Daily BriefsTMT/Internet

TMT: LINE Corp, Western Digital and more

In today’s briefing:

  • Last Week in Event SPACE: Line Corp, Haier, Keppel, China Longyuan, Nichii Gakkan, Cromwell, PCCW
  • Western Digital. NAND Recovery In Doubt As QoQ Revenue Downturn Forecasted

Last Week in Event SPACE: Line Corp, Haier, Keppel, China Longyuan, Nichii Gakkan, Cromwell, PCCW

By David Blennerhassett

Last Week in Event SPACE …

  • Those participating in the recent letter-writing campaign will be upset with no change in the Tender Offer Price for LINE Corp (3938 JP). There are perhaps reasons for them to be upset, and the line of reasoning by the Special Committee will not make them less upset. 
  • All that matters with respect to Haier Smart Home (600690 CH)‘s pre-conditional Scheme for Haier Electronics Group Co (1169 HK), is the level of the A/H premium and what impact the deal has on the A. The divergence this past Friday is likely a sign of things to come.
  • Keppel Corp (KEP SP) investors are now in limbo. Temasek has clearly said they may or may not waive the MAC Pre-Condition and the Partial Offer may or may not eventuate. But because Temasek’s Pre-Conditional Partial Offer is partial, they are only in Partial Limbo. And a week after massive writedowns led to the worst quarterly losses in 20yrs, the stock is where it was before the announcement.
  • China Longyuan Power Group Corp (916 HK) is on a tear, driven by Southbound flow. It looks like this can still run considerably more from here. 
  • The Nichii Gakkan Co (9792 JP) deal smacks of a bad process. It is practically inconceivable that a reasonably-minded, informed outside observer could judge this to have been a “fair” process under existing precedent and guidelines, but the bump gets Bain closer to getting this over the line as they invited Effissimo into the buyer’s group.
  • Ara Asset Management gradually, and inexorably, takes another step towards securing majority control in Cromwell Property (CMW AU).
  • PCCW Ltd (8 HK) share price gain in response to the Now sale/PCPD in-specie/Partial Offer looks more fueled by sentiment than driven by the economics.
  • Accordia Golf Trust (AGT SP) sees a bump which quiets the vocal activists. It gets about 40-45% of the way to where the more vocal of the two wanted to get to. This should get up, but there are a number of niggling contingent values in the calculation. See Travis’ insight (and spreadsheet) for help.
  • Plus, other events, CCASS movements and Mood Spins.

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

M&A – ASIA

LINE Corp (3938 JP)(Mkt Cap: $12.2bn; Liquidity: $17mn)

Naver Corp (035420 KS) and Softbank Corp (9434 JP) announced that the two companies would launch a Tender Offer for the shares in Line not held by Naver. This is as originally planned, and the Tender Offer Price is as originally planned – ¥5380/share – i.e. no change in price. The terms and structure of the business follow the Definitive Integration Agreement as signed and announced on 23 December 2019 and as discussed in depth in New Deal for LINE (A Lot like the Old Deal).

  • LINE minorities wrote their letters and pushed the shares above the Tender Offer Price and the Company and its Special Committee have come back and said that in their opinion there is no need to change the TOB Price, so Softbank and Naver are continuing with the Tender Offer – starting tomorrow and running for 30 business days – at the original price of ¥5380/share.
  • There will be no bump. If shares trade above, there will still be an EGM and a squeezeout. 
  • Unless investors are planning to utilize their Appraisal Rights, I would bail at a price higher than the Tender Offer Price if you can. If the shares go below, you have the optionality to see if someone later decides to build a larger position for the Appraisal Rights. If they are going to build a very large position for that trade, they will be able to afford to pay a little through terms for the optionality. 
  • THE TRADE: Sell above terms. Buy below terms. Trade the range.

(link to Travis Lundy‘s insight: The End of the LINE (3938))

Haier Electronics Group Co (1169 HK) (HEG) (Mkt Cap: $10.7bn; Liquidity: $14mn)

Seven months after a press release from HEG’s parent Haier Smart Home (600690 CH) (HSH) that it was contemplating taking HEG private, HEG has now announced a pre-conditional Scheme such that HEG shareholder will receive 1.6 HSH H shares plus HK$1.95 in cash.  An independent valuer places a fair value for the (as yet unlisted) H shares between RMB16.45-RMB16.90/share. This backs out an indicative value under the Scheme of HK$31.11-HK$31.90 – or $31.51 at the mid-point, against HEG’s last close of HK$26.85; but a 44.20% premium to the price at the time of the 2019 December suspension. Plus an all-time high. The cash/equity split is 6.2%/93.8%. The pre-conditions concern CSRC approval with respect to the issuance of the H shares and approval by two-thirds of HSH’s shareholders to approve the resolutions.

