Brief Industrials: CEVA Logistics: Okay, Now You Can Tender and more

In this briefing:

1. CEVA Logistics: Okay, Now You Can Tender
2. Jain Irrigation: From Up Close The Crop Doesn’t Look Healthy
3. Harbin Electric’s Offer: One For The Brave
4. Quick Update on ZTO Express: Results OK, but Guidance Unimpressive
5. Descente Tamed, Itochu Delicacy Required And Investors Can Probably Wait

1. CEVA Logistics: Okay, Now You Can Tender

CMA CGM SA (144898Z FP) has 89.47% of Ceva Logistics AG (CEVA SW) and will now move to squeeze out and delist. The additional tender period will run from 20 March to 2 April.

After issuing the prospectus back in late January, CEVA’s board of directors recommended shareholders to not tender shares in the belief that shareholders could realise a higher value with their continuing investment.

Investors thought otherwise and have cashed out at CHF 30/share, a 62.8% premium to the undisturbed price. The massive share price under performance of CEVA subsequent to its listing on the 4 May 2018 – down 33% five months out from the IPO – would have crystallized that decision to tender.

CEVA’s board now recommend shareholders tender into the upcoming additional offer period. If delisting occurs, it is expected concurrently occur with a squeeze-out, which would be expected to take place in the third quarter of 2019 once all stock exchange and other legal conditions are fulfilled.

2. Jain Irrigation: From Up Close The Crop Doesn’t Look Healthy

Notwithstanding, the revenue growth Jain Irrigation Systems (JI IN) (JISL) seems to be lacking efficiency in utilization of fixed assets. The sale of stake in a subsidiary company raises eyebrow. Another bug that should bother JISL is the quality of its earnings. This impairs any positive forecast on operating profit. The situation becomes sticky when the issues of free cash flow, performance of subsidiaries and threat to goodwill are thrown in the matrix. 

3. Harbin Electric’s Offer: One For The Brave

Harbin Electric Co Ltd H (1133 HK)‘s (“HE”) composite doc for its merger by absorption has been dispatched. HE’s major shareholder Harbin Electric Corporation (HEC), an SOE, is seeking to delist the company by way of a merger by absorption at HK$4.56/share, an 82.4% premium to last close. The offer has been declared final. The IFA (Somerley) considers the offer fair & reasonable.

As HE is PRC-incorporated with unlisted domestic shares, the transaction is executed as a hybrid scheme/tender offer. The proposal requires ≥ 75% for, ≤10% against, in a scheme-like vote from independent H-shareholders. HEC holds no H shares. A 10% blocking stake is equal to 67.5mn shares. Should the resolution pass, the tendering acceptance condition in this two-step Offer is 90% of H shares out. Those who do not tender will be left holding unlisted scrip.

Indicative Timetable

A Word on Harbin’s Net Cash

In my prior insight, I discussed how the offer was below Harbin’s net cash, using CapIQ 1H18 numbers. That conclusion was not correct. While CapIQ’s net cash exceeds the consideration, its number excludes notes payable, a material number.

Using FY18 figures provided in the composite document, I estimate net cash/share of $3.18, ~70% of the consideration payment. Bloomberg’s number is higher again, while my understanding is Eikon’s $1.73/share (as at 30 June 2018) net cash figure includes (I have not verified, nor drawn a conclusion whether this would indeed be correct) deposits from customers and banks.

What to Do?

The significant offer premium to last close, the material drop in FY18 profit and the zero possibility of a competitive bidder emerging, suggests this Offer falls over the line.

The blocking stake at the H-share meeting is a risk. Although no single shareholder has the requisite stake to block the deal, collectively it is achievable.

The 90% tendering also, prima facie, appears a risk; yet such an acceptance threshold is not uncommon (Shanghai Forte (2337 HK) also required a 90% acceptance condition in 2011; while Hunan Nonferrous Metals H (2626 HK)‘s 2015 merger by absorption required 85%) and once the EGM resolution has been approved, there is little incentive to hold onto shares as Harbin will be delisted. Shares cannot be compulsory acquired.

