Last Week in Event SPACE: Fast Retailing, Evergrande, APA Group, Fairfax, LCY Chem, Hyundai Group

Last Week in Event SPACE ...

• The possible changes to the BOJ's ETF allocations will reduce the impact on the remaining float of future purchases of some stocks, but it does not change how much they own
• Following the broadcasting legislation amendments last year, the widely speculated Nine Entertainment Co Holdings (NEC AU)/Fairfax Media (FXJ AU) merger is announced
• The current pricing on CKI's takeover of APA Group (APA AU) looks optimistic
• KKR's tilt for Lcy Chemical (1704 TT) looks done although Taiwanese regulatory approval is not assured
• Evergrande Real Estate Group (3333 HK) raises the buyback headroom via the exercise of options, but may opt for additional ways to keep buying
• The proposed revisions to Korean holding company rules are not as stringent as expected, however, the Hyundai Group is in the crosshairs

Japan Passive Series

In an ongoing series of insights, Travis Lundy discussed passive investment in Japan, and recent Nikkei reports that the BOJ will at its next meeting (31 July) consider changing the composition of its ETF buying to replace some or all of its Nikkei 225 buying with TOPIX buying. The tone of these article suggests it is effectively decided already.

• All told, Travis estimates passive holdings in Japan are approximately equal to 25-27% of the "float" as calculated by index firms such as MSCI, FTSE, and the TSE float calculations PLUS 27-30,000 baskets worth of Nikkei 225 holdings.
• That puts Fanuc Corp (6954 JP) and Tokyo Electron Ltd (8035 JP) in the 36-40% range of float, if not a little higher. TDK Corp (6762 JP), Cyberagent Inc (4751 JP), Nissan Chemical Industries (4021 JP), and Kikkoman Corp (2801 JP) are in the 40-45+% range. Konami Holdings Corp (9766 JP) and Hitachi Construction Machinery (6305 JP) close to 50%. FamilyMart UNY Holdings Co Ltd (8028 JP) will be 63% now and higher after the tender. Fast Retailing Co Ltd (9983 JP) is near 70%.
• Although changing the BOJ's ETF allocation will reduce the impact on remaining float of future purchases of certain stocks, the main issue is it will not correct the problem of the BOJ, Nikkei 225 ETF Owners, and other passive owners as a whole owning an outsized portion of the float of several stocks, as above.
• What Do I Buy? What Do I Sell? Travis would short a basket of the Top 30 Nikkei Sell names as shown in JAPAN PASSIVE: The Nikkei 225 Baskets if BOJ Changes and buy the basket of Top 30 Buys on an equal-weighted basis.

links to Travis' insights:
JAPAN PASSIVE - BOJ To Buy Less Nikkei 225? Highly Likely
JAPAN PASSIVE: Who Owns What?

Evergrande Real Estate Group Limited (3333 HK) (Mkt Cap: $34.5bn; Liquidity: $88mn)

Evergrande appears now to be using the exercise of options to allow for increased buyback headroom. Travis believes the company will aim to find another way (such as bonus shares, a CB, and/or the CEO offering shares to the public) to keep buying shares. If the company does so, one might expect the shares to rise simply because of a concerted effort to make the shares go up without regard to fundamentals.

• The options are deeply in-the-money, so if the holders wanted to take profits, they could. But if they took profits by selling in the market, there would be no net squeeze. The net squeeze takes place when the company buys stock which in turn reduces the float. That would be the case if option exercisers were induced or incentivized to keep holding, and instead the company bought back shares from the market.

• There are likely only 66mm shares including option conversion available to buy before 9 October 2018. After that, there are another 86+mm shares the company could buy back if all options vesting starting then were exercised early.
• On Friday, Evergrande announced it had bought back just under 6.7mm shares. That leaves it with 1.1mm shares of room to buy. Travis expects another options exercise on Monday so they can buy back on Monday.

