Current Price – $1.26
Expected Buyout – $1.81
Upside – 44%
Expiration Date – expected in H1 2017
Prospect Japan Fund trades below its NAV and received a non-binding all-stock buyout offer from the related party. This offer values the fund at $2.15/share – equivalent to 70% upside. The merger is very likely to go through. The biggest risk is market price of the acquirers shares which affects not only the eventual payout (no possibilities to hedge) but also the NAV of PJF.
This is a fairly straightforward situation:
- Company trades at $1.26/share;
- Disclosed NAV is $1.29/share – 2% upside;
- ‘True’ NAV is $1.82+/share – 44% upside;
- Company received a non-binding buyout offer which values it at $2.15/share – 70% upside.
I am of the opinion that the buyout will happen but at a reduced price – somewhere around the ‘True’ NAV.
Prospect Japan Fund is an investment company listed in London. Shares are denominated in USD and it is possible to trade through IB, however the stock is illiquid.
PJF portfolio is comprised of 7 small cap (sub $200m) Tokyo listed equities, warrants in one company and cash. It owns sizable portions in each of the equities (e.g. 15% of Daito Bank and 12% Fukushima Bank), therefore full portfolio liquidation would take time – still I consider the portfolio to be relatively liquid. The value of portfolio excluding the unlisted warrants is c. $116m and is approximately equal to the current market cap of PJF.
The juicy bit here is warrants in Prospect Co (listed in Tokyo under ticker 3528). Prospect owns PJF’s investment manager (Prospect Asset Manager) and is also the potential acquirer of the company.
PJF has stock acquisition rights (SARs) to purchase 135m of Prospect shares at ¥54 strike price till Dec 2020. Untill recently Propect traded below or close to exercise price and because of that SARs were valued on PJF balance sheet at cost of $2.7m (2015 annual report and 2016 interim fillings). In the latest NAV calculation these SARs continue to be included at costs. However, with the increase in Prospect share price (currently ¥97) the value of SARs has drifted substantially from $2.6m at cost to $51m currently. And that is only counting the intrinsic value of SARs - with almost 4 years before expiration, the time value is likely to be material as well. Adding the difference between cost and intrinsic value of SARs to the reported NAV results in $168m ‘True’ NAV or $1.82/share.
Acquisition proposal by Prospect
On 10th of Jan 2017 Propect issued proposal to acquire all PJF shares in exchange for 2.5 shares of Prospect. Preliminary discussions are ongoing and the initial deadline has already been extended once.
At the time when proposal was issued it valued PJF at $133m, which was roughly equivalent to its true NAV at the time (counting in full intrinsic value of SARs and adding another $4.5m for the time value). With the increase in Prospect share price (from ¥67 on 10th of Jan to ¥92 currently) the exchange offer of 2.5 Prospect shares for each share of PJF significantly overvalues PJF. I do not see any justifiable reason on why would Prospect be willing to pay more than the actual NAV on the portfolio of listed securities and SARs. Therefore, I expect Prospect acquisition offer to be adjusted accordingly in order to reflect the purchase price approximately equivalent to my calculated ‘True’ NAV plus few million for the time value of SARs.
Is Prospect share price sustainable?
Most of the upside in this transaction hinges on SARs valuation and in turn on the share price of Prospect. Prospect share price has shot up from ¥40 to ¥100 in a period of 2 months. This was mostly driven by decision to increase dividend from ¥1 to ¥3. This resulted in substantial increase in yield and in turn pushed the share price upwards – Japanese equities tend to follow yields closer than earnings. I cannot say much on how sustainable this dividend is (all IR info in Japanese), but my guess is that management would not triple the dividend if there were any concerns about ability to pay it for at least few years. If Prospect acquires PJF portfolio, then it will definitely have sufficient financial resources to continue with the pay-outs. As long as dividends remain at ¥3/share it is likely that Prospect share price will continue to trade at least within the ¥90-¥100 range (resulting in 3% yield).
There is some background on Prospect’s business (including short version of financials) in this presentation.
How likely is the acquisition?
Prospect wants PJF mainly for its cash value in order to fund further growth projects (see pages 20-22 of the presentation). I view this acquisition as equivalent to raising equity capital, just with less hassle of finding interested investors (especially foreign ones). At the same time overhang from SARs would be removed resulting in cleaner balance sheet.
Most (88%) of current PJF shareholders are active fund managers, who should only be interested in getting fair value for their PJF shares (which currently is north of $1.81). Depending on the final exchange ratio current PJF shareholders would end up owning c. 50% of the merged company and current large shareholders of PJF (3 companies own 60%) would end up with large stakes in Prospect and be exposed to its business performance instead of a basket of Japanese small cap equities.
However, Prospect is far more liquid than PJF and therefore exiting larger stakes in the open market looks quite feasible – 3% yield really seems to do the trick in attracting investor attention as the daily trading volume increased >10x since the dividend announcement. Thus I do not see much concern from the perspective of current PJF holders and believe they should approve the transaction.
Worth noting that since the acquisition proposal, some funds have sold down and some have added to their PJF positions. One can find all the announcements here.
Another potential catalyst
If the deal does not materialize. the company is still likely to announce materially higher NAV that reflects fair SARs valuation (if Prospect share price remains at current levels) in the annual report, which is due to be released some time at the end of April.