Hollysys Automation Technologies (HOLI) – Merger Arbitrage – 9% Upside

Current Price: $15.72

Offer Price: $17.10

Upside: 9%

Expected Closing: TBD

 

Hollysys’ privatization saga has been ongoing for a while now. We think the situation is interesting and are flagging it among Quick Ideas. However, the spread is volatile (stood at 15% on Monday) and there might be better opportunities to time this trade.

A consortium led by ex-CEO (claims to own 6.8% shares) is trying to acquire US-listed Chinese company Hollysys at a $17.10/share, a spread of 9% to current prices. Both the initial $15.47/share and $17.10/share (raised in Dec’20) offers were thrown out by Hollysys’ management as the proposals allegedly undervalued the company. After Mr. Shao (Ex-CEO) was removed, a poison pill was placed to prohibit any holdings in Hollysys above 15% without management’s approval. Currently, the buyer hopes to bypass the poison pill by commencing a solicitation of consents from Hollysys’ shareholders with the deadline set for the 20th Aug’21 (subject to extensions if no court ruling is present at that time). The current offer comes at 5x TTM EV/EBITDA and 15x TTM P/E – Hollysys has two-thirds of its market cap in net cash and looks both historically and nominally cheap from both an EV/EBITDA and a P/E perspectives. If the buyer is successful with shareholder consent solicitation, investors stand to earn 9% spread. There is also plenty for further bid improvement if the board engages in discussions with the buyer group. The downside looks well-protected by cash on the balance sheet and cheap valuation.

Short Timeline:

  • Jul’ 20 – Mr. Shao was removed from his position as CEO. Board provided limited color to shareholders.
  • 24 Sep’20 – A poison pill and a number of other company’s charter amendments were introduced – holders seeking >15% ownership of the company have to be approved by the board.
  • 28 Sep’20 – Note in the annual report mentions ongoing dispute with regards to Mr Shao’s claim on the 6.8% ownership in the company.

We were made aware of a shareholders dispute regarding ownership of one of the principal shareholders. In August 2016, Mr. Changli Wang, the then sole shareholder of Ace Lead, one of our record shareholders, transferred his single share in Ace Lead to Mr. Baiqing Shao for a nominal consideration. As of the date hereof, Ace Lead owns 4,144,223 ordinary shares of our company, representing 6.9% of the outstanding shares of our company. We were recently notified that Mr. Wang indicated that, as Mr. Shao had stepped down as the chairman and chief executive officer of our company since July 2020, he should no longer be entitled to any share in Ace Lead and he should immediately transfer the share in Ace Lead to one or more persons designated by Mr. Wang. As of the date of this annual report, Mr. Shao has not transferred the share in ACE Lead to any designees of Mr. Wang. We cannot predict the outcome of the dispute. If Mr. Shao refuses to transfer the share in ACE Lead to a person designated by Mr. Wang, the dispute could escalate and litigation may ensue between Mr. Shao and Mr. Wang, and our company may become involved. Any escalation of this dispute, including potential litigation, may cause us to incur significant time, resources and cost if we were to become involved.

  • 7 Dec’20 – Hollysys received a preliminary non-binding proposal to be acquired by a consortium led by former CEO Mr. Shao at $15.47/share. The offer was thrown out as undervaluing the company.
  • 12 Jan’ 21 – The consortium issued a response stating that the board had never engaged in discussions and accused the company of disenfranchising shareholder rights.

We have never before seen a charter document that so blatantly disenfranchises shareholders’ rights on a wholesale basis, encompassing economic rights, voting rights, and fundamental ownership rights, all of which are designed to ensure that the current board members remain in power and avoid accountability for their destruction of the value of the Company. It is manifestly obvious that existing management and board members of the Company do not understand how to run the business successfully, as concretely evidenced by the Company’s rapidly deteriorating financial performance.

