Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Xerox has a reminder for takeover targets and their management everywhere: Be careful what you wish for.

The $9.7 billion company is being sued by a shareholder named Darwin -- Darwin Deason. He owns about 6 percent of Xerox through convertible preferred stock, which was given to him in 2010 when Xerox acquired the company that he founded, Affiliated Computer Services. 

Deason, then chairman of ACS, fought very hard for that preferred stock, which was valued at $300 million at the time. He was even taken to court by investors who painted him as the greedy businessman receiving an unfair windfall. Now, this investment has come back to bite Deason.

Xerox, as you may know, is preparing to split itself into two separate companies, a move that will effectively undo the nearly $8 billion ACS merger. The 110-year-old Xerox that we all know and have forgotten about will continue selling photocopiers and scanners. The new entity will be called Conduent and provide services to government and industries. Conduent is basically ACS.

Stock Scan
Xerox shares have advanced 13% since closing the Affiliated Computer Services acquisition. The S&P 500 doubled over that time.
Source: Bloomberg

Through the spinoff, Xerox common shareholders will also receive Conduent stock. But remember, Deason didn't want to be common. 

He's suing to block the split, claiming that the company is denying him the right to convert his preferred stock into Xerox common shares and Conduent common shares. This means he could get stuck owning only the legacy Xerox and not the business he founded, which will likely fetch a higher valuation once it's separated from Xerox. He'll be left with an investment in an "unattractive, low-growth" document-technology business, according to the complaint filed Wednesday in federal court in Dallas. 

Stacking Up
The services division generates more of Xerox's revenue, but its technology business drives profit.
Source: Bloomberg

In an e-mailed statement to Bloomberg News, a Xerox spokesman called Deason's suit "meritless" and said it's going to seek its dismissal and move forward with the spinoff. 

There's something ironic about an executive, who was in the past perceived to have stuck it to his company's shareholders, now getting the short end of the stick in the same fashion. But he also has a point. Why shouldn't he profit the way other investors will from the spinoff of the business he created, which in many respects is the better half of Xerox? Without the services business, I'm assuming he wouldn't otherwise have wanted to own Xerox.

According to Deason's suit, it all comes down to the fine print. He claims their agreement stipulates that in a "reorganization" he has the right to convert his investment into common stock. However, he says, Xerox has designated the spinoff a "small" distribution -- not a "reorganization event." 

Even if Xerox isn't legally obligated to let him take part in the spinoff, it still seems unfair. But one can't just stomp one's feet in court claiming unfairness. Maybe Xerox can shrug this off the way its statement implies, and perhaps there's more to the story than was presented in Deason's complaint.

Either way, it will be interesting to see what comes of this suit and more important, how this de-merger experiment works for Xerox -- especially if Deason doesn't prevail. If this Darwin ends up owning only Xerox following the split, he had better hope the move is a step forward in the company's evolution.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net