  • Synergies/accretion. Based on the RMB4.10bn and RMB6.72bn profit from continuing operations attributable to owners of HEG and HSH in 2019 and the exchange ratio, the pro-forma EPS for Scheme Shareholders will increase by 9.9% – before the cash payment. The Scheme will also help optimize capital allocation. The intention is to raise the payout to 40% for the enlarged entity. (The announcement is silent on the fact HEG has HK$20bn of net cash, ~27% of its market cap).
  • The Bonds. On 21 November 2017, HSH, issued the HSH Exchangeable Bonds (ticker 5024 HK). Currently, the entire principal amount of HK$8bn of the HSH Exchangeable Bonds are outstanding and are exchangeable into approximately 251mn HEG Shares or ~8.90% of the issued shares of HEG. The implied exchange price is HK$31.89/share – i.e. just in the money at the top-end of the independent valuer’s range. Those bondholders have various options – they can sell their bonds, exercise into HEG shares, hold to maturity etc. An option to convert to HSH shares is now proposed.
  • What to do? The only things which matter are the A-share price now, expectations for where it will move, and the H-share discount to the A.  Buying HEG is effectively buying an HSH H share avatar. HSH is up 14.5% in the past month and 40% in the past year. The HK$31.51/share indicative value is just a forecast opinion, like any other broker’s target price, and not an absolute. I’d be exiting if HEG nears $30, or a 5%/10% gross/annualised spread to the indicative terms if using a 6-month time frame.
    • I also have reservations about what is an appropriate A/H premium. The As were at RMB 16.50 the day before the leak and RMB 18.00 (at the time of the insight). That is HK$31.1 to $33.95 under the Offer terms. HEG’s closing price of $26.85 is a 16-21% discount to the A. On balance, the medium-long-term of the H vs the A will likely be a larger discount than 21%. 

(link to my insight: Haier (1169 HK): Avatar Scrip Offer From Parent)

Keppel Corp (KEP SP) (Mkt Cap: $6.9bn; Liquidity: $15mn)

Keppel announced earnings and they were a doozy. The Net Loss for H1 was the worst net loss of any fiscal half in the past twenty years. Worse even than H2 2017 when they took a S$112mm loss on an investment and a S$619mm penalty in Brazil? Yup. Worse than that.  The Net Loss in H1 was S$547mm, driven mostly by S$930mm of impairments (S$890mm in the Offshore & Marine segment) and a total of S$959mm in red ink in the O&M segment (even though EBITDA was actually positive in the segment). 

  • Assuming that the last four quarters ended 30 June 2020 would be the four quarters used to measure whether or not Keppel had breached any of the pre-conditions to the Temasek Partial Offer, the Profit-After-Tax number has clearly breached the Material Adverse Change (MAC) clause in Schedule 1 (Pre-Conditions) Paragraph 3(iii) in the original document. It needed to achieve S$22mm for the quarter, and missed that number by ~S$721mm.  That’s a miss. But the huge losses were non-cash impairments. On an ex-impairment basis, the businesses did quite well, aided, of course, by revaluation gains and capital recycling. 
  • The question Keppel investors now face is whether Temasek proceeds with the Partial Offer, walks away, does a third thing, and what are the shares worth in each case. On Saturday 1 August, Temasek released an announcement on the SGX to the effect that the Q2 financials for Keppel had indeed missed (they say the bogey was +S$556.9mm and the result was -S$164.7mm) and they recognized this condition breach, but said they had not decided yet what to do.
  • If Temasek announces it will waive the condition and do the deal, the stock is worth more than S$5.40 simply because there is some borrow and the residual breakeven position from buying and tendering is so low-priced. There is a LOT of leverage in the price down here. If Temasek announces it will walk away, the stock will go lower. But the stock is cheap vs is proxy baskets already and there is a lot of asset base and earning power in the business ex-O&M.
  • If you are short for the Tender and there is no news on Temasek’s position, Travis would cover. In the week since the announcement of earnings, the shares fell and came back to end unchanged. Either there is significant expectation that the Temasek deal will go through or there has been selling fatigue significant enough to
  • In Travis’ more recent insight he looks at what would trigger Temasek to walk away. It might be the SMM vote on Tuesday. Thinking about what would trigger them to walk is worthwhile.

(link to Travis’ insights:
after earnings: It’s a MACastrophe!!! Keppel Surprises Bigly and Badly in O&M)
one week later: What Triggers A Temasek Decision on Keppel?)

