Itoen Pref (25935 JP) - Big Discount, Ongoing Governance Disappointment

396 Views02 Mar 2020 18:47

SUMMARY

The History

The stated concept was that the company wanted to attract more individual shareholders, but because most did not vote in shareholder meetings, the idea was to offer shares without votes but with higher dividends to attract long-term individual shareholders.

The idea was, in all likelihood, not that.

It was instituted near the height of the 2007 fear of foreign "hagetaka" (vulture) activist funds to create a different kind of permanent poison pill.

The terms of the preferred shares were that they would receive a dividend which was 125% of the common share dividend, and would not have voting rights unless no dividends had been paid for two consecutive years. If the company ever went into liquidation, the pref shares would have identical rights to common shares, but they would not be convertible to common shares at the option of the holder. They would, instead, be mandatorily convertible if the company did not survive a merger, or if a Tender Offer resulted in the company having a new owner of common shares of a ratio greater than 50%.

For any would-be acquirer, if they bought the common shares but did not also buy the pref shares, they could be diluted post tender offer so that they didn't own as much as they wanted.

The first day of listing, 3 September 2007, the shares traded at a 5% discount to common shares while offering a dividend yield 0.4% higher. That was the tightest discount and dividend spread the pair would ever see. Three months later, the dividend spread was more than a percent wide because the prefs had fallen to a 30% discount, and another 3 months later the pref shares had reached a 40% discount to the commons.

The Prefs now trade at a discount of 57+% to the common shares, and because of the tiny non-market-cap portion of Enterprise Value, at a similar discount of PER and EV/EBITDA. That actually makes the prefs a very inexpensive way to own the future of Ito En.

But the very fact that these Prefs exist 13 years later is a serious governance matter.

Seasoned Japan capital structure and relative value investors will look at the headline and ticker and dismiss this insight out of hand. The discount always widens.

I will agree this has been an unfortunate outcome for shareholders of the common who received the prefs and did not bail immediately.

Over the medium-long-term, it is strange that the company has not allocated its excess capital to buying back the prefs. It is accretive to everyone.

Much more below.

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