Daily Japan: Are Chip Oligopolies Real? and more

In this briefing:

1. Are Chip Oligopolies Real?
2. Global Banks: Some New Year Pointers
3. Extraordinary Fiscal and Monetary Policies Have Disrupted the Global Economy
4. Would a Sale of Founder’s Holdco NXC Corp Trigger a Tender Offer for Nexon (3659 JP)?
5. HOYA Corporation: Fairly Priced but Value Accretive M&A Deals Could Support a Higher Price Target

1. Are Chip Oligopolies Real?

In the semiconductor industry, particularly in the DRAM sector, there has been significant consolidation leading some to hypothesize that there’s now an oligopoly that will cause prices to normalize and thus end the business’ notorious revenue cycles.  Here we will take a critical look at this argument to explain its fallacy.

2. Global Banks: Some New Year Pointers

Here is a look at how regions fare regarding key indicators.

• PH Score = value-quality (10 variables)
• FV=Franchise Valuation
• RSI
• TRR= Dividend-adjusted PEG factor
• ROE
• EY=Earnings Yield

We have created a model that incorporates these components into a system that covers>1500 banks.

3. Extraordinary Fiscal and Monetary Policies Have Disrupted the Global Economy

In their public presentations, central banks seem to be contemplating the use of neutral interest rates (r*) in addition to unemployment/inflation theories. R* has the advantage of appearing to be subject to mathematical precision, yet it’s unobservable, and so unfalsifiable. Thus, it permits central banks to present any policy conclusion they want without fear of verifiable contradiction. R* is the policy rate that would equate the future supply of and demand for loans. It rises and falls as an economy strengthens and weakens. Long-term observation during the non-inflationary gold standard, period indicated that r* in an average economy was 2% plus, which would become 4% plus with today’s 2% inflation target. The Fed may soon end this tightening cycle with the fed funds rate at or near 2¾%, which would be r* if the rate of lending and borrowing in America remained stable thereafter. Rising (falling) lending would indicate a higher (lower) r*. 

4. Would a Sale of Founder’s Holdco NXC Corp Trigger a Tender Offer for Nexon (3659 JP)?

It was reported on January 3rd that Korean founder and heretofore effective controller of Nexon Co Ltd (3659 JP) Mr. Kim Jung-Ju and family, who exercise their ownership of Nexon through near 100% (98.64% according to Douglas Kim) control of NXC Corp (Korea) and NXC’s control of NXMH B.V.B.A (Belgium), planned to sell their stakes in NXC for up to 10 trillion won (US$8.9 billion).

Those two companies – NXC Corp (Korea) and NXMH (Belgium) – own 253.6mm shares and 167.2mm shares respectively, or direct and indirect ownership by NXC of just under a 48% stake in Nexon (3659 JP). Yoo Junghyun (Kim Jung-Ju’s wife) directly holds another 5.12mm shares at last look. 

The speculation is that it might be sold to Tencent Holdings (700 HK) or another global buyer because it might be too big a mouthful to swallow for NCsoft Corp (036570 KS) and Netmarble Games (251270 KS), each of which have a market cap in the area of 10 trillion won themselves. 

Nexon was founded in Korea in 1994 and moved its headquarters from Seoul to Tokyo in 2005, listing itself on the TSE in December 2011. The company is a well-known gamemaker (over 80 PC and online/mobile games), with famous games such as MapleStory, Dungeon & Fighter, and Counter Strike.

Douglas Kim has started the discussion of this situation in Korea M&A Spotlight: Nexon’s Founder Plans to Sell; Will Tencent Buy Nexon? and Korea M&A Spotlight: Will the Nexon Group Sell the Korean or the Japanese Company?. 

The Korea Economic Daily said in its report on the 3rd of January that Deutsche Bank and Morgan Stanley had been selected as advisors to run a sale process, and a formal non-binding offer to potential bidders was expected next month. A Korea Herald article suggested that “potential buyers, according to industry speculation, include China’s Tencent, Korea’s Netmarble Games, China’s NetEase and Electronic Arts of the US.”

The Big Question

In the second piece, Douglas Kim questions whether Kim Jung-Ju would sell NXC (and NXMH) as reported by the local press, or whether NXC and NXMH would sell their stakes in Japan-listed Nexon, the implication being that if they sold the stake in Nexon, it would mean buyers would get a large stake in a single company, whereas there is a bunch of other stuff floating around in NXC and its subsidiaries. 

The other question is whether Tencent or another buyer buying NXC would trigger a mandatory Tender Offer for the shares in Nexon in Japan. The letter of the law in the TOB Rules changed a bit over 10 years ago would indicate not, but there are questions (and precedents) here.

Discussion ensues.

5. HOYA Corporation: Fairly Priced but Value Accretive M&A Deals Could Support a Higher Price Target

HOYA Corporation is currently trading at JPY6,867 per share which we believe is fairly valued based on our SOTP valuation. The company operates with a few stable businesses and holds solid shares in the markets in which it operates. The company generates nearly 50.0% of its revenue from its core business of selling eyeglass lenses and contact lenses. The advancement in eyeglass and contact lenses technology, the growth in global population with vision-related issues due to increased use of PCs, smartphones and tablets and an ageing population will drive demand for eyeglasses and contact lenses. Although the company’s IT Segment which generates around 33.0% of company revenue is growing slowly, the management has aggressively managed the costs to improve the segment’s pre-tax profit margin to over 40.0%. While the Lifecare segment remains the engine of revenue growth for HOYA, it focuses on the IT segment for profitability. HOYA has grown its businesses, mainly the Lifecare segment through value adding M&A deals. The company has announced that it has entered into definitive agreements to acquire US-based Mid Labs and Germany-based Fritz by the end of FY19 (March 2019). The proposed acquisitions could help HOYA to expand its footprint in the global retinal market and further its Lifecare growth. The company has a strong balance sheet with a debt-to-equity ratio of 0.3% as of 2QFY19 with cash and cash equivalents worth JPY252.3bn (35.2% of total assets).

According to our analysis, HOYA operates solid businesses with impressive ROE and positive FCF, however, we believe, the market has already factored most of this into the share price. Therefore, we believe HOYA is worth looking at on the long side if its management continues to find value adding M&A deals which complement its existing lines of business or new business opportunities which would be transformative for HOYA. Our valuation is neutral, but we favour HOYA within the sector as it has held up relatively well despite the tech sell off due to its attractive health care business and shareholder friendliness which was perhaps underappreciated while the market was in its bull phase.