China Longyuan Power Group Corp (916 HK)  (Mkt Cap: $6.1bn; Liquidity: $8mn)
Wind-power play CLPG gained 13% on the 30 July, on ~7x the normal volume (three-month average), plus another 6.3% the following day on even higher volume. 33.3mn shares or 35.5% of the volume on the 30 July came from the Shanghai Southbound Connect program. This program accounted for 10.7% of volume the following day. 7.955mn shares or 8.5% of the volume on the 30 July came from the Shenzhen Southbound Connect program; and 32.6mn shares or 31.1% of the volume on the 31 July.  Therefore the total southbound flow accounted for 44% & 41.8% of volume on the 30 & 31 July. How much more can this run if indeed CLPG is rumoured to be next clean-energy privatization play?
  • CHN Energy holds no H shares, just domestic shares. No matter which option CHN Energy chooses to take CLPG private, a Scheme-like vote (≥ 75% for, ≤10% against)  will be involved for disinterested shareholders. Wellington holds 434mn shares or 13% of the Hs. They need to be on board with any Offer otherwise the vote won’t fly. My analysis of Wellington’s holdings – in which it became a substantial shareholder on the 2 August 2017 – indicates an average in-price of HK$5.90/share.
  • What Price? CLPG was up 31% in the past week, and 68% from its 2020 low in March. YTD, shares are up 19% against 12%, 14% and 14% for wind/solar/clean energy plays, listed in Hong Kong. IF an offer was forthcoming, it will be pitched (much) higher than here – Wellington simply won’t back an offer around these levels. North of HK$7 (~1x P/B & 7.7x EV/EBITDA – similar to Huaneng Renewables Corp H (958 HK)might get key players to the negotiation table.
  • Consensus estimates indicate low single-digit bottom-line growth in FY20E, before expanding 10% in FY21E-FY22E. At ~10x PER now, that looks about right. Plus CLPG is trading at a 15% premium to the street’s target price (25 analysts). I think there is a lot of expectation baked into the share price, absent a confirmed Offer, but, if the offer comes out at a 1.5x EBITDA premium to the last traded EV/EBITDA ratio, that would be a share price 63% higher than the last. Because of the high debt/market cap ratio, small moves in EV/EBITDA multiples mean big things for the share price. The question then is whether to chase it on the rumours because there has been a slew of offers for renewable power companies. If you are inclined to think there is a reason for all of these take-privates in the sector, this one probably still has legs. 

(link to my insight: China Longyuan (916 HK): Running Out Of Puff?)

Nichii Gakkan Co (9792 JP)  (Mkt Cap: $1bn; Liquidity: $8mn)

From the start, this has been a case about a bump. Travis’s original piece was titled Nichii Gakkan MBO:  Great Deal for the Buyers (Not so Much for Minorities. The process was bad. The price was too low. All it needed was for shareholders to object. Bain has now filed an amendment to the Tender Offer Registration Statement which included both an extension of the end date of the Offer and an increase in the Offer Price by 11.3% to ¥1670/share.  But what it did was sneaky. Bain increased the likelihood of the Offer success both because the new price is higher than the price at which the stock was trading AND because it seems to have invited Effissimo Capital Management (at 12.64% of voting rights) to join the bidder group on condition the tender offer is successful. 

  • General shareholder protections in the original deal were abysmally weak. There was a Special Committee who got no separate financial advice, legal advice, or fairness opinion, asked for no “market check”, and used the conflicted advisor acting for conflicted management to opine on fair price, based on conflicted management’s financial projections. It appears that not a single thing has changed in that respect.
  • The price is STILL too cheap. I originally (see original insight here) thought the price needed to be ¥2000+ to be fair, but that it needed minority investors to make noise. I still think Bain and management were buying it too cheaply, and now Effissimo is joining them. Bain needed 27,586,100 shares to get to 66.67% when combined with the holdings of the founder’s personal asset management company. I think this probably gets done, mostly because minority investors did not make enough noise.
  • Buy at just below terms to tender, or to hold and get squeezed out. If I had enough size to make it worthwhile, I would be inclined to attempt an Appraisal Rights process. This is solely Travis’ initial opinion, and is uninformed by expert legal advice. He says, “If I had such an inkling today, and I owned some but not enough shares to make the costs reasonable, I would seek expert legal advice immediately and would likely buy more at or below terms to give myself the optionality so that I could obtain more expert legal advice later.”

(link to Travis’ insight: Nichii Gakkan: Will a Blandiloquent But Bletcherous Bain Bump Bulldoze Backbenchers?)

Cromwell Property (CMW AU) (Mkt Cap: $1.7bn; Liquidity: $5mn)

Back on the 23 June, Singapore’s ARA Asset Management announced a proportional off-market takeover bid to acquire 29% of shares out in Aussie real-estate play Cromwell, not already owned, at A$0.90/stapled security (reduced to A$0.882125  following a distribution), a 3.4% premium to last close. Should it be successful, ARA would hold ~46% of shares out. ARA has now announced it intends to acquire 67.5mn Cromwell shares on-market at a price up to A$0.92/share, via the Creep Exception. In addition, ARA intends to declare the proportional Offer price Final at A$0.92/share – in the absence of a competing Offer. Should ARA be successful in both the on-market and proportional Offer, its holding in Cromwell would increase to an estimated 47.95%. The on-market portion (67.5mn shares) appears to have been fulfilled, lifting ARA’s stake to 26.69%. 

