Pan-Asia Catalysts/Events, Quiddity Advisors

Travis Lundy

Pan-Asia Catalysts/Events

Quiddity Advisors

Event-Driven

When <a href="https://www.smartkarma.com/entities/showa-denko-k-k" target="_blank" data-smartkarma-citation="entities:1496:1" rel="noopener">Showa Denko K.K. (4004 JP)</a> presented their H1 <a href="https://www.sdk.co.jp/assets/files/english/ir/library/pdf_presentation/results2021-2q.pdf" target="_blank" rel="noopener">results</a> on 10 August 2021, and later held their analyst call, it seemed quite bullish. The company was a year ahead of its internal integration efforts after having purchased Hitachi Chemical (renaming it Showa Denko Materials) in a HUGE debt-financed deal in 2020. The company noted that all businesses were operating well and that residual negative numbers coming from restructuring costs and other weaknesses were simply a matter of time to overcome.The company showed an OP forecast which even it admitted was light, and for the year the forecast at ¥85bn remains significantly impacted by the amortisation of goodwill due to the purchase of the Hitachi Chemicals business (¥17.6bn this year). This is to say that OP would be 20% higher if Showa Denko had used US-GAAP or IFRS to account for the purchase of Hitachi Chem.Net Income forecasts out years from now are impacted by this cost to amortise the purchase goodwill. The call was interesting in that it talked about efforts to reduce interest-bearing debt, and also talked about aggressive investment measures. That probably should have been a hint. The shares fell hard from the 17th to the 20th as crude oil did too. <section class="figure"><figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/227/837/original/Screenshot+2021-09-04+at+5.14.22+PM.png?1630746942" class="editor-image img-responsive" data-smartkarma-image-id="227837"></figure></section>And 13 days after the earnings release the company <a href="https://www.sdk.co.jp/assets/files/english/news/2021/20210823_sdknewsrelease_e.pdf" target="_blank" rel="noopener">announced</a> an equity sale where they would sell 35.1mm shares (including greenshoe) to investors. That is a big number, at roughly a quarter of the pre-existing share count. It is even bigger when you consider shareholder structure. Pricing is likely on 6 September. Below the fold we look at shareholder structure, offer structure, and index demand.

When Showa Denko K.K. (4004 JP) presented their H1 results on 10 August 2021, and later held their analyst call, it seemed quite bullish. The company was a year ahead of its internal integration efforts after having purchased Hitachi Chemical (renaming it Showa Denko Materials) in a HUGE debt-financed deal in 2020. The company noted that all businesses were operating well and that residual negative numbers coming from restructuring costs and other weaknesses were simply a matter of time to overcome.The company showed an OP forecast which even it admitted was light, and for the year the forecast at ¥85bn remains significantly impacted by the amortisation of goodwill due to the purchase of the Hitachi Chemicals business (¥17.6bn this year). This is to say that OP would be 20% higher if Showa Denko had used US-GAAP or IFRS to account for the purchase of Hitachi Chem.Net Income forecasts out years from now are impacted by this cost to amortise the purchase goodwill. The call was interesting in that it talked about efforts to reduce interest-bearing debt, and also talked about aggressive investment measures. That probably should have been a hint. The shares fell hard from the 17th to the 20th as crude oil did too. And 13 days after the earnings release the company announced an equity sale where they would sell 35.1mm shares (including greenshoe) to investors. That is a big number, at roughly a quarter of the pre-existing share count. It is even bigger when you consider shareholder structure. Pricing is likely on 6 September. Below the fold we look at shareholder structure, offer structure, and index demand.

Showa Denko (4004 JP) Offering - Supply, Passive Demand, and Opportunity

Japan/Asia Long-Short, LightStream Research

Mio Kato

Japan/Asia Long-Short

Long-Short Analysis on Japan, Asia and the World

LightStream Research

LightStream conducts quantitatively rigorous and data-driven analysis with a focus on Japan and Asia.

We consistently cover the Tech, Consumer and Industrial sectors, and provide ECM and Events coverage more broadly.