(link to Travis' insight: Evergrande (3333 HK) - They're Doing It)

Fairfax Media (FXJ AU) (Mkt Cap: $1.4bn; Liquidity: $40mn)

Nine Entertainment Co Holdings (NEC AU) and Fairfax have entered into a Scheme Implementation Agreement in which the two companies will merge (albeit it is a Nine takeover) via a cash/scrip structure, creating Australia's largest integrated media player. The scrip/cash offer valued Fairfax at A$0.94/share, a 21.9% premium to last close. That places a value on Fairfax of ~8x FY19E EV/EBITDA, which looks fair, especially given the group's five-year EBIT CAGR outlook of minus 6% (excluding Domain Holdings Australia (DHG AU) based on Morningstar's estimates. If completed, Nine shareholders will hold 51.1% and Fairfax's 48.9%.

• A Nine/Fairfax merger has been widely speculated since last year when Australia's House of Representatives repealed both the two-out-of-three & 75% audience reach media ownership rules.
• The ACCC approval is key. Both Nine/Fairfax believe the transaction is in the spirit of the new government media reforms. And PM Malcolm Turnbull has backed the proposal. Concerns also surround Fairfax's media charter of editorial independence, in which ex-PM Paul Keating added some candid comments (paywalled).
• This looks like a done deal. Currently trading tight at a ~1.5% spread. The question is whether you want to hold the combined entity afterward.

links to:
my insight: Nine & Fairfax - Integrated Advertising
Morningstar's insight: Fairfax on Cloud Nine.

APA Group (APA AU) (Mkt Cap: $8.4bn; Liquidity: $9.2mn)

APA bounced off a post-non-binding-announcement low of $9.40 earlier this week. My initial takeaway at the time of the announcement was that the proposal was geared for a political knockdown. I see no reason to alter that opinion, from either an anti-competitive and protection of infrastructure standpoint.

• The Critical Infrastructure Centre (CIC), a pseudo-bolt-on to FIRB, established in January 2017; and the Security of Critical Infrastructure Act passed by parliament this year, have been implemented and enacted to help protect critical infrastructure, such as APA's assets; and also helps to clarify what are critical national infrastructure assets, which remains opaque following the government's lacking-in-depth-reasoning in its decisions on Ausgrid and Duet.
• There is an interesting twist though. A government decision on whether Huawei can bid for Austalia's 5G network is expected to be handed down next month. The question is whether the Aussie government will ding Huawei and CKI.
• Current pricing looks optimistic, at a better than even chance the deal goes through. I would put the odds of the Australian government giving the green light for CKI's transaction at ~30%, indicating an entry level around $9.10/share. A 40% chance is approximately in line with this week's intra-day low.

(link to my insight: APA Group - Too Much Risk, Not Enough Reward)

LCY Chemical Corp (1704 TT) (Mkt Cap: $1.5bn; Liquidity: $16mn)

On Sunday, KKR and LCY jointly announced the signing of a US$1.56bn share exchange agreement for a consortium led by KKR to acquire all of the issued and outstanding shares of LCY for TWD56/share. This includes a TWD2.90/share dividend, with an ex-date this past Friday (27th).

• The offer appears light on a prima facie basis. The offer price represents a premium of 17.28% to LCY’s undisturbed price; and on an EV/EBITDA metric, is at a discount to peers and M&A precedents. And there is regulatory risk. Taiwan's Investment Commission has either blocked and/or delayed approval of a number of large cross-border M&A deals in the past. Including KKR's attempted buyout of Yageo Corporation (2327 TT) in 2011.
• However, LCY trades at a discount to peers for salient reasons: the 2014 Kaohsiung propene explosion was blamed on underground pipes belonging to LCY; and the 2015 bankruptcy of Taiwan Polysilicon, a subsidiary of LCY, the latter resulting in a net loss after tax of NT$9.76/share.
• On balance, I think this offer gets up. The offer price is pitched at a 6+ year high. And a significant % of the issued shares are in favour. Trading at a 3.3% gross spread. Tight but reasonable. A bump is still a possibility.

