Monthly Archives

December 2018

Dec 31
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Daily Japan: Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down? and more

By | Japan

In this briefing:

  1. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?
  2. Recruit Holdings Down 30% From October; Still Not Cheap
  3. Japan: 2018 Market Review – Bear Market Rally Ahead
  4. Last Week in Event SPACE: Harbin Electric, MYOB, TMB Bank, Halla Holdings
  5. Are US Stocks A Buy Yet?

1. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?

N7

Nintendo reported their 2QFY03/19 in October with results showing growth at both the top line and bottom line albeit not living up to consensus expectations. Top line grew by 4.0% YoY to JPY388.9bn in 1H03/19 while OP grew by 53.9% YoY to JPY61.4bn. OP in the last quarter (2QFY03/19) was the second highest the company has experienced over the last five years. This growth has been mainly driven by the sales of Nintendo Switch hardware which sold just over 5m units in 1HFY03/19. However, YoY growth remained at 3.4% compared to 4.9m units sold in 1HFY03/18. This has left investors worried about Nintendo’s aggressive target of selling 20m units of the Switch for FY03/19. Of this target, the company has managed to achieve only around 25.0% in 1H. Nintendo’s financial performance follows a seasonal trend with the December quarter showing stronger performance due to increased sales during Christmas. While the company’s current quarter is likely to show strong results, we remain skeptical about the company reaching the aforementioned target for FY03/19.

Switch Sales Have Caused an Improvement in Nintendo’s OP….

Source: Capital IQ

….Despite a Slowdown in the Growth of Units Sales

Source: Nintendo website

Nintendo’s Last Quarter Has Also Failed to Live Up To Consensus Expectations

Source: Capital IQ
Source: Capital IQ

2. Recruit Holdings Down 30% From October; Still Not Cheap

Capture

The share price of Recruit Holdings (6098 JP) has fallen by around 30% over the past three months from an all-time high of JPY3,826 (on 1st October 2018) to JPY2,705 on 24th December 2018. Prior to this, Recruit’s share price saw a strong upward rally during May-September following the company’s announcement that it would acquire Glassdoor Inc. (the company which operates the employment information website glassdoor.com).

We expect Recruit’s consolidated revenue to grow 7.7% and 6.5% YoY in FY03/19E and FY03/20E respectively, driven by the acquisition of Glassdoor and steady growth in Japanese staffing operations, partially offset by a likely slowdown in global labour market activity. We also expect Recruit’s consolidated EBITDA margin to improve by around 50bps due to higher margin from Glassdoor.

Despite the recent dip in share price and steady topline and bottom line growth over the forecast period, at a FY2 EV/EBITDA multiple of 14.0x, Recruit doesn’t look particularly attractive to us. Recruit’s internet advertising business and employment business peers, Yahoo Japan (4689 JP) and Persol Holdings (2181 JP) are trading at FY2 EV/EBITDAs of 7.7x and 9.6x respectively.

Key Financials FY03/18-20E

 

FY03/18

FY03/19E

FY03/20E

Consolidated Revenue (JPYbn)

2,171

2,338

2,490

YoY Growth %

11.9%

7.7%

6.5%

Consolidated EBITDA (JPYbn)

258

288

312

EBITDA Margin %

11.9%

12.3%

12.5%

Source: Company Disclosures/LSR Estimates

3. Japan: 2018 Market Review – Bear Market Rally Ahead

6

2018 MARKET REVIEW – In this Insight, we shall review the performance of the Japanese stock market, during 2018 and look forward to the coming year. We shall look back at the year from a Sectors, Peer Group and Company perspective in separate Insights to follow next week.

Source: Japan Analytics

BEAR MARKET RALLY AHEAD – From the January 23rd peak to the December 25th low, the All Market Composite declined 24.5% in Yen terms and 24.9% in US$ terms placing Japan in a bear market for the seventh time since the bursting of the 1989 stock market ‘bubble’. The average stock is now 35% below its one-year high compared with just 10% below at the beginning of the year. Total Market Value is still ¥123t above the low of 12th February 2016, and the question remains – are we replaying March 2008 or February 2016? In both cases, there were bear market rallies (25% and 17%) before the final downward leg – which entailed further declines of 50% and 13%, respectively. In our recent Insight on 21st December – Ticking the Bear Market Boxes – we commented that it was too early for contrarians to start ‘nibbling’. The 1,000 point Nikkei 225 (NKY INDEX) decline the next trading day, and the rebound into the year-end suggests that a case can now be made for, at least, a short-term rally. In the charts in the DETAIL below, we shall explore the case for (✓) and against (✕), and attempt to answer the question of the 2008 or 2016 reprise.

4. Last Week in Event SPACE: Harbin Electric, MYOB, TMB Bank, Halla Holdings

29%20dec%20%202018

Last Week in Event SPACE …

(This insight covers specific insights & comments involving Stubs, Pairs, Arbitrage, share Classification and Events – or SPACE – in the past week)

M&A – ASIA-PAC

Harbin Electric Co Ltd H (1133 HK) (Mkt Cap: $546mn; Liquidity: $0.4mn)

As previously discussed in Harbin Electric Expected To Be Privatised, Harbin Electric (HE) has now announced a privatisation Offer from parent and 60.41%-shareholder Harbin Electric Corporation (“HEC”) by way of a merger by absorption. The Offer price of $4.56/share, an 82.4% premium to last close, is bang in line with that paid by HEC in January this year for new domestic shares. The Offer price has been declared final. 

  • Of note, the Offer price is a 37% discount to HE’s net cash of $7.27/share as at 30 June 2018. Should the privatisation be successful, this Offer will cost HEC ~HK$3.08bn, following which it can pocket the remaining net cash of $9.3bn PLUS the power generation equipment manufacturer business thrown in for free.
  • On pricing, “fair” to me would be something like the distribution of net cash to zero then taking over the company on a PER with respect to peers. That is not happening. It will be difficult to see how independent directors (and the IFA) can justify recommending an Offer to shareholders at any price below the net cash/share, especially when the underlying business is profit-generating.
  • Dissension rights are available, however, there is no administrative guidance on the substantive as well as procedural rules as to how the “fair price” will be determined under PRC and HK Law.
  • Trading at a gross/annualised spread of 15%/28% assuming end-July completion, based on the average timeline for merger by absorption precedents. As HEC is only waiting for approval from independent H-shareholders suggests this transaction may complete earlier than precedents. 

(link to my insight: Harbin Electric: The Price Is Not Right)  

MYOB Group Ltd (MYO AU) (Mkt Cap: $1.2bn; Liquidity: $7mn)

KKR and MYOB entered into Scheme Implementation Agreement (SIA) at $3.40/share, valuing MYOB, on a market cap basis, at A$2bn. MYOB’s board unanimously recommends shareholders to vote in favour of the Offer, in the absence of a superior proposal. The Offer price assumes no full-year dividend is paid.

  • On balance, MYOB’s board has made the right decision to accept KKR’s reduced Offer. The argument that MYOB is a “known turnaround story” is challenged as cloud-based accounting software providers Xero Ltd (XRO AU)  and Intuit Inc (INTU US) grab market share. This is also reflected in MYOB’s forecast 7% revenue growth in FY18 and follows a 10% decline in first-half profit, despite a 61% jump in online subscribers.
  • And there is justification for KKR’s lowering the Offer price: the ASX is down 10% since KKR’s initial tilt, the ASX technology index is off by ~14%, a basket of listed Aussie peers are down 17%, while Xero, the most comparable peer, is down ~20%. The Scheme Offer is at a ~27% premium to the estimated adjusted (for the ASX index) downside price of $2.68/share.

  • Bain was okay selling at $3.15/share to KKR and will be fine selling its remaining ~6.5% stake at $3.40. Presumably, MYOB sounded out the other major shareholders such as Fidelity, Yarra Funds Management, Vanguard etc as to their read on the revised $3.40 offer, before agreeing to the SIA with KKR.

  • If the markets avoid further declines, this deal will probably get up. If the markets rebound, the outcome is less assured. This Tuesday marks the beginning of a new year and a renewed mandate for investors to take risk, especially an agreed deal; but the current 5.3% annualised spread is tight.

(link to my insight: MYOB Caves And Agrees To KKR’s Reduced Offer)

TMB Bank PCL (TMB TB) (Mkt Cap: $1.2bn; Liquidity: $7mn)

The Ministry of Finance, the major shareholder of TMB, confirmed that both Krung Thai Bank Pub (KTB TB) and Thanachart Capital (TCAP TB) had engaged in merger talks with TMB. Considering an earlier KTB/TMB courtship failed, it is more likely, but by no means guaranteed, that the deal with Thanachart will happen. Bloomberg is also reporting that Thanachart and TMB want to do a deal before the next elections, which is less than two months away.

  • TMB is much bigger than Thanachart and therefore it may boil down to whether TMB wants to be the target or acquirer. In Athaporn Arayasantiparb, CFA‘s view, a deal with Thanachart would leave TMB as the acquirer rather than the target. But Thanachart’s management has a better track record than TMB.
  • Both banks have undergone extensive deals before this one: 1) TMB acquired DBS Thai Danu and IFCT; and 2) Thanachart engineered an acquisition of the much bigger, but struggling, SCIB.
  • A merger between the two would still leave them smaller than Bank Of Ayudhya (BAY TB) and would not change the bank rankings; but it would give TMB a bigger presence in asset management, hire-purchase finance and a re-entry into the securities business.

(link to Athaporn’s insight: Sathorn Series M: TMB-Thanachart Courtship)  

STUBS/HOLDCOS

Halla Holdings (060980 KS) / Mando Corp (204320 KS)

Mando accounts for 45% of Halla’s NAV, which is currently trading at a 50% discount. Sanghyun Park believes the recent narrowing in the discount may be due to the hype attached to Mando-Hella Elec, which he believes is overdone; and recommends a short Holdco and long Mando. Using Sanghyun’s figures, I see the discount to NAV at 51%, 2STD above the 12-month average of ~47%.

(link to Sanghyun’s insight: Halla Holdings Stub Trade: Downwardly Mean Reversion in Favor of Mando)  

SHARE CLASSIFICATIONS

OTHER M&A UPDATES

CCASS

My ongoing series flags large moves (~10%) in CCASS holdings over the past week or so, moves which are often outside normal market transactions.  These may be indicative of share pledges.  Or potential takeovers. Or simply help understand volume swings. 

Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.   

Name

% change

Into

Out of

Comment

Putian Communication (1720 HK)
69.75%
Shanghai Pudong
Outside CCASS
Chu Kong Shipping Enterprises(Grp) (560 HK)
37.68%
China Industrial
Outside CCASS
C-Mer Eye Care Holdings Limited (3309 HK)
16.23%
HSBC
Outside CCASS
Source: HKEx

5. Are US Stocks A Buy Yet?

Usra

  • 5%-like rallies on Wall Street are signs of a bear market not a bull market
  • Bull markets require strong liquidity and low risk appetite, neither yet apply
  • Risk appetite readings at minus 12.6 are still above the minus 40 criterion for an upturn
  • Recent large fall in risk appetite consistent with upcoming economic recession
Dec 31
0

Daily Japan: Last Week in Event SPACE: Familymart, Takeda, Harbin Electric, Motherson, Young Poong, NTT and more

By | Japan

In this briefing:

  1. Last Week in Event SPACE: Familymart, Takeda, Harbin Electric, Motherson, Young Poong, NTT

1. Last Week in Event SPACE: Familymart, Takeda, Harbin Electric, Motherson, Young Poong, NTT

22%20dec%20%202018

Last Week in Event SPACE …

(This insight covers specific insights & comments involving Stubs, Pairs, Arbitrage, share Classification and Events – or SPACE – in the past week)

M&A – ASIA-PAC

Recapping the original plan: when Familymart Uny Holdings (8028 JP) (“FM”) sold the remaining 60% of UNY to Don Quijote Holdings (7532 JP) (DQ), it entered into an agreement to buy 20+% in DQ, for one of two reasons; 1) a company wants to prove to the employees of a division being sold that they are maintaining a watchful eye over them, or (as is now evident) 2) the buyer wants to gain an equity method affiliate and the income from it (including the placeholder for frontrunner status to future capital events). 