We supplement traditional qualitative insights from company relationships with a robust quantitative foundation that examines as much historical data as is available.
We further refine the accuracy of our insights and calls through the use of alternative data to flesh out current trends, and through a valuation framework that emphasises non-superficial peer group selection and a proper attempt to understand the metrics and changes that have driven security valuations in the past.

Equity Bottom-Up

Pacific Textiles stock has trended sideways since we last looked at the company in November. Nevertheless, given the long downtrend the stock experienced between 2016 and 2020 we believe that the stock’s break out of its downtrend and signs of improved momentum through the sector bode well, particularly in light of valuations which remain very reasonable.

Pacific Textiles stock has trended sideways since we last looked at the company in November. Nevertheless, given the long downtrend the stock experienced between 2016 and 2020 we believe that the stock’s break out of its downtrend and signs of improved momentum through the sector bode well, particularly in light of valuations which remain very reasonable.

Pacific Textiles – Valuation and Sector Momentum Update

On Thursday, the Nikkei came out with an <a href="https://asia.nikkei.com/Economy/BOJ-to-widen-interest-rate-target-range-to-support-bank-profits" target="_blank" rel="noopener">article</a> during the lunch break of equities trading. The headline said "BOJ to widen interest rate target range to support bank profits" and indeed in the article it noted that the BOJ would allow the long end of the curve to fluctuate more widely, creating a slightly steeper curve. This could lead to slightly better bank profits less because of the extra 5bp on the curve but more because of the expectation of forcing borrowers to pay more on an absolute basis. What was MORE important for equity markets was the idea that the BOJ "would also abolish its target for purchasing exchange-traded funds, now 6 trillion yen ($55 billion) per year, and instead vow to make such purchases only in times of market turmoil."The article also suggested that the "Target" would be removed for the ¥90bn of J-REITs they buy as a base case (doubled now to ¥180bn as the ¥6trln was doubled to ¥12trln in the depths of the covid crash of March 2020). This move caused Nikkei to underperform TOPIX on the day. TOPIX actually ended up on the day, and ended above where the market closed the AM session before the article came out. Nikkei fell, and started underperforming TOPIX from that point on. <section class="figure"><figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/195/872/original/Screenshot+2021-03-21+at+3.26.17+PM.png?1616311594" class="editor-image img-responsive" data-smartkarma-image-id="195872"></figure></section>Nikkei underperformed TOPIX in the AM session on Friday, and when the BOJ announcements came mid-day on Friday, there were additional subtleties involved. The details are <a href="https://www.boj.or.jp/en/announcements/release_2021/rel210319c.pdf" target="_blank" rel="noopener">here</a>. The presentation with the basic details is <a href="https://www.boj.or.jp/en/announcements/release_2021/k210319b.pdf" target="_blank" rel="noopener">here</a>.<ul>
<li>The target rates for ETF and REIT buying will be abolished, but the current "Target Rate" of annual buying will become annual maxima (¥12 trillion for ETFs, ¥180bn for J-REITs, with ongoing maximum ownership limits on ETFs in place).</li>
<li>Buying of ETFs and J-REITs will be conducted "as necessary" "in times of market turbulence" and such buying will be done only on TOPIX ETFs.</li>
<li>The "Special Rules for Purchases of ETFs to Support Firms Proactively Investing in Physical and Human Capital" will continue as before with only specific ETFs permitted in this group. The amount of ~¥300bn/year and ¥1.2bn per business day will continue.</li>
</ul>It based the new policy on the Reference <a href="https://www.boj.or.jp/en/announcements/release_2021/k210319c.pdf" target="_blank" rel="noopener">document</a> which backs up the changes in policy is much more interesting reading.  Appendix 5 and Chart 12 are the parts you want to read.The hypotheses and results are described here.<section class="figure"><figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/195/869/original/Screenshot+2021-03-21+at+3.02.28+PM.png?1616310186" class="editor-image img-responsive" data-smartkarma-image-id="195869"></figure></section>There are a couple of other side conclusions but the base understanding is...<div class="content-highlight">When the BOJ steps into the market in size, in times of market turbulence, and when stocks are trading below their medium-term average, it has a greater effect per dollar spent on market-wide risk premia as measured in option premia than buying in normal times, and size matters when looking at the risk premia change on single stocks.  </div><h3>What This Means</h3><ul>
<li>When the BOJ steps into the market in size, in times of market turbulence, and when stocks are trading below their medium-term average, it has a greater effect per dollar spent on market-wide risk premia as measured in option premia than buying in normal times, and size matters when looking at the risk premia change on single stocks.  </li>
<li>Expect the BOJ to follow the concept of its study (Appendix 5 again).</li>
<li>Expect the BOJ to pay greater attention to futures activity. </li>
</ul><h3>What This Does NOT Mean</h3><ul><li>It does NOT mean the BOJ will be selling any ETFs.</li></ul><hr>It is worthwhile taking a look at WHY the market reacted the way it did on Thursday and Friday afternoon, and it is worthwhile looking at what the BOJ ETF buying might look like going forward. So we do so below the fold.Note: This is part 1 of the analysis of potential future BOJ ETF Buying. Part II looks at the difference in single stock makeup.