  • 29 Jan’21 – The consortium sweetened the offer to $17.1/share, which was also dismissed by the board.
  • 1 Feb’21  – The consortium filed a lawsuit against Hollysys on the basis that recent company’s charter amendments (including poison pill, refer to the 12th of Jan’21 statement for details) by the board were not legal and were made without the consent of shareholders.
  • 8 Mar’21 – A preliminary win by the consortium was acknowledged by the court. The trial should take place in July 2021.
  • 9 Mar’21 – Hollysys was notified of legal action against Mr. Shao arguing that his claimed ownership of shares is unlawful.
  • 29 Jun’21 – The consortium commenced a solicitation of consents from Hollysys’ shareholders in an effort to bypass the poison pill.

This solicitation, if successful, will facilitate the Consortium’s efforts to proceed with the Proposed Acquisition despite the inaction of the board of directors of the Company (the “Board”). If shareholders holding more than 50% of the outstanding shares of the Company deliver their consents to the resolutions as provided in the consent card, such resolutions will become effective pursuant to the Company’s articles of association and the BVI Business Companies Act 2004. The intention of these resolutions is, among others, to limit the Board’s power to invoke and exercise rights pursuant to the Company’s existing “poison pill” in respect of the Proposed Acquisition. These approved resolutions, even after becoming effective, do not constitute an approval and authorization of the Proposed Acquisition by shareholders. Shareholders of the Company will be entitled to consider and vote upon the Proposed Acquisition at a special shareholder meeting to be called by the Board following the execution of a definitive merger agreement between the Consortium and the Company in respect of the Proposed Acquisition.

  • 22 Jul’21 – The solicitation of consents deadline has been extended to 20 Aug’21 as some shareholders wished to know the outcome of the trial on Charter amendments. The deadline can be extended further if no court ruling is available by that time.

In a nutshell, Hollysys board argues that the ex-CEO’s stock ownership claims are not valid as these shares belong to employees’ trust and Mr. Shao is no longer with the company. On the other hand, Mr. Shao accuses the company of destroying shareholder value, bypassing shareholder approval on highly objectionable charter amendments (including poison pill) and not fulfilling fiduciary duties by rejecting acquisition offers without any review or discussions. As a result of these conflicts, both parties have taken this matter to court in multiple jurisdictions.

Notable risks include:

  • Lack of transparency from board’s side (for example, investors were given little communication about Mr. Shao’s departure).
  • There is also a risk of HOLI books not representing actual values (especially in cash) as their auditors are not inspected by the Public Company Accounting Oversight Board (no auditor oversight). However, this risk is countered by the notion that a former insider is trying to take the company private. He should be well-familiarized with insides of HOLI’s business and books.
  • It is difficult to predict if shareholders will vote in favor of the buyer’s offer as notable shareholders, including Davis Selected Advisers (position increased from 10.91% to 11.7% as of 31 Dec’20), Eastspring Investments (Singapore) (position decreased from 9.83% to 7.66% as of 31 Dec’20) and M&G Investment Management (6.62% as of 31 Dec’20) have not expressed their opinions on the matter.
  • Litigation outcomes from both sides are uncertain and are likely to impact the efforts to take the company private.

Hollysys, founded in 1993, is an automation control system solutions provider in China with additional overseas operations in 8 countries throughout Asia. The company operates in three business segments: industrial automation, rail transportation, mechanical and electrical solutions. Revenues are mainly derived from solutions to industrial automation and rail transportation businesses.

15 COMMENTS

  1. snowball

    HollySys (HOLI) board is considering new and higher offer (at $23) from company founder Mr. Changli Wang. The previous offer from ex-CEO Mr. Shao Baiqing is at $17.1.

    HollySys Automation Technologies Ltd. (NASDAQ: HOLI) (“HollySys” or the “Company”), a leading provider of automation and control technologies and applications in China, today announced that the Company’s Board of Directors (the “Board”) is in the process of evaluating a non-binding offer from Superior Emerald (Cayman) Limited, a company controlled by Ascendent Capital Partners, and Mr. Changli Wang, the founder of the Company who retired from the Company in 2013 with honor (collectively, the “Emerald Consortium”), received on July 20, 2021 to acquire all of the outstanding ordinary shares of the Company for US$23.00 per share in cash (the “Emerald Offer”).

