Brief Industrials: IPH Goes Hostile on Xenith and more

In this briefing:

1. IPH Goes Hostile on Xenith
2. Toshiba: King Street Round Two
3. Nsk (6471) Conditions Have Deteriorated Significantly but Given Valuations, This Is Now in the Price

1. IPH Goes Hostile on Xenith

Iph Ltd (IPH AU) has gate crashed Xenith Ip (XIP AU)/Qantm Intellectual Property (QIP AU)‘s marriage of equals, submitting a proposal (by way of a Scheme) for Xenith comprising cash (A$1.28) and IPH shares (0.1056 IPH shares) or A$1.97/share, 23.3% above the implied QANTM merger consideration.

Last November, Xenith and QANTM , both leading providers of IP origination services in Australia, announced a merger via an all-scrip scheme of arrangement, whereby Xenith shareholders will receive 1.22 QANTM shares for every Xenith share, or an implied value of A$1.598/share. QANTM and Xenith shareholders would own 55% and 45% of the merged group with a then pro-forma capitalisation of A$285mn. Pre-cost synergies are estimated at A$7mn/annum at the end of  year three.

Xenith’s board unanimously recommended the merger to its shareholders.

IPH did not blink and on the same day as the Xenith/QANTM announcement, lobbed an unsolicited, indicative, preliminary, conditional and non-binding cash & scrip proposal to acquire QANTM at $1.80/share (including a a A$0.05 dividend) by way of a scheme, or a 42% premium to last close.

QANTM’s board rejected the proposal due to its highly conditional nature, significant execution risk, and that the offer undervalued the company. IPH countered those claims, spurring QANTM to counter those countered claims.

On the 13 February 2019, IPH bought a 19.9% stake in Xenith at $1.85/share (or ~A$33mn) from institutional investors, and further added that is does not support the QANTM scheme and intends to vote against it. In response, both Xenith and QANTM announced that neither had received a proposal from IPH. Xenith’s shares increased 20.3% to close at A$1.69/share.

The provisional date for ACCC s clearance of the QANTM/Xenith merger is the 21 March. The provisional date for IPH/Xenith is the 2 May. The QANTM/Xenith Scheme meeting is scheduled for 3 April with a 24 April implementation date. IPH’s proposal has an indicative implementation date of mid-July.

IPH’s proposal currently offers an implied value of $1.98 (65% in cash) against $1.85 for QANTM’s all-scrip offer.

The key risk to IPH’s proposal is ACCC’s consent. IPH, QANTM and Xenith are the only three ASX-listed intellectual property companies. IPH is the oldest, and the largest (in terms of revenue). However privately owned companies collectively hold a larger market share – and growing – compared to the three listcos. It is not apparent a merger between either of these two listcos would lessen IP service competition in Australia.

With IPH’s blocking stake, the QANTM/Xenith scheme will fail. Xenith should engage with IPH.

2. Toshiba: King Street Round Two

Yesterday, King Street sent a letter to Toshiba Corp (6502 JP) CEO Nobuaki Kurumatani, applying pressure by threatening to nominate alternative directors to the company’s board. The full contents of the letter can be found here.

King Street’s requirements for the new board are stated as:

Among other things, the new Board must:

(i) ensure management applies rigorous financial discipline to capital allocation decisions, including use of excess cash, determination of optimal capital structure and capital expenditure return requirements;

(ii) drive management to re-examine Toshiba’s business portfolio with a critical eye on competitive position, sector landscape, synergies available and profitable growth prospects;

(iii) direct management to evaluate non-operating and underperforming businesses and assets (while respecting that Toshiba may need to be engaged in certain activities important to Japan’s national security interests);

(iv) ensure that management attains global peer profitability levels at each business segment based on projections supported by robust, bottoms-up analysis; and

(v) instill a culture of accountability and ownership at all levels of the organization.

By and large these demands amount to, “follow the instructions in our previous presentation“. That presentation, while thorough in some respects struck us as being naively optimistic, as we noted in Toshiba: King Street Assumptions Look Exceedingly Optimistic.

Travis Lundy also commented on the presentation in Toshiba: King Street’s Buyback Proposals Lack Required Detail and Toshiba: King Street’s Valuation Analysis Is… Punchy?

Given developments in the intervening time period including a sell-down of about 27% of King Street’s initial stake at a price of ¥3,925 (some 64% below the “well over ¥11,000” per share they feel Toshiba is worth) according to Bloomberg, and a downward revision to OP guidance from ¥60bn to ¥20bn, we feel that there is little reason to change our assessment.

3. Nsk (6471) Conditions Have Deteriorated Significantly but Given Valuations, This Is Now in the Price

Over the last 12 months, these shares have been a dreadful performer (as have the other ball bearing makers), both in absolute terms (-36%) and on a relative basis (underperformed TOPIX by 30%). Operating profits for the full year have recently been revised down (for the second time). The operating environment has deteriorated markedly into 4Q. It would appear to us that the market, and analysts, are aware of the current poor trading conditions. The question is when will conditions start to improve. The first half of next year will be very poor indeed with profits down perhaps 35% year-on-year. And it now appears that some analyst’s numbers do not assume recovery for any of next fiscal year, which we believe as too harsh.

Clearly the first half of next year (3/20) is going to show very poor year on year comparisons. This will be unavoidable given a good first half this year and business conditions now. The company itself is now forecasting a 4Q operating profit of Y16.7bn (-40%) having made Y24.8bn in 1Q, Y20.2bn in 2Q and Y21.3bn in 3Q. Assuming this level carries on into the first half of next year before starting a gradual recovery in the second half, then first half operating profit may well come in at about Y32-33bn, a 35% year-on-year fall. The consensus for the full year is currently about Y70bn with the lowest number being Y64bn. Sell recommendations have also begun to appear. To us this appear to be a bit after the event given where earnings are now and where the shares are trading.

The shares currently yield 4.2% and the pay-out ratio this year is 36%. Management’s target is for 30% but at the same time they are reluctant to cut the dividend going forward. This may well prove some support. Meanwhile the company owns 7% of itself and on our calculation is trading on an EV/ebitda of just under 4x. Finally, its book value (0.9x) relative to the market’s book value is now at a very depressed level (see chart below) which suggests to us that although there may be some short term down side risk, we would look to buy on a longer term.