(link to my insight: KKR's "Low-Ball" Offer for LCY Chemical Likely to Succeed)

Investa Office Fund (IOF AU) (Mkt Cap: $2.3bn; Liquidity: $12.5mn)

The Explanatory Memorandum for IOF has been dispatched, with the Scheme meeting for unitholders to be held on the 21 August. The Independent Expert (KPMG) concluded that “the Scheme is in the best interests of IOF Unitholders in the absence of a superior proposal. In arriving at this opinion, we have assessed the Scheme to be not fair but reasonable.” (my emphasis)

• IOF is probably worth a few more cents above the proposal, however, it is still a decent price, comparable companies are considered to be trading rich, while IOF's management concluded this is the best offer after numerous approaches.
• APN Property (est. to hold <5%) is probably rattling a saber in its statement in the press (paywalled) the bid does not fully recognise the value of the property portfolio. If they believe IOF is worth considerably more than the current offer, then they probably should have been building a bigger position around the undisturbed price of ~A$4.45.
• The offer has not been declared final. No shareholders have given an irrevocable to vote in favour of the Scheme. Investa Wholesale Fund Management, with 19.9973% of the total issued units, is required to abstain from the vote. Currently trading though terms as it has most of the time since the May 28 announcement.

(link to my insight: Investa - Offer in the Best Interest, But Not Fair & Reasonable)

Fujitsu Component (6719 JP) (Mkt Cap: $123mn; Liquidity: $9mn)

Private equity fund Longreach (and its Bidco Founder's Consultants Holdings) reached an agreement with Fujitsu Ltd (6702 JP) to conduct a Tender Offer on Fujitsu Component at ¥935 in order to take it over and delist the company.

• If the Tender Offer is successful, then the combination of Longreach and Fujitsu will own a minimum of 88%, which will allow the companies to either consolidate the shares, (removing all other shareholders), or otherwise squeeze out minorities in late November or early December.
• The spread will likely trade VERY tight because TIJ (This Is Japan). Travis believes the transaction will go through. He is not terribly bullish on the prospects for getting a bump but suggests it is a non-zero possibility.

(link to Travis' insight: Fujitsu Component - Looks Easier Than It Is)

Very briefly ...

Bayerische Motoren Werke Ag (BMW GR) has secured the rights to invest, via BMW Brilliance, the German car maker's Chinese joint venture, in CATL (A) (300750 CH), should the Chinese battery maker opt to sell shares in China or offshore in the future. The entitlement is up to RMB2.85bn (US$426 million) for a 1.6% stake.

(link to LightStream Research 's insight: BMW to Invest in CATL: Chinese Battery Maker to Gain Exposure in Europe?)

CTFN discussed the appeal filing by the U.S. Department of Justice to overturn the decision of Judge Richard Leon approving the Time Warner Inc (TWX US)/At&T Inc (T US) merger. If the DOJ wins at the appeals level and the companies seek a review by the Supreme Court, new Justice Brett Kavanaugh, assuming he is confirmed for the high court, seems likely to try to persuade fellow justices to grant certiorari. Kavanaugh dissented from DC Circuit merger opinions twice and both of his dissents stated strongly-worded animosity for merger challenges.

(link to CTFN's insight: Pondering the Time Warner/AT&T Legal Drama)

Elliott announced (after the close on Friday) an increase in stake from 6.3% to 7.33% in Alpine Electronics (6816 JP).

Sustinvest provides a solid overview of the proposed revisions to regulate Korean holding companies, which are most likely to be included in the legislation amending the Fair Trade Act, which is to be passed by the Assembly in Sept 2018. Hyundai Motor Group, HDC Group, and Hyundai Department Store Group will likely face imminent governance reforms, while Samsung Group, SK Group, Celltrion Group, and Kolong Group will not.

• Hyundai Group is the only conglomerate where the circular shareholding structure plays a vital role in maintaining the Chung family’s control over the group, and one of the proposals is putting a cap on voting rights attached to the circularity of shares held.

• Sustinvest reiterated points from its previous insights that the Chung family should promptly sell down their shares in Hyundai Glovis Co Ltd (086280 KS) or stop internal transactions between Glovis and other affiliates. HDC Group might merge HDC I-Controls Co Ltd (039570 KS) with HDC Holdings Co Ltd (012630 KS) to remove internal transactions as well as circular shareholding. Hyundai Department Store would be able to avoid the regulation by dividing Hyundai Greenfood Co Ltd (005440 KS) into a holding company and an operating company.

(link to Sustinvest's insight: Updates on Korea's Chaebol Reforms - Proposed Revisions of the Fair Trade Act Were Specified)

My ongoing series flags large moves in CCASS holdings over the past week or so (~10%), 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, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.