    This follows an offer from CPE Funds Management Limited, Mr. Shao Baiqing and Ace Lead Profits Limited (collectively, the “CPE Consortium”) to acquire all of the outstanding ordinary shares of the Company for $17.10 per share in cash (the “CPE Offer”), which was publicly disclosed by the CPE Consortium and to which the Company responded earlier.

    https://www.prnewswire.com/news-releases/hollysys-board-of-directors-evaluating-offers-from-consortiums-301346247.html

  2. Ilja

    Apparently, certain senior managers (co-chief operating officers) joined founder’s consortium and apparently “represent the collective interests of themselves and certain other management and employees of the Company.” I doubt that Shao will outbid this as given management’s support for the founder, Shao would need to raise the offer quite substantially, while founder’s offer is already at 9.3x TTM EBITDA (premium to historical levels). Both offers are still non-binding. 15% spread remains.

    https://www.bamsec.com/filing/119312521254605?cik=1357450

    1. snowball

      It’s intriguing that the potential offer by Longsheng hasn’t been formally announced yet.
      Longsheng has been authorized by its board to make an offer at $24 per share.
      It is possible that Longsheng has already submitted an offer but both sides have agreed to negotiate confidentially.

      1. Ilja

        Given that the court has effectively approved the previously installed poison pill and management has already sided with the founder’s consortium, I doubt that Longsheng has a chance in this. Management owns a negligible amount of stock and is clearly not interested in shareholder value, so a higher price likely doesn’t mean much to them. Unless of course, Longsheng convinces them to join its offer instead, but it seems kind of unlikely as relationships in China are very important and why would they drop the founder for a public company that operates a completely different business. Don’t really remember a case where Chinese management would switch between consortiums too.

        1
  3. snowball

    HOLI changed auditor from E&Y to Union Power HK CPA Limited (an unknown name), and is late in filing annual report for the year ended June 30, 2021. Share is down 12% in pre-market trading.

    On October 31, 2021, the Company engaged Union Power HK CPA Limited (“Union Power”) as the Company’s independent registered public accounting firm. Union Power succeeds Ernst & Young Hua Ming LLP (“EY”), which previously was the independent registered public accounting firm providing audit services to the Company. The change of the Company’s independent registered public accounting firm was approved by the audit committee and the board of directors of the Company.

    EY’s audit report on the Company’s consolidated financial statements as of and for the year ended June 30, 2020 did not contain an adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles. During the audit for year ended June 30, 2020, there was no disagreements, as defined in Item 16F (a)(1)(iv) of Form 20-F and the related instructions, between the Company and EY on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which, if not resolved to the satisfaction of EY would have caused them to make reference thereto in their report on the consolidated financial statements for such year. As of the date of EY’s resignation, EY had not issued their audit reports on the Company’s consolidated financial statements for the year ended June 30, 2021.

    As disclosed in the Company’s Form 12b-25 dated November 2, 2021, the Company is late in filing its annual report on Form 20-F for the year ended June 30, 2021 with the Securities and Exchange Commission. The Company is working closely with EY and Union Power to ensure a seamless transition.
    https://www.sec.gov/Archives/edgar/data/1357450/000119312521317100/d252834d6k.htm

    1
  4. filipasa

    What do you think about the current drop in price and the overall market sentiment around HOLI

  5. g4734g

    The company goes to great lengths describing year ending 6/30/2020….ancient history in my book…..I want to know why EY resigned and why they are late on the 6/30/2021 filings…..based on the stock price apparently lots of other investors are asking the same questions

  6. snowball

    Based on info from Q2’s 13F filings, many well-known arb shops are in this trade.