  • FM launched a Partial Tender Offer at a 20% premium to last in order to buy these shares, and in the MOU to launch the tender offer there was a clause which said that if FM did not reach the full 20%, it had made arrangements to borrow shares in order to get to 20% of the voting rights. And if FM did not manage to get to the full 20%, there was an agreement between DQ which allowed FM to buy shares in the market to get to a 20% (but not larger) position. 
    • If FM managed to get the shares, it was going to buy from the weak hands.  Growth stock managers don’t like selling growth stocks until the growth stops growing. DQ is still growing, and with UNY, DQ may grow faster than previously expected. The upshot is that everyone decided they’d stand pat – FM got nothing in the tender (0.08% of the total desired).
  • Shares in DQ could fall because of a lack of hard strategy announced by FM to buy all the shares at a higher price immediately. That shouldn’t be a big worry – it wasn’t going to happen.
  • Travis Lundy sees DQ having a performance skew which includes a “cushion of sorts” in the ¥5500-6600/share zone where he would expect FM to acquire shares. He does not see a cushion for the shares of FM, and expects them to be volatile. 

(link to Travis’ insight: FamilyMart Tender Offer for Don Quijote Misses The Mark as Mr. Partridge Stands Pat)  

Harbin Electric Co Ltd H (1133 HK) (Mkt Cap: $546mn; Liquidity: $0.4mn)

Power generation equipment manufacturer Harbin Electric Co Ltd H (1133 HK) is currently suspended pursuant to Hong Kong’s Codes on Takeovers and Mergers and Share Buy-backs, suggesting a privatisation offer from parent Harbin Electric Corporation (“HEC”) is pending. As HE is PRC incorporated, a privatisation by way of a merger by absorption may be proposed, similar to Advanced Semiconductor Mfg Corp Ltd. (3355 HK) as discussed in ASMC’s Merger By Absorption. 

  • It is possible this suspension is not in relation to a takeover, but a major sale of assets, for example, from the parent to the sub. This would make sense given the recent share purchase by HEC (completed in January this year), and the fact HE is playing catch-up to Dongfang Electric Corporation (1072 HK) & Shanghai Electric Group Company (2727 HK). Arguably, launching a takeover shortly after subscribing for more shares is unusual.  Then again, when the two SOE railway behemoths CNR and CSR merged in 2015, a merger was disputed (at the time) when both were suspended on account of the fact CNR was only listed (on the HK exchange) in 2Q14.
  • HE has perennially traded at discount to net cash. As at its last traded price, the discount to net cash (using the 2018 interim figure of HK$12.4bn, or HK$7.27/share) was 65%.
  • “Fair” pricing to me would be something like the distribution of net cash to zero then taking over the company on PER. I simply don’t see this happening. And if it doesn’t, the fiduciary duty of independent directors will be tested/scrutinised if they recommend an offer to shareholders at any price less than the net cash/share of the company.

(link to my insight: Harbin Electric Expected To Be Privatised)  

Motherson Sumi Systems (MSS IN) (Mkt Cap: $7.7bn; Liquidity: $1.6mn)

Reportedly Motherson has entered merger/acquisition talks with Leoni AG (LEO GR), a leading provider of cables and cable systems for the automotive sector and other industries. Motherson has made four acquisitions so far in this business segment with the latest being PKC in 2017.

  • Motherson has always aimed at strengthening this business area internationally, therefore the news about a merger with Leoni comes as no surprise and was mentioned as a potential acquisition target in LightStream Research‘s earlier insight Two More Acquisitions on the Way for Motherson Sumi. 
  • Motherson has a strong balance sheet that could support this acquisition, although its ability to make further acquisitions in the short-to-medium term may be hampered – Leoni would be at the higher end of the price range for recent acquisitions. Should the acquisition go through, the company will be very well positioned to reach its US$18bn revenue target by 2020E, given that the combined revenue for FY2017 alone is ~US$13bn.
  • Currently, Motherson is trading at an FY1 EV/EBITDA of 10x, slightly above peers such as Mahindra Cie Automotive (MACA IN) (9x) and below peers such as Bosch Ltd (BOS IN) (25x). If the deal goes through, Motherson’s FY1 EV/EBITDA of ~12x would be at a slight premium to local players, but still reasonable compared to international players. 

(link to Aqila Ali ‘s insight: Motherson In Merger Talks with One of Our Previously Short-Listed Candidates – Leoni)  

MYOB Group Ltd (MYO AU) (Mkt Cap: $1.2bn; Liquidity: $7mn)

Kohlberg Kravis Roberts reduced its indicative offer to $3.40 from $3.77 on Thursday after sifting through MYOB’s books, with MYOB announcing:

Following completion of due diligence and finalisation of debt funding commitments, KKR has revised the offer price to $3.40 per share. …  The board has informed KKR that it is not in a position to recommend the revised proposal, however it remains in discussions with KKR regarding its proposal. (my emphasis)

(link to my insight: Friday Deadline Looms As MYOB Snubs KKR’s Reduced Offer)

EVENTS

NTT (Nippon Telegraph & Telephone) (9432 JP) (Mkt Cap: $75bn; Liquidity: $181mn)

The Nikkei carried an article noting that the Japanese government’s FY2019 budget currently being formed proposes a sale of ¥160bn of shares in NTT to help fund any revenue impact from the upcoming consumption tax rate hike from 8% to 10% next October. The article helpfully notes that they plan on selling when NTT is buying back shares. One of the longstanding features of buybacks for NTT is that NTT is subject to the NTT Law which requires (for the moment) that the government hold at least one-third of the shares outstanding in NTT.

  • Travis estimates NTT has ~1.95bn shares outstanding, or ~1.917bn shares outstanding ex-Treasury shares, after recent buybacks. If NTT cancelled the shares it has bought back prior to buying back shares from the government, this would allow NTT to buy back 59mm shares from the government (assuming those shares are also cancelled). If it did not, it would mean NTT could only buy back about 42-43mm shares. 59mm shares backs out ¥250bn; 43mm shares at a 10% discount would be  ¥180bn. That means there is about 10% leeway in stock price to buy ¥160bn from the government IF shares repurchased under the current buyback are not cancelled.
  • But that also means that there would be no more buybacks from the government after that until the company buys back more shares from the market. If the company wanted to buy back another ¥200bn from the government, ceteris paribus it would have to buy back something like ¥400-450bn first from the market in order to reduce the denominator. Travis concludes there is still more on-market buying to do.
  • At an NTT/ NTT Docomo Inc (9437 JP) ratio of 1.80x, buybacks coming, expected ongoing strong dividend policy (and lots of headroom to do so, unlike perhaps Softbank Corp (9434 JP)), and investor suspicion of what comes next for Docomo, NTT is the home of the cashflow.

(link to Travis’ insight: NTT Buybacks Will Roll On)  

Takeda Pharmaceutical (4502 JP) & Softbank Corp (9434 JP)

The IPO of Softbank Corp and the Merger of Takeda and Shire Pharmaceuticals create significant changes in TOPIX, MSCI, and FTSE because of the addition of roughly ¥5tn of “new” market capitalization in major Japan indices. Pure passive investors have something like ¥1.35tn of Softbank Corp and Takeda Pharmaceutical to buy.

  • However, after Travis’ initial note (Softbank Corp, Takeda, and Newton’s Three Laws of Motion), TSE unhelpfully changed their mind on timing (for Takeda) based on an unhelpful change by the LSE. With the changes at FTSE and now TOPIX and JPX Nikkei 400, we no longer have quite the same clarity of forces on the bodies, and therefore less clarity on the resulting motion. The LSE’s announced market change appears to have led the MSCI to change its deletion date for Shire as well, now also (along with FTSE) deleting Shire at the close of the 21st. The new schedule is:
    Index DeletionShire
    (shs mm)    		Index InclusionTakeda
    (shs mm)    		Index Effect
    (US$ bn)    		Net Delta
    (US$bn)
    21 DecMSCI -50MSCI JP+75– $0.3bn+$1.3bn
    21 DecFTSE UK, All-Share,-100-130FTSE JP+15-$5.2bn+– $2.1bn

    rest of December – end of a pretty bad year for hedge funds, but illiquid

    all of January

    30 JanTOPIX-$1.9bnTOPIX, JPXN400

    +60

    		+$2.1bn+$2.1bn
    30 JanTOPIX-$3.5bnTOPIXSoftbank+$3.5bn+$3.5bn
    all of February
    27 FebTOPIX, JPXN400+60+$2.1bn+$2.1bn
  • It doesn’t change the amounts but a lot more time allows for more risk and preparation and there will no longer be any potential settlement issues on the TOPIX side. There is still the same amount of Takeda to buy in TOPIX and JPX Nikkei 400. 
  • In principle, Travis would want to be long Takeda at the close of the year of 2018, but given the LSE and TSE changes there is less support to give and the payoff is substantially more distant. 

links to Travis’ insights
Softbank Corp, Takeda, and Newton’s Three Laws of Motion
Takeda: Move Over Newton! Now It’s Spooky Action At a Distance

Dic Corp (4631 JP) (Mkt Cap: $2.8bn; Liquidity: $15mn)

Speciality steel maker Nisshin Steel (5413 JP) is slated to merge with parent company Nippon Steel & Sumitomo Metal (5401 JP) as of January 1, 2019. For that, Nisshin Steel will be delisted on December 26th (i.e. the last day of trading is the 25th) and that means the Nikkei Inc was obliged to choose a replacement for Nisshin Steel in the Nikkei 225 and other indices. On December 11th, the Nikkei Inc announced Itoham Yonekyu Holdings Inc (2296 JP) would take Nisshin’s place in the Nikkei 500 Index; announced that Japan Post Holdings (6178 JP) would join the Nikkei 300 Index; and announced that Dic Corp (4631 JP) would replace Nisshin Steel in the Nikkei Stock Average, better known as the Nikkei 225.

  • Nisshin Steel’s deletion is a nothing-burger. 
  • The possibility of a DIC addition was well-flagged as early as May when sell-side brokers started compiling Annual and Ad Hoc Review lists for the Nikkei 225 changes to come in September and as a result of the Nisshin Steel merger. Travis would rather be long DIC than short DIC through the close of December 21st or probably December 25th. 

(link to Travis’ insight: Small Potatoes Nikkei 225 Changes on Christmas Day)

STUBS/HOLDCOS

Young Poong (000670 KS) / Korea Zinc (010130 KS)

YP appeared “cheap” back in April when I last discussed this Holdco, and is now cheaper, with its holding in KZ accounting for near-on 200% of its market cap.  I can’t think of any other parent/subsidiary relationship – one which is essentially a single stock structure – with such a deep discount. Especially one where the stub ops operate in a similar space to that of the listed holding. 