On Thursday, the Nikkei came out with an article during the lunch break of equities trading. The headline said "BOJ to widen interest rate target range to support bank profits" and indeed in the article it noted that the BOJ would allow the long end of the curve to fluctuate more widely, creating a slightly steeper curve. This could lead to slightly better bank profits less because of the extra 5bp on the curve but more because of the expectation of forcing borrowers to pay more on an absolute basis. What was MORE important for equity markets was the idea that the BOJ "would also abolish its target for purchasing exchange-traded funds, now 6 trillion yen ($55 billion) per year, and instead vow to make such purchases only in times of market turmoil."The article also suggested that the "Target" would be removed for the ¥90bn of J-REITs they buy as a base case (doubled now to ¥180bn as the ¥6trln was doubled to ¥12trln in the depths of the covid crash of March 2020). This move caused Nikkei to underperform TOPIX on the day. TOPIX actually ended up on the day, and ended above where the market closed the AM session before the article came out. Nikkei fell, and started underperforming TOPIX from that point on. Nikkei underperformed TOPIX in the AM session on Friday, and when the BOJ announcements came mid-day on Friday, there were additional subtleties involved. The details are here. The presentation with the basic details is here.
The target rates for ETF and REIT buying will be abolished, but the current "Target Rate" of annual buying will become annual maxima (¥12 trillion for ETFs, ¥180bn for J-REITs, with ongoing maximum ownership limits on ETFs in place).
Buying of ETFs and J-REITs will be conducted "as necessary" "in times of market turbulence" and such buying will be done only on TOPIX ETFs.
The "Special Rules for Purchases of ETFs to Support Firms Proactively Investing in Physical and Human Capital" will continue as before with only specific ETFs permitted in this group. The amount of ~¥300bn/year and ¥1.2bn per business day will continue.
It based the new policy on the Reference document which backs up the changes in policy is much more interesting reading.  Appendix 5 and Chart 12 are the parts you want to read.The hypotheses and results are described here.There are a couple of other side conclusions but the base understanding is...When the BOJ steps into the market in size, in times of market turbulence, and when stocks are trading below their medium-term average, it has a greater effect per dollar spent on market-wide risk premia as measured in option premia than buying in normal times, and size matters when looking at the risk premia change on single stocks.  What This Means
When the BOJ steps into the market in size, in times of market turbulence, and when stocks are trading below their medium-term average, it has a greater effect per dollar spent on market-wide risk premia as measured in option premia than buying in normal times, and size matters when looking at the risk premia change on single stocks.  
Expect the BOJ to follow the concept of its study (Appendix 5 again).
Expect the BOJ to pay greater attention to futures activity. 
What This Does NOT MeanIt does NOT mean the BOJ will be selling any ETFs.It is worthwhile taking a look at WHY the market reacted the way it did on Thursday and Friday afternoon, and it is worthwhile looking at what the BOJ ETF buying might look like going forward. So we do so below the fold.Note: This is part 1 of the analysis of potential future BOJ ETF Buying. Part II looks at the difference in single stock makeup. 

