs, there might be a new species called the HProx.

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