  • On the negative front, an investigation into YP’s Seokpo zinc smelter remains ongoing on account of perceived environmental transgressions. The Seokpo smelter is located in a national park on the Nakdong river. Wastewater containing above-legal limits of certain chemicals (fluoride and selenium) allegedly flowed downstream to residents, who are heavily reliant on this water.
  • YP’s stub and KZ are in the same business, but there are differences. YP does not have a balanced product mix as KZ does, with around 84% of its revenue coming from zinc-related production (for the 9M18 period), compared to 42.5% (on a revenue basis) for KZ, followed by lead (20.4%), silver (20.2%), and gold (7.6%).
  • However, YP and KZ remain inextricably intertwined and the current discount is unjustifiably steep. Just that YP’s liquidity, uncertainty on Seokpo, and lack of a near-term catalyst make for a difficult stub set-up.

(link to my insight: StubWorld: Young Poong Blows Out, Again)  

Softbank Group (9984 JP) / Softbank Corp (9434 JP)

A forgettable trading debut for Japan’s largest-ever IPO, with Softbank Corp, closing at ¥1,282/share, down from the IPO price of ¥1,500, and closing at ¥1,316/share on Friday, the same day as its FTSE inclusion.

TOPIX INCLUSIONS!

With seven stocks promoted/reassigned from TSE2, MOTHERS, and JASDAQ in November 2018 leading to the same seven stocks being included in TOPIX at the end of December, Travis tested 340+ TOPIX inclusions over the past five years to see what really happens around TOPIX inclusions?

  • If you own all but the smallest stocks (with a market cap of less than ¥15bn), odds are that, ON AVERAGE, they will underperform TOPIX from inclusion date or the day after, for many months.
  • The larger the market cap, the more marked the AVERAGE underperformance immediately following inclusion. 
  • For names in the ¥25-50bn sweet spot of “large enough to be “small cap” with somebody paying attention to it”, outperformance vs underperformance in the next 10 days is a 47/53 proposition. That is a bigger risk. It may be data-idiosyncratic, but it is not clear.
  • In the case of the 7 names going into TOPIX at month-end this month, the averages would suggest one could still be long the four largest (at the time of Travis’ insight), but one would not want to be long the others; and one could sell long positions in all the names as of the close of the 27th or 28th and have it be an ex-ante expected net positive outcome vs TOPIX over the following 10-60 trading days.

(link to Travis’ insight: Historical TOPIX Inclusions:  How Do They Do Around Inclusion Date?)

SHARE CLASSIFICATIONS

Ke Yan, CFA, FRM provided an update on the HK Connect/southbound flow. Fullshare Holdings (607 HK), Shandong Gold Mining Co Ltd (1787 HK) and Shanghai Fosun Pharmaceutical (Group) (2196 HK) rounded out the top three inflows relative to their free float in the past seven days.  Shandong Gold remained in the top inflow list for the third consecutive week. Top outflows relative to the free float are Wuxi Biologics (Cayman) Inc (2269 HK), China Southern Airlines (1055 HK) and Sino Biopharmaceutical (1177 HK). 

(link to Ke Yan’s insight: Discover HK Connect: Mainlanders Are Buying Shandong Gold, and Pharmaceuticals (2018-12-17))  

Briefly …

OTHER M&A UPDATES

  • LCY Chemical Corp (1704 TT).  MOEA (Ministry of Economic Affairs) approval has now been received and LCY has applied for the delisting from the TWSE. The last trading day is the 23 Jan 2019 and the stock delists on the 30 Jan.  The settlement is expected to take place mid-Feb.
  • Healthscope Ltd (HSO AU). In an ASX announcement on Friday Brookfield said: “based on its enquiries and financing discussions to date, it has no reason to believe it will not be willing and able to proceed with the proposal“. The exclusivity provisions have been extended to 18 January. Separately, Healthscope has also received correspondence from the BGH-AustralianSuper Consortium that it has indicated it is able to commence due diligence immediately. HSO’s board stated it will consider the correspondence. These are both positive developments.

CCASS

My ongoing series flags large moves (~10%) in CCASS holdings over the past week or so, moves which are often outside normal market transactions.  These may be indicative of share pledges.  Or potential takeovers. Or simply help understand volume swings. 

Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.   

Name

% change

Into

Out of

Comment

Tsaker Chemical (1986 HK)
11.53%
CMBC
China Sec
Hing Ming Holdings Ltd (8425 HK)
37.50%
Kingston
Outside CCASS
Postal Savings Bank Of China (1658 HK)
17.24%
UBS
Outside CCASS
Source: HKEx
Dec 31
0

Daily Japan: Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019 and more

By | Japan

In this briefing:

  1. Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019
  2. Japan Pharma – Top Picks (28 Dec 2018)
  3. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI
  4. GMO Internet (9447 JP) – Grossly or Modestly Overrated?
  5. Autonomous Driving. Waymo Leading The Charge With Ten Million Miles Driven And Counting

1. Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019

The year 2018 has proven tumultuous for global markets. Rapidly changing geopolitical priorities of the US, an erstwhile hegemon, have played a role no less significant than the withdrawal of liquidity by leading central banks or US monetary policy tightening. The US has openly declared that it is in a state of “cold war” with China. Despite the recent truce, signs are abundant that the confrontation between the two global superpowers will continue into 2019 and beyond. In 2019, we expect more countries to find themselves in a position where they must choose who they want to side with, the US or China. There are other tectonic shifts, too, which are causing re-alignment of global geopolitical alliances.

2. Japan Pharma – Top Picks (28 Dec 2018)

Pa%20coverage 20181228

Source: Pathology Associates research

                                                                                                                                                                                                                                                                        `                        

3. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

Dps

As the colder winter weather is felt and the icy blast of industry tariff cuts continues to chill sentiment, we seek some respite (at least mentally) in the warmer climes of Okinawa. Okinawa Cellular is a unique company. It’s a small cap telecom network operator in Japan with a focus on the sub-tropical islands of Okinawa Prefecture. As part of the KDDI group, the company benefits from its parent’s economies of scale, but with its local presence, it also benefits from being the hometown hero. 

Because the stock is relatively small, from an investment perspective it runs into liquidity constraints that the other telcos do not have, so it’s a different type of investment but one that we think is worth looking at. Over the past 12 months Okinawa Cellular’s stock has fallen by 12.3%, but over the past year the stock has delivered a return in the middle of its peer group and has outperformed the broad TOPIX by about 5.5%. Like most telcos, Okinawa Cellular is also ramping its dividend payments, and the current yield is about 3.5%.

4. GMO Internet (9447 JP) – Grossly or Modestly Overrated?

Gpa2

Source: Japan Analytics

THE GMO INTERNET (9449 JP) STORY – GMO internet (GMO-i) has attracted much attention in the last eighteen months from an unusual trinity of value, activist and ‘cryptocurrency’ equity investors.

  • VALUE– Many traditional, but mostly foreign, value investors have seen the persistent negative difference between GMO-i’s market capitalisation and the value of the company’s holdings in its eight listed consolidated subsidiaries as an opportunity to invest in GMO-i with a considerable ‘margin of safety’.
  • ACTIVIST – Since July 2017, the activist investor, Oasis, has waged a so-far-unsuccessful campaign with the aim of improving GMO’s corporate governance, removing takeover defences, addressing a ‘secularly undervalued stock price we are not able to tolerate’ (sic), and redefining the role and influence of the company’s Chairman, President, Representative Director and largest shareholder, Masatoshi Kumagai.
  • ‘CRYPTO!’ – In December 2017, GMO-i committed to spending more than ¥35b or 10% of non-current assets. The aim was threefold: to set up a bitcoin ‘mining’ headquarters in Switzerland (with the ‘mining’ operations being carried out at an undisclosed location in Scandinavia), to develop proprietary state-of-the-art 7nm-node ‘mining chips’, and, in due course, to sell GMO-branded and developed ‘mining’ machines. The move was hailed in the ‘crypto’ fraternity as GMO-i became the largest non-Chinese and the first well-established Internet conglomerate to make a major investment in ‘cryptocurrency’ infrastructure.

OUTSTANDING – Following the December 2017 announcement, trading volumes spiked into ‘Overtraded’ territory – as measured by our Volume Score. Many investors saw GMO-i shares as a safer way of gaining exposure to ‘cryptocurrencies’, even as the price of bitcoin began to subside. By early June 2018, GMO-i’s shares had reached a closing price of ¥3,020: up 157% from the low of the prior year and outperforming TOPIX by 135%. Whatever the primary driver of this outstanding performance, each of our trio of investor groups no doubt felt vindicated in their approach to the stock.

CRYPTO CLOSURE – On December 25th 2018, GMO-i’s shares reached a new 52-week low of ¥1,325, a decline of 56% from the June high. Year to date, GMO-i shares have now declined by 31%, underperforming TOPIX by nine percentage points. On the same day, GMO-i announced that the company would post an extraordinary ¥35.5b loss for the fourth quarter, incurring an impairment loss of ¥11.5b in relation to the closure of the Swiss ‘mining’ headquarters and a loss of ¥24b to cover the closure of the ‘mining chip’ and ‘mining machine’ development, manufacturing and sales businesses. GMO-i will continue to ‘mine’ bitcoin from its Tokyo headquarters and intends to relocate the ‘mining’ centre from Scandinavia to (sic) ‘a region that will allow us to secure cleaner and less expensive power supply, but we have not yet decided the details’. Unlisted subsidiary GMO Coin’s ‘cryptocurrency’ exchange will also continue to operate, and the previously-announced plans to launch a ¥-based ‘stablecoin’ in 2019 will proceed. In the two trading days following this announcement, the shares have recovered 13% to ¥1,505. 

RAIDING THE LISTCO PIGGY BANK – As we shall relate, this is the second time since listing that GMO-i has written off a significant new business venture which the company had commenced only a short time before. In both cases, the company was forced to sell stakes in its listed consolidated subsidiaries to offset the resulting losses. On this occasion, the sale of shares in GMO Financial (7177 JP) (GMO-F) on September 25 2018, and GMO Payment Gateway (3769 JP) (GMO-PG) on December 17 2018, raised a combined ¥55.6b and, after the deduction of the yet-to-be-determined tax on the realised gains, should more than offset the ‘crypto’ losses. According to CFO Yasuda, any surplus from this exercise will be used to pay down debt. Also discussed below and in keeping with this GMO-i ‘MO’, in 2015, the company twice sold shares in its listed subsidiaries to ‘smooth out’ less-than-desirable operating results.

In the DETAIL section below we will cover the following topics:-

I: THE GMO-i TRACK RECORD – TOP-DOWN v. BOTTOM UP

  • BOTTOM LINE No. 1: NET INCOME
  • BOTTOM LINE No.2 – COMPREHENSIVE INCOME

II: THE GMO-i BUSINESS MODEL – THROWING JELLY AT THE WALL

III: THE GMO-i BALANCE SHEET – NOT SO HAPPY RETURNS

IV: THE GMO-i CASH FLOW – DEBT-FUNDED CASH PILE

V: THE GMO-i VALUATION – TWO METHODS > SAME RESULT

  • VALUATION METHOD No.1 – THE ‘LISTCO DISCOUNT’
  • VALUATION METHOD No.2 – RESIDUAL INCOME

CONCLUSION – For those unable or unwilling to read further, we conclude that GMO-i ‘rump’ is a grossly-overrated business. Despite having started and spun off several valuable GMO Group entities, CEO Kumagai bears responsibility for two decades of serial and very poorly-timed ‘mal-investments’. As a result, the stock market has, except for the ‘cryptocurrency’-induced frenzy of the first six months of 2018, historically not accorded GMO-i any premium for future growth, and has correctly looked beyond the ‘siren song’ of the ‘HoldCo discount’. According to the two valuation methodologies described below, the company is, however, fairly valued at the current share price of ¥1,460. Investors looking for a return to the market-implied 3% perpetual growth rate of mid–2018 are likely to be as disappointed as those wishing for BTC to triple from here.