Quantifying the BOJ Change in ETF Policy: Assessing Future ETF Buying Methodology

Pacific Textiles has staged a sharp rebound, bouncing off the HKD3.50 level it had ploughed at the start of the pandemic to briefly surge above HKD6.00. There have been a few false dawns in the past but the stock’s multiple has been depressed and even after its recent surge, remains extremely reasonable. With the company slowly adding to its net cash position even during tough times, a return to revenue growth and the earnings and dividends which accompany that could drive further strong performance.

Pacific Textiles has staged a sharp rebound, bouncing off the HKD3.50 level it had ploughed at the start of the pandemic to briefly surge above HKD6.00. There have been a few false dawns in the past but the stock’s multiple has been depressed and even after its recent surge, remains extremely reasonable. With the company slowly adding to its net cash position even during tough times, a return to revenue growth and the earnings and dividends which accompany that could drive further strong performance.

Pacific Textiles – Breaking Out of Its Slump

On Friday 29 November 2019, <a href="https://www.smartkarma.com/entities/sanyo-chemical-industries" target="_blank" data-smartkarma-citation="entities:16624:1" rel="noopener">Sanyo Chemical Industries (4471 JP)</a> and <a href="https://www.smartkarma.com/entities/nippon-shokubai-co-ltd" target="_blank" data-smartkarma-citation="entities:19373:1" rel="noopener">Nippon Shokubai (4114 JP)</a> announced (<a href="https://www.sanyo-chemical.co.jp/wp/wp-content/uploads/2019/11/k191129a.pdf" target="_blank" rel="noopener">Japanese</a>, <a href="https://www.shokubai.co.jp/en/news/file.cgi?file=file1_0215.pdf" target="_blank" rel="noopener">English</a>) the result of their 6-month long deliberations towards agreeing a merger with the announcement of a Final Agreement Concerning the Business Integration by Way of Joint Share Transfer of the two companies.
The Final Agreement states the two will create a holding company called Synfomix Co., Ltd. which will entail a share transfer to a single listed company on 1 October 2020, with the intention to effect a merger of the units under the holdco no later than two years from that date. 
General meetings to approve the deal on the part of the shareholders of both companies will take place in June 2020, with record date for the vote 31 March 2020. 
The Share Exchange Ratio means 1 Sanyo Chemical share will get 1 Synfomix (Holdco) share and 1 share of Nippon Shokubai will get 1.225 Synfomix shares. That means an effective SanyoChem /Nippon Shokubai ratio of 0.8163265, just below the closing price ratio of 0.822747. 
As I stated in the original piece <a href="https://www.smartkarma.com/insights/sanyo-chemical-nippon-shokubai-merger-another-guess-the-ratio-trade" target="_blank" data-smartkarma-citation="insights:30122" rel="noopener">Sanyo Chemical - Nippon Shokubai Merger - Another "Guess the Ratio" Trade</a> 
<blockquote>
The fundamentals here are not terribly lopsided. Similar GPMs and OPMs over time and not too dissimilar Net Income growth over the past ten years. A difference in volatility and 2020 forecast growth may tip the scales (compared to current ratio) towards Sanyo Chemical.
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/108/568/original/Screenshot%202019-11-30%20at%202.12.24%20PM.png?1575094360" class="editor-image img-responsive" data-smartkarma-image-id="108568"></figure>
</blockquote>
In the end, the ratio here is probably not bad enough to get really upset, especially if you did not make noise to Sanyo Chem during the 6 months when you could have. It IS disappointing for Sanyo Chemical shareholders based on recent years' performance and even worse when taking into account the forecast for this year and beyond, and the recent deterioration of performance of Nippon Shokubai financial performance.  The ratio selected is even lower than the ratio of the day before the original announcement they were looking to merge, which itself was too low, even if the ratio had run up recently. Given developments since then, a bare minimum of a few percent higher would have been appropriate.
I would be reluctant to say that the penchant of Japanese management and directors to ignore things like assets and cashflow is one of the dangers one has when making decisions on fundamentals in Japan. But it is. That is one reason why I recommend relatively few "guess-the-ratio" trades. It is also one reason why I was somewhat comfortable recommending a trade in this case, recommending the dollar-neutral Long Sanyo-Short Shokubai trade as a Buy on 23 July (0.7433) and the next several days, again 16 August (0.7475), and again 4 November (0.7856).
Now we move on to what happens next...