  • Following the (successful) completion of the partial, ARA’s stake will increase to 47.95%, by my estimates. This number assumes the 29% proportional offer is based on shares now owned after today’s on-market buy-in, not the % held as at the initial announcement on the 23 June. Assuming this is correct, then under the creeper provisions, ARA can theoretically go above 50% six months after the completion of the Proportional offer. If ARA gets to >50%, it will likely vote down the remuneration report, potentially leading to a board spill. This would enable ARA to appoint “friendly” directors, such as the nomination of Gary Weiss to the board
  • Currently trading at a tight 2.2% spread to terms. The initial trade was to get hit at the opening print under the on-market portion. Now this is a short-dated proportional put at $0.92/security from the largest shareholder, in what is optically an opportunistic Offer. Buying here or a spread or two below, the downside is limited. 
  • If you are long 1mn shares of the stock and intend to remain long 1mn shares after this is done, you can buy an additional 408,000 shares below terms (which will be A$0.92) and tender your 1.408mm shares, and you will have 1mn shares afterwards, and you will pick up a small profit on the 408,000 shares you incrementally purchased. If you are an arbitrageur, note that unlike a Partial Offer, your pro-ration is fixed. This should give you ideas about stock borrow. I like this arb trade at A$0.90-0.905. Longer-term I think this trades higher so I don’t mind the residual. This is an opportunistic deal. Cromwell has rejected the revised Offer.

(link to my insight: Cromwell/​ARA: Hit & Run)

FamilyMart Co Ltd (8028 JP)  (Mkt Cap: $11.1bn; Liquidity: $41mn)

The language in the statement made by Itochu CFO Hachimura-san is clear that Itochu sees the maximum amount they can pay for the shares – at this time – to be ¥2300/share. There are parts where one might make the case that they might reluctantly give a little bump and pay more than they should, but Travis is not hopeful in that regard. Interestingly, the statement provides clear evidence that Itochu does not understand what a “fair” Tender Offer Price is, or it is totally willing to gaslight FamilyMart investors.

  • Medium-term to long-term, Travis likes a post-restructuring (with synergies) FM at the current price. Travis thinks the future of PPIH is pretty decent. He expects Itochu does too, and expects they may want PPIH managers in to help run parts of FM. Travis expects Yasuda-san is a seller in the not-too-distant-future.
  • If Travis were a long-only active fund, he would be hesitant to tender my FM. If he were an arb, he’d think that IF ITOCHU IS TELLING THE TRUTH, it could be a couple of years before Itochu comes back and pays up, and in the meantime, while he entertains the possibility, he would be hard-pressed to think of FM trying to be much more efficient with their balance sheet. They aren’t Itochu. Which is why Itochu wants them and wants to delist them. 
  • If Travis were prepared to be aggressive in Appraisal Rights, especially if he could swing a very big balance sheet for a short period, he thinks this is a VERY interesting case. The Target Board has said that the process is fair (though it is not clear that it is), but very specifically that the price is not fair. This knocks down a central thesis of the JCOM precedent. And if this gets to 67% in the Tender, that means there is $3bn of stock which would need to be squeezed out. That is a lot of leverage on legal costs. And you can’t do an appraisal rights trade without being squeezed out. 
  • The single best trade for aggressive funds at this point is probably to let this deal get done, and then take the back end trade. Better bang for the buck even if it is more of a PITA. But it doesn’t necessarily get done completely easily.

(link to Travis’ insight: Itochu Haz Opinionz About FamilyMart)

Fujitsu Frontech (6945 JP)  (Mkt Cap: $0.3bn; Liquidity: $2mn)

In December we discussed prospects for Fujitsu buying out investors in its various listed subsidiaries. At the time we highlighted Fujitsu Frontech and FDK as candidates to be bought out and Fujitsu General and Shinko Electric as candidates to be sold. We also felt Fujitsu Frontech was more attractive than FDK due to its large discount to book and strategic fit with Fujitsu that could open up the path to further acquisitions. On July 30th Fujitsu announced a tender offer for Fujitsu Frontech at ¥1,540. This is about 15% above the levels the stock was trading at when we wrote on it but we nevertheless feel the premium is light. 

  • Even using rather conservative valuations, we believe this offer is 20-50% too light. Trying to value Fujitsu Frontech fully would probably require a bump closer to 50-60%.
  • Do we think the offer will get bumped? Unfortunately, the probability of that looks relatively low and the market certainly doesn’t seem to be pricing it in.
  • We are not experts on appraisal rights and would refer readers to Travis Lundy on such matters but we feel the valuation here is opportunistic and probably egregious.