5. Autonomous Driving. Waymo Leading The Charge With Ten Million Miles Driven And Counting

Screen%20shot%202018 12 26%20at%204.52.57%20pm

Waymo CEO John Krafcik made some bold decisions after taking the helm at Alphabet‘s self-driving project in September 2015. Chief among them was the fact that the company abandon its plans for Level 3 automated driving and focus exclusively on levels 4 & 5. Furthermore, he decreed that Waymo would no longer manufacture its own vehicles but would instead integrate their technology into those of other automakers. Three years later, those decisions would appear to be finally paying off.

On October 10 2018, Waymo reached a significant milestone having completed 10 million self-driving miles across 25 cities in the US. While their first million self-driving miles took 18 months to complete, Waymo now clocks up over a million self-driving miles per month.  The company also recently announced the launch of its robo taxi service in Phoenix, Arizona and looks set to quickly follow suit in California. Plans to extend its self-driving technology beyond robotaxis, most notably for trucks and last-mile transportation solutions are also in the works. Furthermore, the company has begun laying down a framework of innovative B2B revenue models which should help accelerate the speed with which they can eventually monetize their technology.

It hasn’t been smooth sailing all the way for Waymo however. Earlier this year, the company was derided for the driving style of its autonomous vehicles and faced the criticism that its driverless cars continue to have safety drivers. There was also an embarrassing incident where one of those very safety drivers caused the self-driving car he was monitoring to hit a motorcyclist when he attempted to take control of the vehicle. According to Waymo’s own analysis of the vehicle log files, the accident would not have happened had he not intervened. 

With ten million self-driving miles under their belt and a thoughtful, strategic approach to monetizing their technology beginning to emerge, Waymo remains firmly ahead of their peers in leading the autonomous driving charge.  

Dec 31
0

Daily Thematic: China’s Sluggish Inbound Tourism Industry and more

By | Thematic (Sector/Industry)

In this briefing:

  1. China’s Sluggish Inbound Tourism Industry
  2. Japan: Moving Average Outliers – Year-End Blues
  3. What Just Happened In The Stock Market?

1. China’s Sluggish Inbound Tourism Industry

How can we explain the fact that in the five years from 2012 the number of tourist visits to China fell from 11.6 to 10.5 million per year? True, business and family reunion visits have risen, but such a culturally rich country should have more tourists.

2. Japan: Moving Average Outliers – Year-End Blues

2018 12 22 16 49 53

MARKET COMPOSITE

Source: Japan Analytics

TRADING ZONE – As of last Friday, the Japan All Market Composite has now entered a bear market, having declined by 20% from the January 23rd high if Y757t. At the close, only 8% by number and 11% by value of Japanese stocks were trading above their weighted composite of 5, 20, 60, 120, and 240-day moving averages. These were the lowest closing values since February 2016 when the All Market Composite reached a low of Y475tand  offer an entry point for a short-term trade for those happy to hold over the extended New Year Holiday period.

Source: Japan Analytics

BREAKOUTS –  The ‘Breaking Bad’ percentage reached 11% on December 4th, the tenth-lowest reading in three years bu thas yet to fall below ‘-15-.  Adding the Breaking Above and Breaking Below percentages together provides a more straightforward view of the 15% threshold that has marked previous short and medium-term turning points, and which again we have yet to reach.

SECTORS

LEGEND: The ‘sparklines’ show the three-year trend in the weighted percentage above moving average relative to the Market Composite and the ‘STDev’ column is a measure of the variability of that relative measure. The table also provides averages for the breaks above and breaks below and the positive and negative ‘crossovers’.

SECTOR BREAKDOWN – The top six sectors measured by the percentage above the weighted average of 5-240 Days are all, predictably, domestic and defensive –  Food, Beverages & Tobacco, REITs, Information Technology, Internet, Media and Utilities. Equally predictable are the bottom half-dozen – Banks, Non-Bank Finance, Autos, Metals, Electrical Equipment and Chemicals. 

COMPANIES

COMPANY MOVING AVERAGE OUTLIERS – As with the market and sectors, out moving average outlier indicator uses a weighted sum of the share price relative to its 5-day, 20-day, 60-day, 120 day and 240-day moving averages. Extreme values are weighted sums greater than 100% and less than -100%. We would caution that this indicator is best used for timing shorter-term reversals and, in many cases, higher highs and lower lows will be seen. 

Source: Japan Analytics

THE 100% CLUB – As of Friday 21st, there were 16 extreme positive outliers and 622 extreme negative outliers. The number of extreme negative outliers suggests we are a short-term bottom.

In the DETAIL section below, we highlight the current top and bottom twenty-five larger capitalisation outliers as well as those companies that have seen the most significant positive and negative changes in their outlier percentage in the last two weeks and provide short comments on companies of particular note. 

3. What Just Happened In The Stock Market?

The velocity and ferociousness of the recent U.S. equity market weakness caught even cautious investors like us by surprise. Our social media feed has been filled with extreme bearishness. Opinions are now becoming bifurcated. Either the decline is the signal of something big or the fall in stock prices represents a buying opportunity for fundamentally oriented investors.

It is impossible to make a buy, hold or sell decision without some understanding of what the market is discounting. Further analysis reveals that investors are discounting only a mild U.S. slowdown in 1H 2019, but no recession. From a technical perspective, both the U.S. and global markets have violated well-defined uptrend lines, just as they did in 2015 and 2007. It remains an open question as to whether the trend line breakdowns will result in just a mild pullback, or a deeper bear market.

From a technical perspective, we would look for conditions when the market stops responding to bad news. One example can be found during the eurozone and Greek Crisis of 2011. During the summer of 2011, the eurozone was at risk of breaking apart, and European leaders were having almost weekly summits on how to solve the problem. At times, it seemed that Europe was leaderless, and no one was in charge. The crisis lifted after the ECB unveiled its LTRO program to backstop the banking system in order to buy time for member states to engage in structural reform. Sometime during that process, the market stopped falling on bad news. We are not there yet.

Our recommendation is to monitor the evolution of financial risk, as well as the evolution of investor psychology, in order to determine the timing of a market bottom

Dec 31
0

Daily Growth Ideas: Tesla Motors Inc: Come Hell or High Water and more

By | Growth Ideas

In this briefing:

  1. Tesla Motors Inc: Come Hell or High Water
  2. FutureBright (703 HK): Typhoon Dampens 3Q Results
  3. Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long
  4. Alkem Laboratories – En Route to Recovery, Valuations Attractive
  5. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich

1. Tesla Motors Inc: Come Hell or High Water

Figure%201 %20tesla%20shorts

It is our view, that come hell or high-water, in 2019, Tesla Motors (TSLA US) will establish itself as the pre-eminent large-cap growth stock. Those that are short would cover the position at a loss and those that are long are looking at another Apple Inc (AAPL US) or Amazon.com Inc (AMZN US) in the making. The ride may be volatile, but will be worth it. 

2. FutureBright (703 HK): Typhoon Dampens 3Q Results

1

We recently met with management to discuss the company’s 3Q results and outlook for the coming year.

There was clear disappointment that goals for 2018 had not been achieved: rising opex dampened the recovery in EBITDA, despite solid SSSg, the Hengqin Land sale is racked with yet further delays, and the key rental property is still untenanted. That said, we feel much of the frustration is due to positive outcomes on all front being just around the corner.

This note aims to give a brief update on the key pillars forming our thesis.

3. Larsen & Toubro (LT IN): Slowdown in New Orders Is Risk for 3Q, Markets Can’t Ignore It for Long

Larsen & Toubro (LT IN) has reported the new orders worth only Rs95 bn after 2Q FY19 results (reported on 31st October 2018). This is much lower run rate as compared to 2Q FY19 (Rs419 bn) or 1H FY19 (Rs781 bn). All these orders by Larsen & Toubro (LT IN) have been received from construction segment where margins are relatively poor e.g. the construction and infrastructure segment of Larsen & Toubro (LT IN) in 2H FY19 has reported 6.8% EBITDA margin, much lower than 11.8% for the company on an overall basis.

Unless new orders pick up in next few weeks, there is a strong likelihood that there could be a negative surprise in 3Q results on order inflow for Larsen & Toubro (LT IN) . This is despite the fact that overall number reported for a quarter for order inflow is a bit higher than the sum of individual orders announced and reported by the company. While the market has not noticed decline in new orders so far and may have been still hopeful about a recovery in order wins, it is highly unlikely that this will continue to get ignored by investors if the trend doesn’t change and get better in next couple of weeks.

4. Alkem Laboratories – En Route to Recovery, Valuations Attractive

Rev%20&%20prof

Alkem Laboratories (ALKEM IN) produces branded generics, generic drugs, active pharmaceutical ingredients and neutraceuticals, which it markets in India and over 50 countries internationally. With a portfolio of over 700 brands covering all the major therapeutic segments and a pan-India sales and distribution network, Alkem has been ranked amongst the top ten pharmaceutical companies in India by sales for the past 13 years.

We are optimistic about Alkem because-

  • Alkem continues to grow significantly ahead of the segment growth rate of ~16% in the chronic therapy areas of Cardiac, Antidiabetic, Neuro / Central nervous system (CNS) and Derma. Alkem continues grow in the acute therapy areas of Anti-infective, Gastro-intestinal, Pain/ Analgesic and Vitamins / Minerals /Nutrients.
  • We expect India revenues to grow at CAGR 13% (FY18-21E) to Rs 64,687 mn in FY21E from Rs 44,900 mn in FY18. We expect US revenues to grow at CAGR 31% (FY18-21E) to Rs 30,438 mn from Rs 13,667 mn in FY18 and other international business revenues to grow at CAGR 11% (FY18-21E) to Rs 6,443 mn in FY21E from Rs 4,670 mn in FY18.
  • We expect EBITDA to grow at CAGR 21% (FY18-21E) to Rs 18,638 mn in FY21E from Rs 10,566 mn in FY18 and EBITDA margins to expand by ~ 190 bps to 18.4% in FY21E from 16.5% in FY18. We expect PAT to grow at CAGR 27% (FY18-21E) to Rs. 12,979 mn in FY21E from Rs 6,289 mn in FY18 and we expect PAT margins to expand by ~ 300 bps to 12.8% in FY21E from 9.8% in FY18.
  • We expect RoE to expand by ~530 bps to 19.0% in FY21E from 13.7% in FY18 and RoCE to expand by ~390 bps to 21.1% in FY21E from 17.2% in FY18

We initiate coverage on Alkem with fair value of Rs. 2,260/- representing a potential upside of 21% in the next 12 months. We arrived at the fair value by applying 22x multiple to September 20E EPS of Rs 102. Currently, the stock trades at 21x and 17x its earnings estimates for FY20E and FY21E respectively. After a very volatile 2018, we believe Alkem share price may have smooth upwards move in 2019 driven by strong PAT growth in the next 3 quarters.  