On Friday 29 November 2019, Sanyo Chemical Industries (4471 JP) and Nippon Shokubai (4114 JP) announced (Japanese, English) the result of their 6-month long deliberations towards agreeing a merger with the announcement of a Final Agreement Concerning the Business Integration by Way of Joint Share Transfer of the two companies.
The Final Agreement states the two will create a holding company called Synfomix Co., Ltd. which will entail a share transfer to a single listed company on 1 October 2020, with the intention to effect a merger of the units under the holdco no later than two years from that date. 
General meetings to approve the deal on the part of the shareholders of both companies will take place in June 2020, with record date for the vote 31 March 2020. 
The Share Exchange Ratio means 1 Sanyo Chemical share will get 1 Synfomix (Holdco) share and 1 share of Nippon Shokubai will get 1.225 Synfomix shares. That means an effective SanyoChem /Nippon Shokubai ratio of 0.8163265, just below the closing price ratio of 0.822747. 
As I stated in the original piece Sanyo Chemical - Nippon Shokubai Merger - Another "Guess the Ratio" Trade 

The fundamentals here are not terribly lopsided. Similar GPMs and OPMs over time and not too dissimilar Net Income growth over the past ten years. A difference in volatility and 2020 forecast growth may tip the scales (compared to current ratio) towards Sanyo Chemical.


In the end, the ratio here is probably not bad enough to get really upset, especially if you did not make noise to Sanyo Chem during the 6 months when you could have. It IS disappointing for Sanyo Chemical shareholders based on recent years' performance and even worse when taking into account the forecast for this year and beyond, and the recent deterioration of performance of Nippon Shokubai financial performance.  The ratio selected is even lower than the ratio of the day before the original announcement they were looking to merge, which itself was too low, even if the ratio had run up recently. Given developments since then, a bare minimum of a few percent higher would have been appropriate.
I would be reluctant to say that the penchant of Japanese management and directors to ignore things like assets and cashflow is one of the dangers one has when making decisions on fundamentals in Japan. But it is. That is one reason why I recommend relatively few "guess-the-ratio" trades. It is also one reason why I was somewhat comfortable recommending a trade in this case, recommending the dollar-neutral Long Sanyo-Short Shokubai trade as a Buy on 23 July (0.7433) and the next several days, again 16 August (0.7475), and again 4 November (0.7856).
Now we move on to what happens next...

SanyoChem / NipponShokubai Merger Announced - OK-Not-Great Ratio but Synergies+Accretion

Japan

TORAY INDUSTRIES, INC. manufactures yarns, synthetic fibers, and man-made leather used as apparel and industrial materials.  The Company also makes chemical products such as polyester films, engineering plastics, and resin materials.  Toray develops information equipment such as electronic circuit and liquid crystal color filter.

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Toray Industries (3402 JP)

Showa Denko (4004 JP) Offering - Supply, Passive Demand, and Opportunity

Showa Denko's offering is not ginormous, but it is BIG. And it will engender a fair bit of passive flow. The question is whether investors will buy...

Travis Lundy

Pacific Textiles – Valuation and Sector Momentum Update

As Pacific Textiles stock threatens a break out of its five year down trend with industry momentum strengthening we look at valuations and Toray's...

Mio Kato

Quantifying the BOJ Change in ETF Policy: Assessing Future ETF Buying Methodology

The BOJ has announced a change in ETF Buying Program Parameters. The study/review they did is required reading to understand how they might buy...

Travis Lundy

Pacific Textiles – Breaking Out of Its Slump

While Pacific Textiles has already risen significantly, the turnaround in revenue expectations is significant and the stock had fallen to such...

Mio Kato

SanyoChem / NipponShokubai Merger Announced - OK-Not-Great Ratio but Synergies+Accretion

On Friday 29 November 2019, Sanyo Chemical Industries (4471 JP) and Nippon Shokubai (4114 JP) announced (Japanese, English) the result of their...

Travis Lundy

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