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.

3 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

Leave a Reply