Particulars (Rs mn, Y/E March)

Net sales

EBITDA

PAT

EPS

ROE

ROCE

PE(x)

FY18

64,137

10,566

6,289

52.6

13.7%

17.2%

35

FY19E

74,075

12,406

8,130

68.0

16.0%

16.8%

27

FY20E

87,716

15,659

10,772

90.1

18.4%

20.4%

21

FY21E

1,01,568

18,638

12,979

108.6

19.0%

21.1%

17

 Source- Alkem Annual Report FY18, Trivikram Consultants Research as on 27/12/2018

5. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich

Share%20price%2027 12 2018

Swaraj Engines (SWE IN) (SEL)is primarily manufacturing diesel engines for fitment into Swaraj tractors manufactured by Mahindra & Mahindra Ltd. (M&M). The Company is also supplying engine components to SML Isuzu Ltd used in the assembly of commercial vehicle engines. SEL was started as a joint venture between Punjab Tractor Ltd (now acquired by M&M Ltd) and Kirloskar Oil Engines Ltd. M&M holds 33.3% stake in SEL and is its key client.  

We are positive about the business because:

  • SEL’s growth is correlated with M&M’s tractor business growth. SEL supplies engines to the Swaraj division of M&M. M&M expects tractor growth to be around 12% YoY in FY19E. We forecast SEL’s tractor engine volumes will grow at a CAGR of 12% for FY18-21E.
  • The growth of the company is dependent on the monsoon and rural sentiments. We expect the profitability to improve with normal rainfall and government initiatives towards the rural sector. We expect the revenue/ EBITDA/ PAT CAGR for FY18-21E to be 14%/ 15%/ 14% respectively.
  • SEL is debt free and a cash generating company. It has a healthy and stable ROCE and ROE. SEL has increased its capacity from 75,000 engines in FY16 to 120,000 engines in FY18. We expect the capacity utilisation to reach 97% by FY20E from 90% in 1HFY19. SEL funds its capex through internal accruals. We forecast a capex of Rs 600 mn for FY19E to FY21E considering the requirement of the additional capacity, R&D and testing costs for new and higher HP engines & for upgradation of engines according to the TREM IV emission norms for >50 HP engines.

We initiate coverage on SEL with a fair value objective of Rs 1,655/- over the next 12 months. This represents a potential upside of 15% from the closing price of Rs 1,435/- (as on 26-12-2018). We arrive at the fair value by applying PE multiple of 18x to EPS of Rs 87/- to the year ending December-20E and add cash of Rs 82/- per share. While the business outlook is good, we think the upside in the share price is limited due to rich valuation.

Particulars (Rs mn) (Y/E March)

FY18

FY19E

FY20E

FY21E

Revenue

 7,712

 9,210

 10,478

 11,525

PAT

 801

 906

 1,063

 1,190

EPS (Rs)

 64.5

 74.8

 87.6

 98.1

PE (x)

 22.3

 19.2

 16.4

 14.6

Source: SEL Annual Report FY18, Trivikram Consultants Research as on 26-12-2018

Note: E= Estimates

Dec 31
0

Daily Growth Ideas: Elastic: Why Is It Outperforming In Recent Tech Carnage? and more

By | Growth Ideas

In this briefing:

  1. Elastic: Why Is It Outperforming In Recent Tech Carnage?
  2. Horiba (6856 JP): Bad News Largely Discounted

1. Elastic: Why Is It Outperforming In Recent Tech Carnage?

Db 1

  • Elastic NV (ESTC US) has been one of the best tech IPOs globally in 2018. Its current price is $62.53, up 74% from its IPO price of $36. Elastic’s share price has been holding up very nicely since its IPO on October 5th, 2018. Meanwhile, from October 5th to December 21st 2018, many tech stocks have experienced brutal declines. Elastic’s ability to outperform the top US tech stocks in a very difficult environment for the stock market sets the stage for a continued out-performance once the stock market starts to stabilize. 
  • Since the IPO, the company reported better than expected second quarter results (quarter ending October 31, 2018) on December 4th. The company’s adjusted net loss in FY2Q19 was $0.38 per share, beating analysts’ consensus estimate by 9 cents. It generated revenue of $63.6 million, up 72% YoY. Calculated billings were also strong at $88.5 million, up 73% YoY. 
  • The company’s guidance for FY3Q19 (quarter ending January 31, 2019) is to generate revenue in the range of $64 million to $66 million, representing a 56% YoY growth rate at the midpoint of the guidance. It expects to generate operating margin of negative 28% to negative 30% in FY3Q19. 
  • A combination of major investors shifting their assets away from FAANG and semiconductor stocks has resulted in some improved performance of many software related stocks in recent months relative to other major tech stocks. In general, these stocks face less negative impact from a prolonged trade war between China and the US. Plus, they are not as exposed to the higher cycle volatility as the semiconductor related stocks. In many respects, Elastic shares many business similarities with these software driven companies, and thus has been more immune from the decline in the stock prices since early October. We remain positive on Elastic NV (ESTC US).

2. Horiba (6856 JP): Bad News Largely Discounted

Horiba%20spe

Horiba combines high gearing to semiconductor capital spending with a large and growing automotive test business characterized by upward trending but uneven profitability. At ¥4,545 (Friday, December 21, closing price), its share price has dropped by 53% from an all-time high of ¥9,590 reached last May. Falling demand for semiconductor production equipment and a downward revision to FY Dec-18 sales and profit guidance announced in November appear to be largely in the price. 

The downward revision, which cut projected full-year operating profit growth from 15.5% to 2.5%, followed a 22.2% year-on-year decline in operating profit in 3Q and implies a similar rate of decline in 4Q. The weakness is concentrated in Semiconductor Equipment and Automotive Test, the former due to a cyclical downturn in overall demand, the latter due to M&A-related and other one-time expenses. New Automotive Test orders continued to outpace sales, leading to a 9.5% increase in the order backlog during 3Q.

Automotive Test sales and profits should rise next year, while semiconductor equipment sales and profits seem likely to bottom out. In a report issued on December 17, SEMI (the semiconductor equipment and materials industry organization) forecasts a further decline in wafer fab equipment sales in 1H of 2019, followed by recovery in 2H. Other industry sources we talked to before the report was issued had similar views. 

This scenario could fall apart due to general economic weakness, American attempts to stifle China’s semiconductor industry, or both. On December 21, Reuters reported that Foxconn “…is in the final stages of talks with the local government of the Chinese city of Zhuhai to build a chip plant there with a total investment of about $9 billion… most of which would be shouldered by the Zhuhai government through subsidies and tax breaks…” This looks like a perfect target for the Americans, but whether or not they will notice or care remains to be seen.

Horiba is now selling at 9.6x our EPS estimate for this fiscal year, 13.4x our estimate for next year and 12.1x our estimate for FY Dec-20. These and other projected valuations are near the bottom of their 5-year historical ranges. If the Semiconductor Equipment division does not recover in 2H of 2019, historical data suggest that its operating profit could drop by 70% rather than the 47% we are now forecasting, resulting in a P/E ratio of 17x. Nevertheless, it is time to start considering when and at what price to buy Horiba.

Horiba is a diversified Japanese maker of precision and analytical devices and systems with a significant presence in the global markets for automotive test, industrial process and environmental analysis, hematology, semiconductor production equipment and scientific instruments. It is by far the world’s leading producer of automotive emission measurement systems (EMS), having supplied about 80% of the installed base worldwide, and also the world’s top manufacturer of mass flow controllers for the semiconductor industry, with an estimated global market share of nearly 60%.

Dec 31
0

Daily Event-Driven: Reality Check 2019: What Premium Does Thanachart Deserve from TMB’s Takeover? and more

By | Event-Driven

In this briefing:

  1. Reality Check 2019: What Premium Does Thanachart Deserve from TMB’s Takeover?
  2. Hyosung Holdings: 10%p Drop in Discount to NAV Should Be Reverted Soon
  3. Last Week in Event SPACE: Harbin Electric, MYOB, TMB Bank, Halla Holdings
  4. Celltrion/Celltrion H Pair: Last 2 Days Must Be Price Divergence, Not Mean Reversion
  5. Halla Holdings Stub Trade: Downwardly Mean Reversion in Favor of Mando

1. Reality Check 2019: What Premium Does Thanachart Deserve from TMB’s Takeover?

Tmb

As the merger between TMB and Thanachart gets a nudge from the Ministry of Finance and could be finalized this month, we try to answer a few questions in this review:

  • Takeover premium. Based on our estimates, the potential improvements in ROE from the merger and potential divestment of MBK, we think it justifies an Bt11.1/sh premium for Thanachart. The new best case price target for Thanachart stands at Bt64.25/sh, implying a 29% premium over current share price.
  • Negotiations will play a key role in the actual takeover price. We provide a table of how much money is left on the table for TMB if they acquire TCAP at lower than what we expect.
  • Benefits. Thanachart has a higher ROE than TMB and appears smaller but better managed. The merger would allow TMB to re-enter the securities business (more cross-selling), enlarge its asset management franchise, and scale up deposit base for both banks…more so on the Thanachart side.
  • Size. Even after the merger, the combined bank would still have a much smaller headcount than BAY, smallest of the five largest Thai banks. However, it would have more branches than BAY and just 11% less branches than KBANK. 

2. Hyosung Holdings: 10%p Drop in Discount to NAV Should Be Reverted Soon

5

  • Hyosung Corporation (004800 KS) had fallen 16% just in two days. Holdco is now at a 50% discount to NAV. This is a 10%p drop from 10 days ago (Dec 19). Holdco price must have been overly corrected. The ongoing police investigation on Cho Hyun-joon’s alleged crime won’t lead to a delisting. 10%p drop in discount to NAV must be a price divergence, not a sensible price correction.
  • Trade volume remained steady. Local hedge funds led the selling on Dec 27. Even they changed their position the following day. No short selling spike has been seen either. Hyosung is one of the highest yielding div holdco stocks. Hyosung Capital liquidation and Anyang Plant revaluation would be another short-term plus.
  • I’d exploit this price divergence. It would soon revert to the Dec 19 discount level. It should at least stay at the peer average.

3. Last Week in Event SPACE: Harbin Electric, MYOB, TMB Bank, Halla Holdings

29%20dec%20%202018

Last Week in Event SPACE …

(This insight covers specific insights & comments involving Stubs, Pairs, Arbitrage, share Classification and Events – or SPACE – in the past week)

M&A – ASIA-PAC

Harbin Electric Co Ltd H (1133 HK) (Mkt Cap: $546mn; Liquidity: $0.4mn)

As previously discussed in Harbin Electric Expected To Be Privatised, Harbin Electric (HE) has now announced a privatisation Offer from parent and 60.41%-shareholder Harbin Electric Corporation (“HEC”) by way of a merger by absorption. The Offer price of $4.56/share, an 82.4% premium to last close, is bang in line with that paid by HEC in January this year for new domestic shares. The Offer price has been declared final. 

  • Of note, the Offer price is a 37% discount to HE’s net cash of $7.27/share as at 30 June 2018. Should the privatisation be successful, this Offer will cost HEC ~HK$3.08bn, following which it can pocket the remaining net cash of $9.3bn PLUS the power generation equipment manufacturer business thrown in for free.
  • On pricing, “fair” to me would be something like the distribution of net cash to zero then taking over the company on a PER with respect to peers. That is not happening. It will be difficult to see how independent directors (and the IFA) can justify recommending an Offer to shareholders at any price below the net cash/share, especially when the underlying business is profit-generating.
  • Dissension rights are available, however, there is no administrative guidance on the substantive as well as procedural rules as to how the “fair price” will be determined under PRC and HK Law.
  • Trading at a gross/annualised spread of 15%/28% assuming end-July completion, based on the average timeline for merger by absorption precedents. As HEC is only waiting for approval from independent H-shareholders suggests this transaction may complete earlier than precedents. 