However, I still consider “fair” to be something like the distribution of net cash to zero then taking over the company on a PER with respect to peers.

Dissension rights are available, although I am not aware of any precedents, nor the calculation methodology of a “fair price” under such a dissension, nor the timing of payment. 

Trading at a wide gross/annualised spread of 9.6%/61.4%, implying a >80% chance of completion. The current downside should this break is 40%. I don’t see an attractive risk/reward here.

4. Quick Update on ZTO Express: Results OK, but Guidance Unimpressive

After reviewing 4Q18 results and guidance for 2019, we retain our negative view of ZTO. For 2019 and 2020, we continue to expect slower top-line growth, margin compression, and a sharp increase in CapEx requirements. Our 2019-20 EPS forecasts and target price of $13.31 remain unchanged.

With help from a sharp increase in non-operating income, ZTO’s 4Q18 Adjusted EPS met consensus expectations of $0.24per ADS. But FY19Adjusted Net Profit guidance fell short of expectations, and management’s decision to withdraw quarterly guidance altogether is also disappointing.

ZTO’s gross margin fell ~370 bps in 4Q18 due to cost pressures and the rapid growth of certain low-margin businesses. We believe the same factors will continue to put downward pressure on margins in 2019 and 2020.

ZTO stated during the earnings call that Capex this year would increase by 50-100% compared to the 4bn RMB the company spent in 2018. According to management, much of the increase will go into building out ‘last-mile’ and rural infrastructure and we suspect the initial returns on these investments will be poor

5. Descente Tamed, Itochu Delicacy Required And Investors Can Probably Wait

I started writing this over the weekend after the results of the Itochu Corp (8001 JP) Tender Offer for 9.56% of Descente Ltd (8114 JP) were announced late Friday. 

Itochu planned on buying 7.21 million shares out of the 75.37mm shares which bear voting rights (as of the commencement of the Tender), and 15,115,148mm shares were tendered, which led to a pro-ration rate of 47.7% which was 0.3% below my the middle of my “wide range” expected pro-ration rate of 42-54% and 0.7% beyond the 44-47% tighter range discussed in Descente Descended and Itochu Angle Is More Hostile of 28 February.

Two more central ideas were discussed in that piece:

1. The hostility shown by Descente management during the Tender Offer had led Itochu to abandon discussions about post-tender management until after the Tender Offer was completed. Both sides indicated a willingness to pick up where things had left off – at Descente’s request – but Descente needed to stew a bit.
2. The revelation by ANTA Sports in an interview with the CEO in the Nikkei in late February that ANTA supported Itochu meant that the likelihood of Itochu NOT having enough votes to put through its own slate of directors was almost zero. At a combined 47.0% of post-Tender voting rights, if 94% or less of shares were to vote, it would mean Itochu could get the majority of over 50% and determine the entire slate of directors themselves. If there was another shareholder holding a couple of percent which supported Itochu, it would be a done deal even if everyone voted. And that 2-3% existed.

So… the threat that Itochu would hold an EGM to seat new directors to oblige a stronger course for management was a very strong probability. Management who was rabidly opposed to Itochu owning the stake could not very well bow down in front of Itochu post-tender just to save its own hide – not after the employee union and the OB group came out against. President Ishimoto had effectively put himself in an untenable position unless a miracle occurred because Itochu could not legally walk away from its offer, and Ishimoto-san was bad-mouthing Itochu even as they were negotiating during the Tender Offer Period. 

It was not, therefore, any surprise that President Ishimoto would step down. The surprise for me was that the news he would go came out as talks commenced over the weekend (but did not “bridge the gap” as the Nikkei reported), before we got to the first business day post-results. 

Talks apparently continue with no resolution, and the media reports offer no hint as to what the issues might be.