(link to Mio’s insight: Fujitsu Frontech – Why Steal an ATM When You Can Steal the ATM Maker)
Travis’ earlier insight: Fujitsu TOB For Fujitsu Frontech At a Discount? 

Sanyo Chemical Industries (4471 JP) / Nippon Shokubai (4114 JP)

In May 2019, longtime sometime partners and cross-holders Sanyo Chem and Nippon Shokubai announced that they would commence business integration talks. Sanyo Chem had been outperforming Nippon Shokubai, and indeed had stronger forecasts for the year ahead than Nippon Shokubai, but because Sanyo Chem had outperformed Shokubai of recent, the 1-month, 3-month, and 6-month averages at the time of the initial announcement were below the spot price ratio.  At that announcement, the companies simply said they would come up with a ratio later. As the fiscal year went on, Nippon Shokubai had to lower their forecast sharply. Sanyo Chem lowered its forecast slightly. They came out with a ratio at 0.8163265 NS shares per SanyoChem share, which was ever so slightly below the ratio at the time of the announcement. 

  • Nippon Shokubai lowered its full-year forecast further later in early February (after Q3 but pre-covid), then reportedly the Sanyo Chem CEO visited the Sanyo Shokubai CEO and asked how he could explain the merger ratio to his shareholders, suggesting the companies needed to re-verify the ratio.  CEO of Sanyo Chem explains in his portion of the interview found a Nikkei article , “the immediate reason for postponing the integration is a major downward revision of Nippon Shokubai’s earnings forecast. It should be revisited when the environment changes dramatically. Only the schedule and the integration ratio will change.” It is pretty clear the Sanyo Chem boss thinks the ratio should change. 
  • The Trade?  Buy the SC/NS ratio at 0.86 or better.  Keep on buying it.  The ratio could spike on a weak Nippon Shokubai forecast, but bear in mind that through the cycle, the two companies are not terribly expensive outright, see potential for a lot of synergies in combination, and will see cross-held shares cancelled. As Stephen Fry would say, “This is a Good Deal” (youtube link).
  • Assuming it does pop, if you feel you are slightly outsized in the trade, you could take some off in the low 0.90s and then look to put back on a little lower. The current 0.86 ratio would – in Travis’ mind – still be a bit low given expectations for March 2021 similar to the results in March 2020, but the ratio will be much better for Sanyo Chem this year according to the two companies’ respective forecasts. 

(link to Travis’ insight: SanyoChem/NipponShokubai Forecasts Out – Stay Long the SC/NS Ratio for Merger Rerate)

Kawasumi Laboratories (7703 JP) (Mkt Cap: $0.2bn; Liquidity: <$1mn)

Sumitomo Bakelite (4203 JP) announced a Tender Offer to buy out minorities in medical device manufacturer Kawasumi. This deal comes at a knockout premium of 116.8% or ¥1700/share, which is a 20+yr high.  But it is not that much of a knockout price. Most of the market cap at takeover price is in net cash and securities, and net receivables. Using those terms, the Adjusted EV/EBITDA of this deal is under 4x the 20yr low EBITDA. Get some synergies in place and it’s cheaper. 

  • It is also likely a done deal. There are a certain number of cross-holders who will likely get Sumitomo Bakelite about half what they need, and if 50% of the remaining active shareholders tender. This is a done deal also because it is at a 20yr high price. 
  • Unfortunately,  once again, the “Special Committee” did not do what it needed other than interfere with the first two insultingly low prices, and the METI Fair M&A Guidelines earned a passing glance and lip service but no Special Committee financial adviser or fairness opinion. There was no “market check”, General shareholders did not get to the midpoint of the lower of the two DCF ranges, and the mentions of synergies are “yes we will see some and that is a reason to do the deal” and “there are no synergies included in the fair valuation”. 
  • Travis says he may sound like a broken record, but there’s a reason for it. It might be entertaining to object to this but it is small enough and there are few enough people with a position in it that nobody will care, and it would be quite difficult to block. THE TRADE: Buy at a small discount. That’s it. He doubts this is going to get a bump. 

(link to Travis’ insight: Kawasumi Labs Takeout Tender Offer – Big Premium Is Not Too Big)

Accordia Golf Trust (AGT SP)  (Mkt Cap: $0.5bn+; Liquidity: <$1mn)

Accordia Golf announced an Offer to buy out the golf course assets of Accordia Golf Trust in June. The price offered was a bit lower than the indicated price last November, and was lower than some parties had long expected. Those parties had made noise, and gone as far as requisitioning an EGM to deal with some smaller issues, and had promised to not vote for the deal unless the price was raised. 

Accordia Golf came back and offered ~S$0.04 more than previously – a bump of about 5.5% – having signed an agreement with Hibiki Path Advisors and the smaller vocal investor for them to withdraw the EGM Requisitionand vote for the deal.