(link to my insight: Harbin Electric: The Price Is Not Right)  

MYOB Group Ltd (MYO AU) (Mkt Cap: $1.2bn; Liquidity: $7mn)

KKR and MYOB entered into Scheme Implementation Agreement (SIA) at $3.40/share, valuing MYOB, on a market cap basis, at A$2bn. MYOB’s board unanimously recommends shareholders to vote in favour of the Offer, in the absence of a superior proposal. The Offer price assumes no full-year dividend is paid.

  • On balance, MYOB’s board has made the right decision to accept KKR’s reduced Offer. The argument that MYOB is a “known turnaround story” is challenged as cloud-based accounting software providers Xero Ltd (XRO AU)  and Intuit Inc (INTU US) grab market share. This is also reflected in MYOB’s forecast 7% revenue growth in FY18 and follows a 10% decline in first-half profit, despite a 61% jump in online subscribers.
  • And there is justification for KKR’s lowering the Offer price: the ASX is down 10% since KKR’s initial tilt, the ASX technology index is off by ~14%, a basket of listed Aussie peers are down 17%, while Xero, the most comparable peer, is down ~20%. The Scheme Offer is at a ~27% premium to the estimated adjusted (for the ASX index) downside price of $2.68/share.

  • Bain was okay selling at $3.15/share to KKR and will be fine selling its remaining ~6.5% stake at $3.40. Presumably, MYOB sounded out the other major shareholders such as Fidelity, Yarra Funds Management, Vanguard etc as to their read on the revised $3.40 offer, before agreeing to the SIA with KKR.

  • If the markets avoid further declines, this deal will probably get up. If the markets rebound, the outcome is less assured. This Tuesday marks the beginning of a new year and a renewed mandate for investors to take risk, especially an agreed deal; but the current 5.3% annualised spread is tight.

(link to my insight: MYOB Caves And Agrees To KKR’s Reduced Offer)

TMB Bank PCL (TMB TB) (Mkt Cap: $1.2bn; Liquidity: $7mn)

The Ministry of Finance, the major shareholder of TMB, confirmed that both Krung Thai Bank Pub (KTB TB) and Thanachart Capital (TCAP TB) had engaged in merger talks with TMB. Considering an earlier KTB/TMB courtship failed, it is more likely, but by no means guaranteed, that the deal with Thanachart will happen. Bloomberg is also reporting that Thanachart and TMB want to do a deal before the next elections, which is less than two months away.

  • TMB is much bigger than Thanachart and therefore it may boil down to whether TMB wants to be the target or acquirer. In Athaporn Arayasantiparb, CFA‘s view, a deal with Thanachart would leave TMB as the acquirer rather than the target. But Thanachart’s management has a better track record than TMB.
  • Both banks have undergone extensive deals before this one: 1) TMB acquired DBS Thai Danu and IFCT; and 2) Thanachart engineered an acquisition of the much bigger, but struggling, SCIB.
  • A merger between the two would still leave them smaller than Bank Of Ayudhya (BAY TB) and would not change the bank rankings; but it would give TMB a bigger presence in asset management, hire-purchase finance and a re-entry into the securities business.

(link to Athaporn’s insight: Sathorn Series M: TMB-Thanachart Courtship)  

STUBS/HOLDCOS

Halla Holdings (060980 KS) / Mando Corp (204320 KS)

Mando accounts for 45% of Halla’s NAV, which is currently trading at a 50% discount. Sanghyun Park believes the recent narrowing in the discount may be due to the hype attached to Mando-Hella Elec, which he believes is overdone; and recommends a short Holdco and long Mando. Using Sanghyun’s figures, I see the discount to NAV at 51%, 2STD above the 12-month average of ~47%.

(link to Sanghyun’s insight: Halla Holdings Stub Trade: Downwardly Mean Reversion in Favor of Mando)  

SHARE CLASSIFICATIONS

OTHER M&A UPDATES

CCASS

My ongoing series flags large moves (~10%) in CCASS holdings over the past week or so, moves which are often outside normal market transactions.  These may be indicative of share pledges.  Or potential takeovers. Or simply help understand volume swings. 

Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.   

Name

% change

Into

Out of

Comment

Putian Communication (1720 HK)
69.75%
Shanghai Pudong
Outside CCASS
Chu Kong Shipping Enterprises(Grp) (560 HK)
37.68%
China Industrial
Outside CCASS
C-Mer Eye Care Holdings Limited (3309 HK)
16.23%
HSBC
Outside CCASS
Source: HKEx

4. Celltrion/Celltrion H Pair: Last 2 Days Must Be Price Divergence, Not Mean Reversion

7

  • The accounting fraud issue had hammered the Celltrion duo nearly equally up until Dec 26. But last two days were different. Healthcare got hurt much more deeply. Celltrion fell only 2.41%, but Healthcare fell 11.52%.
  • The accounting issue is supposed to be equal to both. KOSPI move and merger are still alive to push up Healthcare. Local institutions and foreigners have bashed both pretty much equally in the last two days. This is another sign that it was more of a price divergence than a mean reversion.
  • The duo is now at 20D MA and also the yearly mean. I expect it to go substantially below the yearly mean on KOSPI move and merger expectations. A powerful downwardly mean adjusting force still seems to be in action. I’d long Healthcare and short Celltrion to exploit the latest price divergence.

5. Halla Holdings Stub Trade: Downwardly Mean Reversion in Favor of Mando

2

  • Halla Holdings is falling nearly 5% today. Holdco said it’d give a ₩2,000 div per share. This is about 4.5% div yield at yesterday’s closing price. 5% drop today shouldn’t be much as an ex-dividend date price drop. Mando fell 5%. Mando was oversold relative to the other local auto stocks, particularly to Halla Holdings. They are still close to +1 σ on a 20D MA.
  • Mando-Hella Elec has been another reason behind Holdco’s valuation divergence against Mando lately. I believe Mando-Hella is being overhyped. Mando-Hella-caused divergence should no longer be effective. I expect ‘downwardly’ mean reversion from now on. I’d go short Holdco and long Mando at this point.
Dec 31
0

Daily Event-Driven: MYOB Caves And Agrees To KKR’s Reduced Offer and more

By | Event-Driven

In this briefing:

  1. MYOB Caves And Agrees To KKR’s Reduced Offer
  2. Last Week in Event SPACE: Familymart, Takeda, Harbin Electric, Motherson, Young Poong, NTT
  3. Sathorn Series M: TMB-Thanachart Courtship

1. MYOB Caves And Agrees To KKR’s Reduced Offer

Chart

It could have gone either way.

After securing a 19.9% stake from Bain in early October and initially pitching A$3.70/share, in a textbook bear hug, KKR (marginally) bumped its indicative offer to A$3.77/share to a get a look under the hood, then following seven weeks of due diligence, backtracked with a lower price of A$3.40/share, citing adverse market conditions.

MYOB Board’s response last week to the reduced offer was to inform KKR that it is not in a position to recommend the revised proposal, however, “it remains in discussions with KKR regarding its proposal”, leaving the door open for ongoing negotiations. KKR for its part, said there were no landmines following the DD process. The price action last Friday suggested the outcome was a coin toss.

Today, KKR and MYOB entered into Scheme Implementation Agreement (SIA) at $3.40/share, valuing MYOB, on a market cap basis, at A$2bn. MYOB’s board unanimously recommends shareholders to vote in favour of the Offer, in the absence of a superior proposal and subject to an independent expert concluding the Offer is in the best interest of shareholders. The Offer price assumes no full-year dividend is paid.

The agreement provides a “go shop” provision until the 22 February 2019 – when MYOB is expected to release its FY18 results – to solicit competing proposals.

The Offer appears reasonable when compared to peers and with regards to the 14% decline in the ASX technology index; but conversely, could be construed as being opportunistic.

A Scheme Booklet is expected to be dispatched mid-March with an estimated implementation date of 3 May. Currently trading at a 3.8%/11% gross/annualised spread. 1 January makes a new year and there will be investors who would want to take an agreed deal at 11%.

2. Last Week in Event SPACE: Familymart, Takeda, Harbin Electric, Motherson, Young Poong, NTT

22%20dec%20%202018

Last Week in Event SPACE …

(This insight covers specific insights & comments involving Stubs, Pairs, Arbitrage, share Classification and Events – or SPACE – in the past week)

M&A – ASIA-PAC

Recapping the original plan: when Familymart Uny Holdings (8028 JP) (“FM”) sold the remaining 60% of UNY to Don Quijote Holdings (7532 JP) (DQ), it entered into an agreement to buy 20+% in DQ, for one of two reasons; 1) a company wants to prove to the employees of a division being sold that they are maintaining a watchful eye over them, or (as is now evident) 2) the buyer wants to gain an equity method affiliate and the income from it (including the placeholder for frontrunner status to future capital events). 

  • FM launched a Partial Tender Offer at a 20% premium to last in order to buy these shares, and in the MOU to launch the tender offer there was a clause which said that if FM did not reach the full 20%, it had made arrangements to borrow shares in order to get to 20% of the voting rights. And if FM did not manage to get to the full 20%, there was an agreement between DQ which allowed FM to buy shares in the market to get to a 20% (but not larger) position. 
    • If FM managed to get the shares, it was going to buy from the weak hands.  Growth stock managers don’t like selling growth stocks until the growth stops growing. DQ is still growing, and with UNY, DQ may grow faster than previously expected. The upshot is that everyone decided they’d stand pat – FM got nothing in the tender (0.08% of the total desired).
  • Shares in DQ could fall because of a lack of hard strategy announced by FM to buy all the shares at a higher price immediately. That shouldn’t be a big worry – it wasn’t going to happen.
  • Travis Lundy sees DQ having a performance skew which includes a “cushion of sorts” in the ¥5500-6600/share zone where he would expect FM to acquire shares. He does not see a cushion for the shares of FM, and expects them to be volatile. 

(link to Travis’ insight: FamilyMart Tender Offer for Don Quijote Misses The Mark as Mr. Partridge Stands Pat)  

Harbin Electric Co Ltd H (1133 HK) (Mkt Cap: $546mn; Liquidity: $0.4mn)

Power generation equipment manufacturer Harbin Electric Co Ltd H (1133 HK) is currently suspended pursuant to Hong Kong’s Codes on Takeovers and Mergers and Share Buy-backs, suggesting a privatisation offer from parent Harbin Electric Corporation (“HEC”) is pending. As HE is PRC incorporated, a privatisation by way of a merger by absorption may be proposed, similar to Advanced Semiconductor Mfg Corp Ltd. (3355 HK) as discussed in ASMC’s Merger By Absorption. 

  • It is possible this suspension is not in relation to a takeover, but a major sale of assets, for example, from the parent to the sub. This would make sense given the recent share purchase by HEC (completed in January this year), and the fact HE is playing catch-up to Dongfang Electric Corporation (1072 HK) & Shanghai Electric Group Company (2727 HK). Arguably, launching a takeover shortly after subscribing for more shares is unusual.  Then again, when the two SOE railway behemoths CNR and CSR merged in 2015, a merger was disputed (at the time) when both were suspended on account of the fact CNR was only listed (on the HK exchange) in 2Q14.
  • HE has perennially traded at discount to net cash. As at its last traded price, the discount to net cash (using the 2018 interim figure of HK$12.4bn, or HK$7.27/share) was 65%.
  • “Fair” pricing to me would be something like the distribution of net cash to zero then taking over the company on PER. I simply don’t see this happening. And if it doesn’t, the fiduciary duty of independent directors will be tested/scrutinised if they recommend an offer to shareholders at any price less than the net cash/share of the company.

