Pan-Asia Catalysts/Events, Quiddity Advisors

Travis Lundy

Pan-Asia Catalysts/Events

Quiddity Advisors

Event-Driven

When one looks upon the landscape of Japan's oil refineries - a delightful vista of 20th century industrialisation being left by the wayside in the move to EVs, solar power, "green" investment, etc, one small refinery stands out - the Keihin refinery of <a href="https://www.smartkarma.com/entities/toa-oil-co-ltd" target="_blank" data-smartkarma-citation="entities:11021:1" rel="noopener">Toa Oil Co Ltd (5008 JP)</a>. 
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Toa Oil's Keihin Refinery has a Nelson Complexity Index higher than any other refinery in Japan to my knowledge (the Nelson Complexity Index provides a measure of the ability of a refinery to process inputs into lighter product. The lighter the end product, the higher the complexity score on that particular line/output (crude goes into an atmospheric distillation process and comes out as several products which are subsequently treated by hydro- or merox treaters, subject to secondary distillation, or gas processing, then subject to FCC feeds, cokers, hydrocracking, isomerization, reformer stages, etc). The complexity score of a refinery is the weighted average complexity of its output lines. Toa Oil is in the very high teens whereas most major refiners just get to double digits or slightly above.
Generically, a refinery's Nelson Complexity Index/Score is a measure of the value of the refinery - both in cost terms and in terms of value-add. 
Toa Oil effectively sold itself to Showa Shell in 1979 then Showa Shell consolidated it in 2005 when activists were knocking on the door of cheap stocks and Toa placed shares with Showa Shell taking their ownership to 50.1%. Since then, Showa Shell (and now Idemitsu) has effectively used it as an outsourced capital asset. Huge sums were invested, and subsequently depreciated, and now the "book value" of the assets is effectively below 20% of the investment cost, and the book value of the refinery portion (not including the land or some of the financial assets related to the oil business in Japan (oil refining taxes stream through companies like this as both assets and liabilities because of the methodology applied)) is probably on the order of 10-15% of its replacement value. 
But Showa Shell used it, and now Idemitsu uses it, as a rented asset. Toa sells 90% of its output to Idemitsu, and generates electricity with much of the rest, which it sells to TEPCO. The business with Idemitsu is just a tolling charge. Idemitsu supplies crude, uses the refinery for a fee, then takes the product. If spreads are good, Idemitsu benefits. If spreads are low, Idemitsu effectively has the low-cost producer on tap at a low price. How is that tolling charge set? It's not clear. The arithmetic doesn't add up to arms' length or market pricing. The board of Toa is a couple of inexpert independents, a former customer (who is described as independent), one or two internal people, and four people from Idemitsu and Showa Shell. It would be surprising if it were NOT Idemitsu determining for Toa how much Toa was going to charge. Toa could, of course, negotiate fiercely. The CEO (a former Idemitsu man) who gets paid by the board (full of Idemitsu people) to rent its asset to Idemitsu at a rate which is completely uneconomic long-term and ignores the value built up over the years by shareholders. 
Today, after years of speculation, Idemitsu announced that it would launch a Tender Offer for Toa Oil to take out the minorities. It comes at ¥2450/share which is a 23% premium to last, a slight premium to book, a discount to the land value under the refinery, and a tiny fraction of the replacement value of the asset, but the "fair value" assessed by the independent valuation agent based on numbers supplied by the Target Company based on its contract with the parent company shows that the price is not too far off "fair", as long as the contract with its parent is fair, and one ignores what the real world value is.
The Tender Offer starts today and goes for 30 days. 
Because this was a clear situation of informational edge owned by the Acquiror, who controls the company and its board, in a highly technical industry, with highly-regulated processes and somewhat complex valuation methodologies, it would make total sense that the inexpert independent board members seek out expert help to value the complex asset in a complex business. Obviously, with the social demands of the Corporate Governance Code and last year's METI Fair M&amp;A Guidelines weighing heavily on the Toa directors, they would have ensured that they were extra careful to establish a fair process, including a market check, expert valuation, a majority of minority investor agreement, and separate advisors for the Special Committee. They would have gotten a fairness opinion.
Toa Oil minority shareholders, unfortunately, are left without any of that. 
There is a large foreign shareholder who has been buying who, given their buying activity, and their long-term average purchase price, is unlikely to be ecstatic with this price. But to see this get a bump, it probably needs more people getting upset.

