Pan-Asia Catalysts/Events, Quiddity Advisors

Travis Lundy

HK Type 4 license through Ballingal Investment Advisors Ltd. ("BIA" or "BIAL")

BACKGROUND
I have 20+yrs experience in Asia doing alternative strategies (i.e. non-delta1 non long-only) in fixed income, equity derivatives, and activist/catalyst/event-driven and long-short equity strategies with most of that time spent managing money. 

4 years in fixed income macro, 8 years running internal hedge fund and 4yrs investment banking at Citi in Japan, 3 years running an Asia multi-strat portfolio at a hedge fund, 4+yrs as an independent special situations analyst.

Pan-Asia Catalysts/Events

Sanyo Special Steel - Still Mis-Underestimated, Still Special, But Now Different.

Nippon Steel Aiming at 51% of Sanyo Special Steel

Japan's Corporate Governance Code Amendments - A Much Bigger Stick for Activists and Stewards

Sanyo Special Steel - A MISUNDERESTIMATED Tender Opportunity

Quiddity Advisors

Event-Driven

In mid-March this year, <a href="https://www.smartkarma.com/entities/15900" target="_blank" data-smartkarma-citation="entities:15900:1">Sanyo Special Steel (5481 JP)</a> and <a href="https://www.smartkarma.com/entities/961" target="_blank" data-smartkarma-citation="entities:961:1">Nippon Steel &amp; Sumitomo Metal (5401 JP)</a><a href="http://www.sanyo-steel.co.jp/system/upload/news_en/180315_1.pdf" target="_blank">announced</a> that they had commenced discussions on a transaction to make Sanyo Special Steel a consolidated subsidiary of NSSMC. A decision and details were expected in August. At the same time, Nippon Steel announced that it was going to purchase Ovako AB, without disclosing either the transaction amount or the metrics (i.e. EV/EBITDA level). I discussed the likely economics of the transaction in <a href="https://www.smartkarma.com/insights/nippon-steel-aiming-at-51-of-sanyo-special-steel" target="_blank" data-smartkarma-citation="insights:18544">Nippon Steel Aiming at 51% of Sanyo Special Steel</a> based on information gleaned from various sources (EBITDA in 2017 (before restructuring costs) was €100 million with €31mm of that coming from depreciation). The original <a href="http://www.nssmc.com/common/secure/en/news/20180315_200.pdf" target="_blank">announcement</a> suggested this deal could be done by Sanyo Special Steel issuing shares in a third party allotment, by a partial tender offer, a combination of the two, or other method. In the case of the Nisshin Steel deal where Nippon Steel was going to move to a 51% holding, the language was similar (see <a href="http://www.nssmc.com/en/ir/library/pdf/20160201_040.pdf" target="_blank">p4</a>) but they clearly pointed at a tender offer. This time there was no stated preference, however, because Sanyo Special Steel is relatively financially healthy and with less than 2 turns of EBITDA of debt (unlike Nisshin Steel which at the time was undergoing restructuring and had debt of 8+x EBITDA), I and others had expected this would be a tender offer, with a possible reorganization of Ovako and Sanyo Special Steel and the existing in-house specialty steel operations of Nippon Steel combined at some future point in time.Today we got the results of those discussions. They are something of a disaster from a Corporate Governance perspective. Both Sanyo Special Steel and Nippon Steel should be ashamed of themselves for the presentation of the finances of the deal, though they may be commended for requiring an EGM of Sanyo Special Steel shareholders to approve the overall transaction. Sanyo Special Steel has <a href="http://www.sanyo-steel.co.jp/system/upload/news_en/_%E3%83%AA%E3%83%AA%E3%83%BC%E3%82%B9_%E4%BA%8C%E6%A0%A1_0802_cln.pdf" target="_blank">announced</a> that it will issue 24.0125mm new shares (a 72% increase in shares outstanding) in a 3rd party allotment, placed with Nippon Steel, at the price of ¥2800 apiece. This will take Nippon Steel from a holding of 15.3% to 51.5%. The funds raised will then be used to purchase all of the shares of Ovako AB from Nippon Steel, which Nippon Steel just purchased in March (with the close occurring in Q2). A presentation is linked <a href="http://www.sanyo-steel.co.jp/system/upload/news_en/180802+%E5%B1%B1%E7%89%B9%E5%AD%90%E4%BC%9A%E7%A4%BE%E5%8C%96%E7%AD%89%E8%A8%98%E8%80%85%E4%BC%9A%E8%A6%8B%E8%B3%87%E6%96%99E.pdf" target="_blank">here</a>. This conversion of Sanyo Special Steel to be a subsidiary of Nippon Steel will require the approval of anti-trust authorities in Japan and abroad, and there will be a special shareholder meeting of Sanyo Special Steel shareholders in February 2019 to approve the transaction. Sanyo's purchase of Ovako is scheduled to take place at just under 10x the annualized net income level shown in the first half of 2018 (¥67.2bn purchase price divided by ¥6.8bn estimated annual net income based off H1 of ¥3.4bn), but one should be wary - that net income estimate is a) adjusted for one-off costs, b) is more than 3x last year's number, and c) is 50% higher than last year's number when Ovako's previous high interest costs are added back. But Ovako's EBITDA this year is already €81mm in H1 against a full-year number of €100mm last year. They are making hay while the sun shines this year.An EV/EBITDA multiple Sanyo is paying for Ovako is harder to estimate because while the values shown in the presentation appear to be accurate as of 6 months ago, statements made by NSSMC in the Conference Call of 22 March regarding its purchase of Ovako would seem to render obsolete some of the data in the presentation materials released today, as would some of the footnotes. The fact that it is a question is shocking. The level of debt and equity at Ovako is highly, highly material. And it is not clear to the public.But it can be reasonably derived. More below.