  • It is likely now a done deal. The bump may be smaller than what was hoped for by some, but the vocal leadership has crossed to the other side.
  • Only about S$0.718/unit (assuming SGDJPY of 77.15) is “fixed.” There is a likelihood of getting a decent part (or all?) of the S$0.0384+/unit claims amount back early next year, and there may be a residual at the end.
  • With a likely average-weighted payment date sometime in November, this shouldn’t trade too wide to average expected terms. It is a sell at S$0.755.

Mio has previously expressed some scepticism about the longevity of Warframe, and therefore the overall valuation of Leyou. While he has not abandoned that view, in Leyou – You Need to Be Tracking Warframe This Month if You Own This, some recent developments do have him questioning whether there could be a change in Warframe’s momentum, at least in the short-term, increasing its appeal to Tencent Holdings (700 HK)

STUBS

PCCW Ltd (8 HK) / HKT Ltd (6823 HK) 

PCCW announced 1H20 results (net loss to shareholders was HK$547mn against HK$263mn in 1H19); a special dividend involving the in-specie distribution of 657mn Pacific Century Premium Developments (432 HK) shares; the sale of NOW TV to HKT for HK$1.95bn; and a voluntary partial Offer by Richard Li for 2% of shares out at HK$5.20/share, a 15.8% premium to last close. Shares closed up 9.1% on Friday. 

  • PCPD accounts for just 1% of NAV. What happens regarding this holding is largely immaterial (although, I would expect a lot of selling in PCPD after the distribution). The Now TV transaction is marginally more material, but not by a lot. Now is worth around 5% of my NAV. PCCW is getting around 80% of that value in cash. But cash is also assigned a nominal discount in a holding company structure  – say 10-15%. That would place the net effect roughly in line with the current value, if not, perhaps fractionally below. The difference is largely inconsequential.
  • The Partial Offer is small – around 2% of shares out. But Richard Li seeking to go above 30% is potentially two-fold. Anyone looking to take out Richard Li’s stake (after the partial is successful) in PCCW would trigger an MGO for the remaining shares in PCCW. Or Li creeps his stake in PCCW, which potentially could be become a large cash entity should PCCW’s stake in HKT be acquired. The creeper provision is mentioned on page 7 of the announcement.  This could suggest PCCW can (will?) undertake future buybacks, such that Richard Li will not be forced to undertake an MGO – assuming his stake does not increase by 2% under each buyback. 
  • THE TRADE: I think a privatisaton of HKT is inevitable. And reconfiguring a way to get the cash out of PCCW to the Li family would be the logical progression. Or at a minimum, elevating Li’s stake in PCCW via him creeping, or PCCW buying back and canceling shares. Timing is everything. Right now, PCCW appears to be fully priced, and then some. I would look to unwind here. 

(link to my insight: PCCW: Partial Offer To Lift Li Above 30%

Haier Smart Home (600690 CH) (HSH) / Haier Electronics Group Co (1169 HK) (HEG)

HSH had been limit up (at the time of the insight) the past two trading sessions (ahead of, and) in response to the privatisation of  45.68%-held HEG. I estimate HSH’s premium to NAV at 32% against a 12-month average of 20%. It has only briefly exceeded these levels in the last year after HEG announced on the 19 December 2019, that HSH was contemplating taking HEG private with newly issued Hong Kong shares. Bear in mind,  the EPS for the enlarged HSH  – page 104 of the announcement – declines to RMB1.01/share on a proforma basis from RMB1.05 in FY19.

  • What’s in the Stub? The independent report from Platinum Securities (beginning on page 74) loosely breaks down the stub ops. The simple diagram below provides the briefest of snapshots. Ex-HEG (of which 96% of its revenue is sourced from China), HSH’s stub business units comprise refrigerators, air-cons, kitchen appliances, and the “Smart Home Business Overseas”. I’ve multiplied that deconsolidated EBITDA figure of RMB8.247bn by the peers flagged in the valuer’s report, which have an average trailing EV/EBITDA of 9.7x as viewed below.
  • The market is assigning a PER, EV/EBITDA and P/B of 17.5x, 12x & 2.5x respectively for the stub ops. Though punchy, those figures aren’t too out of whack – some of HSH’s local peers trade in excess of these metrics.  But it is interesting to note that while almost the entire revenue for HEG is sourced from the PRC, only 21% of the stub ops revenue is sourced from China. Are international peers a better yardstick to value the stub ops? These peers trade at a premium to Chinese peers on a PE basis, but slightly below on EV/EBITDA and P/B. 
  • Assuming HSH’s Hs trade at a 20% discount to the As then the H-share value is HKD 17.60.  HK$17.60 * 1.60 + 1.95 = HK$30.11, the implied price under the proposed Scheme. Shares closed at HK$28.85 so a 4.4% spread – if assuming a 20% discount to the A share. Short the As? There is borrow out there. But it’s not a clear-cut trade. If HSH pops again and the HEG largely follows, I’d exit HEG. Even at yesterday’s close, it looks full.  I think the implied discount is too narrow between the As and the (yet to be listed) Hs. 