When one looks upon the landscape of Japan's oil refineries - a delightful vista of 20th century industrialisation being left by the wayside in the move to EVs, solar power, "green" investment, etc, one small refinery stands out - the Keihin refinery of Toa Oil Co Ltd (5008 JP). 



Toa Oil's Keihin Refinery has a Nelson Complexity Index higher than any other refinery in Japan to my knowledge (the Nelson Complexity Index provides a measure of the ability of a refinery to process inputs into lighter product. The lighter the end product, the higher the complexity score on that particular line/output (crude goes into an atmospheric distillation process and comes out as several products which are subsequently treated by hydro- or merox treaters, subject to secondary distillation, or gas processing, then subject to FCC feeds, cokers, hydrocracking, isomerization, reformer stages, etc). The complexity score of a refinery is the weighted average complexity of its output lines. Toa Oil is in the very high teens whereas most major refiners just get to double digits or slightly above.
Generically, a refinery's Nelson Complexity Index/Score is a measure of the value of the refinery - both in cost terms and in terms of value-add. 
Toa Oil effectively sold itself to Showa Shell in 1979 then Showa Shell consolidated it in 2005 when activists were knocking on the door of cheap stocks and Toa placed shares with Showa Shell taking their ownership to 50.1%. Since then, Showa Shell (and now Idemitsu) has effectively used it as an outsourced capital asset. Huge sums were invested, and subsequently depreciated, and now the "book value" of the assets is effectively below 20% of the investment cost, and the book value of the refinery portion (not including the land or some of the financial assets related to the oil business in Japan (oil refining taxes stream through companies like this as both assets and liabilities because of the methodology applied)) is probably on the order of 10-15% of its replacement value. 
But Showa Shell used it, and now Idemitsu uses it, as a rented asset. Toa sells 90% of its output to Idemitsu, and generates electricity with much of the rest, which it sells to TEPCO. The business with Idemitsu is just a tolling charge. Idemitsu supplies crude, uses the refinery for a fee, then takes the product. If spreads are good, Idemitsu benefits. If spreads are low, Idemitsu effectively has the low-cost producer on tap at a low price. How is that tolling charge set? It's not clear. The arithmetic doesn't add up to arms' length or market pricing. The board of Toa is a couple of inexpert independents, a former customer (who is described as independent), one or two internal people, and four people from Idemitsu and Showa Shell. It would be surprising if it were NOT Idemitsu determining for Toa how much Toa was going to charge. Toa could, of course, negotiate fiercely. The CEO (a former Idemitsu man) who gets paid by the board (full of Idemitsu people) to rent its asset to Idemitsu at a rate which is completely uneconomic long-term and ignores the value built up over the years by shareholders. 
Today, after years of speculation, Idemitsu announced that it would launch a Tender Offer for Toa Oil to take out the minorities. It comes at ¥2450/share which is a 23% premium to last, a slight premium to book, a discount to the land value under the refinery, and a tiny fraction of the replacement value of the asset, but the "fair value" assessed by the independent valuation agent based on numbers supplied by the Target Company based on its contract with the parent company shows that the price is not too far off "fair", as long as the contract with its parent is fair, and one ignores what the real world value is.
The Tender Offer starts today and goes for 30 days. 
Because this was a clear situation of informational edge owned by the Acquiror, who controls the company and its board, in a highly technical industry, with highly-regulated processes and somewhat complex valuation methodologies, it would make total sense that the inexpert independent board members seek out expert help to value the complex asset in a complex business. Obviously, with the social demands of the Corporate Governance Code and last year's METI Fair M&amp;A Guidelines weighing heavily on the Toa directors, they would have ensured that they were extra careful to establish a fair process, including a market check, expert valuation, a majority of minority investor agreement, and separate advisors for the Special Committee. They would have gotten a fairness opinion.
Toa Oil minority shareholders, unfortunately, are left without any of that. 
There is a large foreign shareholder who has been buying who, given their buying activity, and their long-term average purchase price, is unlikely to be ecstatic with this price. But to see this get a bump, it probably needs more people getting upset. 

Idemitsu Launches Lowball Tender Offer for Subsidiary Toa Oil (5008)

Japan

TOA OIL CO., LTD. refines oil on a consignment basis.  The Company also ties up with Tokyo Electric Power Company to distribute electric power as well as steam air.  Toa Oil is a member of Showa Shell Sekiyu.

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Idemitsu Launches Lowball Tender Offer for Subsidiary Toa Oil (5008)

Idemitsu is 90% of revs, 50% of the ownership of Toa Oil. The business is not conducted at an arms' length basis so value has been transferred. Now...

Travis Lundy