(link to my insight: Harbin Electric Expected To Be Privatised)  

Motherson Sumi Systems (MSS IN) (Mkt Cap: $7.7bn; Liquidity: $1.6mn)

Reportedly Motherson has entered merger/acquisition talks with Leoni AG (LEO GR), a leading provider of cables and cable systems for the automotive sector and other industries. Motherson has made four acquisitions so far in this business segment with the latest being PKC in 2017.

  • Motherson has always aimed at strengthening this business area internationally, therefore the news about a merger with Leoni comes as no surprise and was mentioned as a potential acquisition target in LightStream Research‘s earlier insight Two More Acquisitions on the Way for Motherson Sumi. 
  • Motherson has a strong balance sheet that could support this acquisition, although its ability to make further acquisitions in the short-to-medium term may be hampered – Leoni would be at the higher end of the price range for recent acquisitions. Should the acquisition go through, the company will be very well positioned to reach its US$18bn revenue target by 2020E, given that the combined revenue for FY2017 alone is ~US$13bn.
  • Currently, Motherson is trading at an FY1 EV/EBITDA of 10x, slightly above peers such as Mahindra Cie Automotive (MACA IN) (9x) and below peers such as Bosch Ltd (BOS IN) (25x). If the deal goes through, Motherson’s FY1 EV/EBITDA of ~12x would be at a slight premium to local players, but still reasonable compared to international players. 

(link to Aqila Ali ‘s insight: Motherson In Merger Talks with One of Our Previously Short-Listed Candidates – Leoni)  

MYOB Group Ltd (MYO AU) (Mkt Cap: $1.2bn; Liquidity: $7mn)

Kohlberg Kravis Roberts reduced its indicative offer to $3.40 from $3.77 on Thursday after sifting through MYOB’s books, with MYOB announcing:

Following completion of due diligence and finalisation of debt funding commitments, KKR has revised the offer price to $3.40 per share. …  The board has informed KKR that it is not in a position to recommend the revised proposal, however it remains in discussions with KKR regarding its proposal. (my emphasis)

(link to my insight: Friday Deadline Looms As MYOB Snubs KKR’s Reduced Offer)

EVENTS

NTT (Nippon Telegraph & Telephone) (9432 JP) (Mkt Cap: $75bn; Liquidity: $181mn)

The Nikkei carried an article noting that the Japanese government’s FY2019 budget currently being formed proposes a sale of ¥160bn of shares in NTT to help fund any revenue impact from the upcoming consumption tax rate hike from 8% to 10% next October. The article helpfully notes that they plan on selling when NTT is buying back shares. One of the longstanding features of buybacks for NTT is that NTT is subject to the NTT Law which requires (for the moment) that the government hold at least one-third of the shares outstanding in NTT.

  • Travis estimates NTT has ~1.95bn shares outstanding, or ~1.917bn shares outstanding ex-Treasury shares, after recent buybacks. If NTT cancelled the shares it has bought back prior to buying back shares from the government, this would allow NTT to buy back 59mm shares from the government (assuming those shares are also cancelled). If it did not, it would mean NTT could only buy back about 42-43mm shares. 59mm shares backs out ¥250bn; 43mm shares at a 10% discount would be  ¥180bn. That means there is about 10% leeway in stock price to buy ¥160bn from the government IF shares repurchased under the current buyback are not cancelled.
  • But that also means that there would be no more buybacks from the government after that until the company buys back more shares from the market. If the company wanted to buy back another ¥200bn from the government, ceteris paribus it would have to buy back something like ¥400-450bn first from the market in order to reduce the denominator. Travis concludes there is still more on-market buying to do.
  • At an NTT/ NTT Docomo Inc (9437 JP) ratio of 1.80x, buybacks coming, expected ongoing strong dividend policy (and lots of headroom to do so, unlike perhaps Softbank Corp (9434 JP)), and investor suspicion of what comes next for Docomo, NTT is the home of the cashflow.

(link to Travis’ insight: NTT Buybacks Will Roll On)  

Takeda Pharmaceutical (4502 JP) & Softbank Corp (9434 JP)

The IPO of Softbank Corp and the Merger of Takeda and Shire Pharmaceuticals create significant changes in TOPIX, MSCI, and FTSE because of the addition of roughly ¥5tn of “new” market capitalization in major Japan indices. Pure passive investors have something like ¥1.35tn of Softbank Corp and Takeda Pharmaceutical to buy.

  • However, after Travis’ initial note (Softbank Corp, Takeda, and Newton’s Three Laws of Motion), TSE unhelpfully changed their mind on timing (for Takeda) based on an unhelpful change by the LSE. With the changes at FTSE and now TOPIX and JPX Nikkei 400, we no longer have quite the same clarity of forces on the bodies, and therefore less clarity on the resulting motion. The LSE’s announced market change appears to have led the MSCI to change its deletion date for Shire as well, now also (along with FTSE) deleting Shire at the close of the 21st. The new schedule is:
    Index DeletionShire
    (shs mm)    		Index InclusionTakeda
    (shs mm)    		Index Effect
    (US$ bn)    		Net Delta
    (US$bn)
    21 DecMSCI -50MSCI JP+75– $0.3bn+$1.3bn
    21 DecFTSE UK, All-Share,-100-130FTSE JP+15-$5.2bn+– $2.1bn

    rest of December – end of a pretty bad year for hedge funds, but illiquid

    all of January

    30 JanTOPIX-$1.9bnTOPIX, JPXN400

    +60

    		+$2.1bn+$2.1bn
    30 JanTOPIX-$3.5bnTOPIXSoftbank+$3.5bn+$3.5bn
    all of February
    27 FebTOPIX, JPXN400+60+$2.1bn+$2.1bn
  • It doesn’t change the amounts but a lot more time allows for more risk and preparation and there will no longer be any potential settlement issues on the TOPIX side. There is still the same amount of Takeda to buy in TOPIX and JPX Nikkei 400. 
  • In principle, Travis would want to be long Takeda at the close of the year of 2018, but given the LSE and TSE changes there is less support to give and the payoff is substantially more distant. 

links to Travis’ insights
Softbank Corp, Takeda, and Newton’s Three Laws of Motion
Takeda: Move Over Newton! Now It’s Spooky Action At a Distance

Dic Corp (4631 JP) (Mkt Cap: $2.8bn; Liquidity: $15mn)

Speciality steel maker Nisshin Steel (5413 JP) is slated to merge with parent company Nippon Steel & Sumitomo Metal (5401 JP) as of January 1, 2019. For that, Nisshin Steel will be delisted on December 26th (i.e. the last day of trading is the 25th) and that means the Nikkei Inc was obliged to choose a replacement for Nisshin Steel in the Nikkei 225 and other indices. On December 11th, the Nikkei Inc announced Itoham Yonekyu Holdings Inc (2296 JP) would take Nisshin’s place in the Nikkei 500 Index; announced that Japan Post Holdings (6178 JP) would join the Nikkei 300 Index; and announced that Dic Corp (4631 JP) would replace Nisshin Steel in the Nikkei Stock Average, better known as the Nikkei 225.

  • Nisshin Steel’s deletion is a nothing-burger. 
  • The possibility of a DIC addition was well-flagged as early as May when sell-side brokers started compiling Annual and Ad Hoc Review lists for the Nikkei 225 changes to come in September and as a result of the Nisshin Steel merger. Travis would rather be long DIC than short DIC through the close of December 21st or probably December 25th. 

(link to Travis’ insight: Small Potatoes Nikkei 225 Changes on Christmas Day)

STUBS/HOLDCOS

Young Poong (000670 KS) / Korea Zinc (010130 KS)

YP appeared “cheap” back in April when I last discussed this Holdco, and is now cheaper, with its holding in KZ accounting for near-on 200% of its market cap.  I can’t think of any other parent/subsidiary relationship – one which is essentially a single stock structure – with such a deep discount. Especially one where the stub ops operate in a similar space to that of the listed holding. 

  • On the negative front, an investigation into YP’s Seokpo zinc smelter remains ongoing on account of perceived environmental transgressions. The Seokpo smelter is located in a national park on the Nakdong river. Wastewater containing above-legal limits of certain chemicals (fluoride and selenium) allegedly flowed downstream to residents, who are heavily reliant on this water.
  • YP’s stub and KZ are in the same business, but there are differences. YP does not have a balanced product mix as KZ does, with around 84% of its revenue coming from zinc-related production (for the 9M18 period), compared to 42.5% (on a revenue basis) for KZ, followed by lead (20.4%), silver (20.2%), and gold (7.6%).
  • However, YP and KZ remain inextricably intertwined and the current discount is unjustifiably steep. Just that YP’s liquidity, uncertainty on Seokpo, and lack of a near-term catalyst make for a difficult stub set-up.

(link to my insight: StubWorld: Young Poong Blows Out, Again)  

Softbank Group (9984 JP) / Softbank Corp (9434 JP)

A forgettable trading debut for Japan’s largest-ever IPO, with Softbank Corp, closing at ¥1,282/share, down from the IPO price of ¥1,500, and closing at ¥1,316/share on Friday, the same day as its FTSE inclusion.

TOPIX INCLUSIONS!

With seven stocks promoted/reassigned from TSE2, MOTHERS, and JASDAQ in November 2018 leading to the same seven stocks being included in TOPIX at the end of December, Travis tested 340+ TOPIX inclusions over the past five years to see what really happens around TOPIX inclusions?

  • If you own all but the smallest stocks (with a market cap of less than ¥15bn), odds are that, ON AVERAGE, they will underperform TOPIX from inclusion date or the day after, for many months.
  • The larger the market cap, the more marked the AVERAGE underperformance immediately following inclusion. 
  • For names in the ¥25-50bn sweet spot of “large enough to be “small cap” with somebody paying attention to it”, outperformance vs underperformance in the next 10 days is a 47/53 proposition. That is a bigger risk. It may be data-idiosyncratic, but it is not clear.
  • In the case of the 7 names going into TOPIX at month-end this month, the averages would suggest one could still be long the four largest (at the time of Travis’ insight), but one would not want to be long the others; and one could sell long positions in all the names as of the close of the 27th or 28th and have it be an ex-ante expected net positive outcome vs TOPIX over the following 10-60 trading days.

(link to Travis’ insight: Historical TOPIX Inclusions:  How Do They Do Around Inclusion Date?)

SHARE CLASSIFICATIONS

Ke Yan, CFA, FRM provided an update on the HK Connect/southbound flow. Fullshare Holdings (607 HK), Shandong Gold Mining Co Ltd (1787 HK) and Shanghai Fosun Pharmaceutical (Group) (2196 HK) rounded out the top three inflows relative to their free float in the past seven days.  Shandong Gold remained in the top inflow list for the third consecutive week. Top outflows relative to the free float are Wuxi Biologics (Cayman) Inc (2269 HK), China Southern Airlines (1055 HK) and Sino Biopharmaceutical (1177 HK). 

(link to Ke Yan’s insight: Discover HK Connect: Mainlanders Are Buying Shandong Gold, and Pharmaceuticals (2018-12-17))  

Briefly …

OTHER M&A UPDATES

  • LCY Chemical Corp (1704 TT).  MOEA (Ministry of Economic Affairs) approval has now been received and LCY has applied for the delisting from the TWSE. The last trading day is the 23 Jan 2019 and the stock delists on the 30 Jan.  The settlement is expected to take place mid-Feb.
  • Healthscope Ltd (HSO AU). In an ASX announcement on Friday Brookfield said: “based on its enquiries and financing discussions to date, it has no reason to believe it will not be willing and able to proceed with the proposal“. The exclusivity provisions have been extended to 18 January. Separately, Healthscope has also received correspondence from the BGH-AustralianSuper Consortium that it has indicated it is able to commence due diligence immediately. HSO’s board stated it will consider the correspondence. These are both positive developments.