    It’s not inconceivable that many of them have stop-loss risk-control rules in place, which may have exacerbated yesterday’s sell-off after the initial 10% fall.

    Arb shops have scaled back their risk appetite significantly this year after being burned by the WTW/AON merger in the US and Soho China in Asia. Many of them are more focused on preserving YTD profit and earning this year’s performance fee.

    Personally I won’t double down. There may be better opportunities in 51Job (JOBS), etc, which may (but have not) experience collateral damage as some arb shops (Oasis for example) have positions in both HOLI and JOBS.

  7. Lukas

    Stock is up after management stated it is evaluating the $24/share (non-binding) proposal from Zhejiang Longsheng Group Co., Ltd. and Loyal Valley Innovation Capital.

    Seems that the buyer is still interested in the company despite the recent auditor change news. “Following the Company’s public announcement on November 2, 2021 regarding the change of the Company’s auditor, the Lonsen Consortium has reaffirmed its interest to pursue the Transaction, subject to due diligence”

    Another offer (the $23/share bid coming from Emerald Consortium) is still on the table. “The Hollysys Board also confirming with the Emerald Consortium their continued interest in a potential acquisition of the Company and the offer price with respect to any such potential acquisition.”

    https://seekingalpha.com/filing/5788990

    4
  8. dt

    Yet another unusual development from HollySys – Dr. Changli Wang, the founder of HOLI and one of the bidders for it (the $23/share bid) is now the CEO and director of the board.

    Not really sure what to make of it and whether this increases or decreases the chances of Wang’s $23/share going through. He is already running the company, so might be less willing to take it private now or sell it to someone else.

    Any other thoughts on this?

    Sell-side analyst at Citi thinks it is a positive.:

    “We believe that Dr. Wang’s comeback will greatly reduce further uncertainties of the privatization and accelerate the privatization process”

    https://seekingalpha.com/news/3785055-hollysys-automation-gains-again-as-ceo-news-may-increase-going-private-effort

  9. Lukas

    Interesting developments from HOLI as always.

    On the 24th of January, the company received another non-binding bid for the company coming in at $25/share (highest bid yet).

    “As our consortium includes a Chinese state-owned strategic investor in the same and adjacent industries, we envision a transaction with our consortium will generate synergies for the Company, and we foresee no impediments to effectively integrating our respective businesses and organizations.”
    https://www.prnewswire.com/news-releases/buyer-consortium-led-by-recco-control-technology-pte-ltd-and-dazheng-group-hong-kong-investment-holdings-company-limited-announces-non-binding-offer-to-acquire-hollysys-301466387.html

    However, on the same day HOLI itself announced that it is not currently considering a sale of the company and will suspend any evaluation of all buyout proposals.:

    In the letter, the founder compares himself to Steve Jobs by returning to HOLI. His priorities for the next few months are: “to reunite all the invaluable human resources and rekindle their working morale and aspiration; to examine and evaluate each business divisions and segments, to optimize our business and seize opportunities to grow; and to restore the confidence of our investors.”

    https://www.bamsec.com/filing/119312522015320/2?cik=1357450

    Thus despite 2 bids at $24 and $25/share (80% spread to current prices), the company does not even want to consider the offers. Any activism or hostile offers are unlikely. In light of the latest info, the offer from the founder at $23 seems even more bizarre.

  10. Lukas

    Although this case is no longer active as management basically said the company is not for sale, very interesting news came about.

    “TFI Asset Management has joined a consortium led by Recco Control Technology and Dazheng Group (Hong Kong) Investment Holdings in respect of pursuing a potential acquisition of Hollysys Automation Technologies (NASDAQ:HOLI)”

    The “potential” bids keep on coming.
    https://seekingalpha.com/pr/18706513-tfi-asset-management-limited-announces-to-join-consortium-led-recco-control-technology-pte

    Also, the company announced a small annual $0.32/share dividend, implying a 20% payout ratio.
    https://www.bamsec.com/filing/119312522072063?cik=1357450

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