In mid-March this year, Sanyo Special Steel (5481 JP) and Nippon Steel &amp; Sumitomo Metal (5401 JP)announced that they had commenced discussions on a transaction to make Sanyo Special Steel a consolidated subsidiary of NSSMC. A decision and details were expected in August. At the same time, Nippon Steel announced that it was going to purchase Ovako AB, without disclosing either the transaction amount or the metrics (i.e. EV/EBITDA level). I discussed the likely economics of the transaction in Nippon Steel Aiming at 51% of Sanyo Special Steel based on information gleaned from various sources (EBITDA in 2017 (before restructuring costs) was €100 million with €31mm of that coming from depreciation). The original announcement suggested this deal could be done by Sanyo Special Steel issuing shares in a third party allotment, by a partial tender offer, a combination of the two, or other method. In the case of the Nisshin Steel deal where Nippon Steel was going to move to a 51% holding, the language was similar (see p4) but they clearly pointed at a tender offer. This time there was no stated preference, however, because Sanyo Special Steel is relatively financially healthy and with less than 2 turns of EBITDA of debt (unlike Nisshin Steel which at the time was undergoing restructuring and had debt of 8+x EBITDA), I and others had expected this would be a tender offer, with a possible reorganization of Ovako and Sanyo Special Steel and the existing in-house specialty steel operations of Nippon Steel combined at some future point in time.Today we got the results of those discussions. They are something of a disaster from a Corporate Governance perspective. Both Sanyo Special Steel and Nippon Steel should be ashamed of themselves for the presentation of the finances of the deal, though they may be commended for requiring an EGM of Sanyo Special Steel shareholders to approve the overall transaction. Sanyo Special Steel has announced that it will issue 24.0125mm new shares (a 72% increase in shares outstanding) in a 3rd party allotment, placed with Nippon Steel, at the price of ¥2800 apiece. This will take Nippon Steel from a holding of 15.3% to 51.5%. The funds raised will then be used to purchase all of the shares of Ovako AB from Nippon Steel, which Nippon Steel just purchased in March (with the close occurring in Q2). A presentation is linked here. This conversion of Sanyo Special Steel to be a subsidiary of Nippon Steel will require the approval of anti-trust authorities in Japan and abroad, and there will be a special shareholder meeting of Sanyo Special Steel shareholders in February 2019 to approve the transaction. Sanyo's purchase of Ovako is scheduled to take place at just under 10x the annualized net income level shown in the first half of 2018 (¥67.2bn purchase price divided by ¥6.8bn estimated annual net income based off H1 of ¥3.4bn), but one should be wary - that net income estimate is a) adjusted for one-off costs, b) is more than 3x last year's number, and c) is 50% higher than last year's number when Ovako's previous high interest costs are added back. But Ovako's EBITDA this year is already €81mm in H1 against a full-year number of €100mm last year. They are making hay while the sun shines this year.An EV/EBITDA multiple Sanyo is paying for Ovako is harder to estimate because while the values shown in the presentation appear to be accurate as of 6 months ago, statements made by NSSMC in the Conference Call of 22 March regarding its purchase of Ovako would seem to render obsolete some of the data in the presentation materials released today, as would some of the footnotes. The fact that it is a question is shocking. The level of debt and equity at Ovako is highly, highly material. And it is not clear to the public.But it can be reasonably derived. More below.

Sanyo Special Steel Special Deal with NSSMC - A Steal? Or Stolen?