CCASS

My ongoing series flags large moves (~10%) in CCASS holdings over the past week or so, moves which are often outside normal market transactions.  These may be indicative of share pledges.  Or potential takeovers. Or simply help understand volume swings. 

Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.   

Name

% change

Into

Out of

Comment

Tsaker Chemical (1986 HK)
11.53%
CMBC
China Sec
Hing Ming Holdings Ltd (8425 HK)
37.50%
Kingston
Outside CCASS
Postal Savings Bank Of China (1658 HK)
17.24%
UBS
Outside CCASS
Source: HKEx

3. Sathorn Series M: TMB-Thanachart Courtship

Right before Christmas, the Ministry of Finance confirms that both Thanachart and KTB were in talks to merge with TMB. We note that:

  • Considering that KTB’s earlier courtship failed once, it is more likely, but by no means guaranteed, for the deal with Thanachart to happen.
  • A deal with Thanachart would leave TMB as the acquirer rather than the target. Thanachart’s management has better track record than TMB.
  • Both banks have undergone extensive deals before this one: 1) TMB acquired DBS Thai Danu and IFCT; and 2) Thanachart engineered an acquisition of the much bigger, but struggling, SCIB.
  • A merger between the two would still leave them smaller than BAY and not really change the bank rankings, but it would give TMB a bigger presence in asset management and hire-purchase finance and an re-entry into the securities business.
Dec 31
0

Daily Event-Driven: Harbin Electric: The Price Is Not Right and more

By | Event-Driven

In this briefing:

  1. Harbin Electric: The Price Is Not Right
  2. MYOB (MYO AU): Shareholders Are Caught Between a Rock and a Hard Place
  3. New Pride Rights Offer: Tempting but Tricky
  4. LG Chem Share Class: Another Pref to Watch as Div Yield Gap at 4Y High
  5. Daelim Industrial Share Class: One of Prefs to Arb Trade on Div Payout Record Date

1. Harbin Electric: The Price Is Not Right

Dissent

As speculated in Harbin Electric Expected To Be Privatised, Harbin Electric Co Ltd H (1133 HK) has now announced a privatisation Offer from parent and 60.41%-shareholder Harbin Electric Corporation (“HEC”) by way of a merger by absorption. 

The Offer price of $4.56/share, an 82.4% premium to last close, has been declared final. The price corresponds to the subscription of 329mn domestic shares (~47.16% of the existing issued domestic shares and ~24.02% of the existing total issued shares) @$4.56/share by HEC in January this year. 

Of greater significance, the Offer price is a 37% discount to HE’s net cash of $7.27/share as at 30 June 2018. Should the privatisation be successful, this Offer will cost HEC ~HK$3.08bn, following which it can pocket the remaining net cash of $9.3bn PLUS the power generation equipment manufacturer business thrown in for free.

On pricing, “fair” to me would be something like the distribution of net cash to zero then taking over the company on a PER with respect to peers. That is not happening. It will be difficult to see how independent directors can justify recommending an Offer to shareholders at any price which gave cash less cavalier than cash.

Dissension rights are available, however, what constitutes a “fair price” under those rights, and the timing of the settlement under such rights, are not evident. 

As all PRC approvals have been obtained, this transaction may complete earlier than prior mergers by absorption, which have taken 6-8 months from the initial announcement.

2. MYOB (MYO AU): Shareholders Are Caught Between a Rock and a Hard Place

Valuation%2024%20dec

On 24 December, MYOB Group Ltd (MYO AU) announced that it entered into a scheme implementation agreement under which KKR will acquire MYOB at $3.40 per share, which is 10% lower than 2 November offer price of A$3.77. MYOB claims its decision to recommend KKR’s lower offer was based on current market uncertainty, long-term nature of its strategic growth plans and the go-shop provisions of the deal. 

We believe that KKR’s revised offer is opportunistic, but MYOB’s shareholders are caught between a rock and a hard place. Shareholders can take a short-term view and grudgingly accept the revised offer. Alternatively, shareholders can take a long-term view by rejecting the offer and hope MYOB’s strategic growth plans and a market recovery can reverse the inevitable share price collapse.

3. New Pride Rights Offer: Tempting but Tricky

1

  • New Pride Corp (900100 KS) announced a ₩36.2bil rights offer. This is a public offering, so there won’t be subscription rights to trade. Pricing will be done as 3-day VWAP on Jan 9~11 at a 30% discount.
  • Supposedly, we can have ample opportunity to arb trade. This may be what the company is hoping. Simply, we wait until Jan 16~17 (subscription period) and see the spread. At this much discount, there must be a huge spread opening.
  • Proration risk can be much more annoying than a usual stockholder offering. In the previous public offering event by New Pride, subscription rate went as high as 370 to 1. It should be way much lower this time. But still this is risky enough.

4. LG Chem Share Class: Another Pref to Watch as Div Yield Gap at 4Y High

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  • LG Chem Ltd (051910 KS) 1P is now at a 44.20% discount to Common. Div would be the same as last year of ₩6,000 despite lower earnings. Payout would be 28%. Div yield for Common will be 1.68%, and 3.03% for 1P. Div yield difference stands at 1.35%p. This is a record high at least since 2014.
  • 1P’s discount to Common is hovering at the highest level in 2 years. On a 20D MA, it is close to +1 σ. It may not be tempting enough for those seeking high yields. Otherwise, this’d be worth giving it a shot. Liquidity shouldn’t be an issue. Short recovering risk on Common also appears to be limited.

5. Daelim Industrial Share Class: One of Prefs to Arb Trade on Div Payout Record Date

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  • Daelim Industrial (000210 KS) is one of the main targets of local activist movement. This makes a setting for higher dividends. Common div yield to 1.58% and Pref to 4.18%. Difference is 2.59%p. This is the widest gap in many years.
  • Pref is currently at a 60.89% discount to Common. Among those > ₩100bil MC prefs, it is the second highest discounted pref, only behind CJ Cheiljedang 1P (097955 KS). Local street expects at least ₩1,600 div per share. This should be a conservative estimate. On a 20D MA, Pref is above +1 σ.
  • Dec 26 is record date of dividend payout. I expect a price catchup movement tomorrow in favor of Pref. I’d go long Pref and short Common as early in the morning as possible.
Dec 31
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Daily Equities Bottom-Up: Tesla Motors Inc: Come Hell or High Water and more

By | Equity Bottom-Up

In this briefing:

  1. Tesla Motors Inc: Come Hell or High Water
  2. FutureBright (703 HK): Typhoon Dampens 3Q Results
  3. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?
  4. Recruit Holdings Down 30% From October; Still Not Cheap
  5. Hotel Properties Ltd– Dissolution of Wheelock-OBS Partnership Could Pave Way for Privatization Offer

1. Tesla Motors Inc: Come Hell or High Water

Figure%201 %20tesla%20shorts

It is our view, that come hell or high-water, in 2019, Tesla Motors (TSLA US) will establish itself as the pre-eminent large-cap growth stock. Those that are short would cover the position at a loss and those that are long are looking at another Apple Inc (AAPL US) or Amazon.com Inc (AMZN US) in the making. The ride may be volatile, but will be worth it. 

2. FutureBright (703 HK): Typhoon Dampens 3Q Results

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We recently met with management to discuss the company’s 3Q results and outlook for the coming year.

There was clear disappointment that goals for 2018 had not been achieved: rising opex dampened the recovery in EBITDA, despite solid SSSg, the Hengqin Land sale is racked with yet further delays, and the key rental property is still untenanted. That said, we feel much of the frustration is due to positive outcomes on all front being just around the corner.

This note aims to give a brief update on the key pillars forming our thesis.

3. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?

N7

Nintendo reported their 2QFY03/19 in October with results showing growth at both the top line and bottom line albeit not living up to consensus expectations. Top line grew by 4.0% YoY to JPY388.9bn in 1H03/19 while OP grew by 53.9% YoY to JPY61.4bn. OP in the last quarter (2QFY03/19) was the second highest the company has experienced over the last five years. This growth has been mainly driven by the sales of Nintendo Switch hardware which sold just over 5m units in 1HFY03/19. However, YoY growth remained at 3.4% compared to 4.9m units sold in 1HFY03/18. This has left investors worried about Nintendo’s aggressive target of selling 20m units of the Switch for FY03/19. Of this target, the company has managed to achieve only around 25.0% in 1H. Nintendo’s financial performance follows a seasonal trend with the December quarter showing stronger performance due to increased sales during Christmas. While the company’s current quarter is likely to show strong results, we remain skeptical about the company reaching the aforementioned target for FY03/19.

Switch Sales Have Caused an Improvement in Nintendo’s OP….

Source: Capital IQ

….Despite a Slowdown in the Growth of Units Sales

Source: Nintendo website

Nintendo’s Last Quarter Has Also Failed to Live Up To Consensus Expectations

Source: Capital IQ
Source: Capital IQ

4. Recruit Holdings Down 30% From October; Still Not Cheap

Capture

The share price of Recruit Holdings (6098 JP) has fallen by around 30% over the past three months from an all-time high of JPY3,826 (on 1st October 2018) to JPY2,705 on 24th December 2018. Prior to this, Recruit’s share price saw a strong upward rally during May-September following the company’s announcement that it would acquire Glassdoor Inc. (the company which operates the employment information website glassdoor.com).

We expect Recruit’s consolidated revenue to grow 7.7% and 6.5% YoY in FY03/19E and FY03/20E respectively, driven by the acquisition of Glassdoor and steady growth in Japanese staffing operations, partially offset by a likely slowdown in global labour market activity. We also expect Recruit’s consolidated EBITDA margin to improve by around 50bps due to higher margin from Glassdoor.

Despite the recent dip in share price and steady topline and bottom line growth over the forecast period, at a FY2 EV/EBITDA multiple of 14.0x, Recruit doesn’t look particularly attractive to us. Recruit’s internet advertising business and employment business peers, Yahoo Japan (4689 JP) and Persol Holdings (2181 JP) are trading at FY2 EV/EBITDAs of 7.7x and 9.6x respectively.

Key Financials FY03/18-20E

 

FY03/18

FY03/19E

FY03/20E

Consolidated Revenue (JPYbn)

2,171

2,338

2,490

YoY Growth %

11.9%

7.7%

6.5%

Consolidated EBITDA (JPYbn)

258

288

312

EBITDA Margin %

11.9%

12.3%

12.5%

Source: Company Disclosures/LSR Estimates

5. Hotel Properties Ltd– Dissolution of Wheelock-OBS Partnership Could Pave Way for Privatization Offer

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Hotel Properties (HPL SP)  (“HPL”) announced on Friday evening a significant change in its shareholdings relating to the HPL shares owned by 68 Holdings Pte Ltd. 

The restructuring of shareholding did not come as a surprise and was within expectations. 

Now, Wheelock holds only a significant minority interest of 22.53% and without a board seat in HPL. Wheelock’s influence in HPL has been reduced significantly. Without control, Wheelock’s investment in HPL is as good as any other non-strategic investment in quoted securities.

In the event that Wheelock Properties decides to sell its HPL shares, Mr Ong will be a likely buyer of the HPL shares. This will present a very good opportunity for Mr Ong to successfully privatise and delist HPL.