EVENTS

Samsung Electronics (005930 KS) (Mkt Cap: $322bn; Liquidity: $913mn)

The incumbent Democratic Party of Korea recently included an amendment to the Insurance Business Act to require Samsung Group’s insurance subsidiaries to sell their shares in Samsung Electronics. The Financial Services Commission (FSC) has agreed in favour of the government’s decision for this amendment. In terms of timing, it appears likely that this could be officially changed by the end of this year. Under the current terms of the Insurance Business Act, an insurance company’s shareholding in a subsidiary is limited to 3% of its total assets and this is currently calculated on the historical cost method. The government wants to change this to a market value basis. 
  • Samsung Life Insurance (032830 KS) (“SLI”)’s 8.5% stake in Samsung is estimated at ₩500bn, based on acquisition cost. Once the law is amended, SLI may be forced to sell more than ₩10tn of Samsung Electronics over a 5-year grace period. Samsung Fire & Marine Ins (000810 KS) (“SFM”) may also be forced to sell its stake.
  • The two companies most likely to step up to buy additional stakes in Samsung are Samsung C&T (028260 KS) and Samsung Sds (018260 KS). C&T and SDS have the financial capacity to purchase at least ₩10tn worth of Samsung. What’s not clear is that although ₩10tn is a chunk of change, that covers only about half of the total amount of Samsung that needs to be sold. It remains unclear if the other Samsung affiliates including Samsung Biologics Co., (207940 KS) and Samsung SDI (006400 KS) would step in to purchase additional Samsung shares. 

M&A – US

Varian Medical Systems (VAR US)  (Mkt Cap: $15.8bn; Liquidity: $129mn)

On 2nd August 2020, Germany-based medtech company Siemens Healthineers AG (SHL GR) announced they would acquire US-based medical-devices maker Varian in an all-cash deal that valued the company at ~US$16.4bn. The Deal is conditional on the receipt of Varian shareholder approval and regulatory approvals. The Offer Price is $177.50 per share and the transaction is expected to close in the first half of calendar year 2021. The Target’s board has agreed to the Transaction and has recommended the shareholders to vote in favour.  The Offer translates to a premium of 24.4% to the pre-announcement closing price and is 42.0%, 45.5%, and 50.6% higher than the stock’s 1-month, 3-month, and 6-month VWAPs.  On both LTM and NTM bases, the offer price translates to EV/EBITDA and PER multiples that are higher than the estimated mean and median for peers.

  • On the other hand, the Acquirer shareholders did not respond very well to the Deal announcement.  At the time of writing, SHL shares have dipped more than 10% since the Deal was announced.  The Deal will be financed through a combination of debt and equity. As part of this, Siemens Healthineers will be issuing new shares later this year. The NTM EV/EBITDA multiple of 24.5x for Varian is almost 90% higher than that for Siemens Healthineers (12.9x).
  • However, this Deal is a long term bet on cancer therapeutics. Siemens Healthineers currently does not have much exposure to this area and the Deal will give them a substantial market share in the field of cancer treatment which is expected to face greater demand in the future. According to the Deal presentation, the Acquirer is expecting EBIT synergies of more than EUR300mn by FY2025. This is quite significant when compared to the FY2021 CapIQ consensus projection for Varian’s EBIT of ~EUR390mn and might somewhat justify the high multiple offered for Varian which already has strong growth and cash generation. 
  • Varian closed (at the time of the insight) at US$174.50 which translates to a gross spread of ~1.7% with 5-11 months to completion.  Janaghan Jeyakumar expects regulatory approvals will be no problem. This would be a slightly-long-dated rate-of-return Trade. At 5 months to completion, this seems like a reasonable risk arb spread to carry. At 11 months it would seem long and low return. Janaghan believes the only way this sees a higher price is if a competitor with some cancer therapeutic business in a complementary area looks to join them to increase coverage. At the moment, I do not have a list of preferred possibilities.

(link to Janaghan’s insight: Varian-Siemens Deal: DAX Promotion on the Cards for the Acquirer)

Livongo Health Inc (LVGO US)  (Mkt Cap: $13.1bn; Liquidity: $452mn)

Virtual healthcare powerhouse Teladoc Health, Inc. (TDOC US) announced they will be acquiring chronic-illness health-tech company Livongo in a cash and scrip deal that values the company at a market cap of US$15.5bn (going by cash-equivalent numbers based on pre-announcement closing price for Teladoc).  With the COVID-19 pandemic forcing consumers to look for substitutes for conventional in-person health care, virtual health care providers have seen demand for their services rise significantly in the last few months, and both stocks have rallied sharply. The Deal has been unanimously approved by the Board of Directors of each company. Livongo’s second-largest shareholder Kinnevik – who holds ~13% of Livongo’s shares – has agreed to support the deal. 

  • This Deal will give Teladoc access to the lucrative Chronic-healthcare segment which will give them more repeat-users as opposed to their current areas of coverage which mostly deal with one-off healthcare visits. Furthermore, Teladoc will be able to attract more clients with a wider range of services as consumers will find it more convenient to access multiple healthcare solutions through a single platform. On the other hand, Livongo’s monitoring devices will be able to tap into Teladoc’s large client base. These cross-selling opportunities, improved member churn, and larger scale are expected to result in run-rate revenue synergies of approximately US$500mn by FY2025. 
  • The Offer seems to favour Livongo shareholders more. Teladoc shareholders might not be happy with the price. Teladoc shares fell sharply (~19%) on the day following the announcement and in reaction to that, Livongo shares also declined given the large scrip component of the Deal. The Terms of the Offer (at the time of writing) translate to a total consideration of US$137.13 per Livongo share which values the company at an EV/Revenue (LTM) multiple of ~50x and EV/Revenue (NTM) multiple of ~30x. These are much higher than Teladoc’s multiples of ~24x and ~14x respectively.  The Offer multiples are also well above the estimated means for health-tech peers and some other disruptive/popular SaaS businesses. 
  • At the time of writing, Livongo’s shares were at US$134.35 and Teladoc’s share price translates to an Offer consideration of US$137.13. This translates to a gross spread of ~2.1% with roughly 5 months to completion. Although Janaghan expects the Deal to complete as-is, he expects this to trade with some noise. There may be some range-trading opportunities. At the moment, multiples are so high and price moves have been so dramatic, that spread volatility may be higher than for normal deals. For this reason, he might wait a little bit to understand how volatility in share prices affects the risk arb spread, however, he expects this deal to complete. 

(link to Janaghan’s insight:  Livongo-Teladoc: Virtual Healthcare Giants to Combine)

In Seven & I Acquires Speedway for $21 Billion: Expensive but Necessary Acquisition, Oshadhi Kumarasiri discusses Marathon Petroleum (MPC US)‘s announcement that it has agreed to sell its Speedway petrol stations business to Seven & I Holdings (3382 JP) in a $21bn all-cash deal ($16.5 billion after-tax cash proceeds), five months after the initial deal was put on hold in the midst of the coronavirus crisis. 

INDEX REBALS

In Tesla: S&P500 Inclusion Secured?, Brian Freitas discusses the possibility of Tesla Motors (TSLA US) being added to the S&P500. 

In Sarana Menara Nusantara (TOWR IJ): Potential Inclusion in MSCI & FTSE Indices, Brian discusses the possibility of Sarana Menara Nusantara (TOWR IJ) being added to the MSCI Standard indices or the FTSE Global Equity Index Series. 

FTSE GEIS Index Rebalance

The FTSE Russell is scheduled to announce the results of the September 2020 Semi-Annual Index Review on 21 August. The changes will be implemented as the close on 18 September and will be effective from the start of trading on 21 September.

OTHER M&A & EVENT 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, lock-up expiry, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.   

Name

%chg

Into

Out of

10.75%
HSBC
Outside of CCASS
15.38%
Citic
BEA
12.94%
Guotai
Outside of CCASS
18.23%
Soliotn
Outside of CCASS
Source: HKEx

The following large movement(s) concern recently listed companies, and therefore are (likely) lock-up related.

Name

% chg

Into

Out of

Pipeline (1865 HK)
51.09%
China Tonghui
HSBC
World Super (8612 HK)
12.135
Sun Int’l
Outside of CCASS
Source: HKEx

Western Digital. NAND Recovery In Doubt As QoQ Revenue Downturn Forecasted

By William Keating

Western Digital reported earnings this week with revenues of $4.3 billion, marginally below the midpoint of their forecast. Their outlook for current quarter for revenues of $3.8 billion at the midpoint, down 11.6% sequentially, was a nasty surprise that led the company’s share price to decline by more than 16% the following day. 

Western Digital’s outlooks stands in contrast to their peers. Micron called for current quarter revenues to increase roughly 10% QoQ. While neither SK Hynix or Samsung Electronics are in the habit of providing specific next-quarter guidance, there was little on their earnings calls to suggest that we should expect anything untoward.

Separately, DRAMeXchange published a report on July 30 claiming that the NAND flash market would weaken rapidly in the third quarter, directly contradicting a report they published one month earlier where they predicted NAND prices would remain relatively stable. 

So what’s really going on at Western Digital and how should we think about NAND pricing through the remainder of the year?


Before it’s here, it’s on Smartkarma