Hollysys Automation Technologies (HOLI) – Expected Management Privatization – 37% Upside
Last year I said, “the two-year-long saga of Hollysys Automation Technologies privatization might finally be coming to an end”. One year forward, this saga (now three-year-long) is still ongoing and is starting to feel like a never-ending story. However, there are a few intriguing new twists that have recently materialized.
After almost a year of silence, chatter around a potential management buyout at HOLI resurfaced again in June’23, this time with a price tag of $25.6/share (37% upside). Then, about a week ago, MergerMarket reported something a bit more interesting – the buyout consortium has apparently been finalized, and the offer is expected to be made in September.
These rumors seem to be in line with what we heard last year. Previously, it was reported that HOLI’s management was trying to partner with some kind of state-owned operator of railways/subways in Beijing. The recent reports state that the consortium has been joined by CITIC Group, a major state-owned PE firm, with investments in railroad sector and Beijing Subway. Huarong Asset Management, another state-owned investment firm, is also reportedly a part of the consortium now. The main financier for the deal is still ICBC International – a major Chinese lender. It sort of looks like the privatization might be advancing in the right direction.
One very important new development is that HOLI shareholders are seemingly fed up with this buyout saga and have started making noise. Reuters has reported it has seen a letter from a group of 33 shareholders who collectively own 32% stake, asking HOLI’s management for special meeting amidst building up frustration with the takeover process. The group includes some reputable names including Oasis Management – one of the most prominent Asian activist hedge funds with a solid track record (e.g. Nintendo campaign to focus on mobile games, RENN litigation settlement, etc.). HOLI’s management has remained silent, as usual, but it is interesting to note that the rumors of a finalized buyout consortium and a more concrete timeline for the offer (expected in September) came out just one week after the shareholder group’s letter.
Amidst all of this, another buyer consortium led by Recco Control Technology has re-emerged. This consortium has been bidding for HOLI since December 2021, but their proposals have been ignored by management. The consortium has now re-affirmed its previous bid of $25/share.
The strategic rationale for a management buyout remains unchanged. The management’s main goal appears to be relisting HOLI in Chinese markets, where it is likely to receive a much higher valuation than in the US, where Chinese stocks are out of favor. The valuation gap between HOLI and its main, very similar domestic peer Zhejiang Supcon (annual report) remains very wide. HOLI now trades at 10.8x FY23 PE vs Zhejiang Supcon trading at 31.6x last year’s earnings. The rumored buyout offer at $25.6/share would value HOLI at 15x PE. It is also not surprising that CITIC Group would be interested in HOLI, given that a large portion of HOLI’s revenue (24%) comes from the sale of signaling control and automation products to the rail/subway sector. The Chinese government’s interest in HOLI is also understandable, given that HOLI’s automation systems are also used in sensitive industries such as nuclear power and petrochemicals. More background on the buyout saga and HOLI business can be in my previous write-up here.
HOLI’s share price is up 20% since the media reports have resurfaced in June’23. The main risk is that these rumors will once again turn out empty. Given that the saga has already been ongoing for 3 years, such probability is definitely considerable. Nonetheless, the rumored timeline is much more specific and short this time, whereas pressure on the management from such a large shareholder group is a big positive that could finally turn the corner for this privatization.
During this last year, HOLI’s financial performance has been quite decent. Revenue actually grew 10% YoY in FY23 (ended June). USD revenue guidance was not reached, yet management said it was mostly due to FX impact. Gross margins were in line with last year’s, whereas net income grew by 28% YoY. Free cash flow for the year was negative due to high CAPEX, which has been gradually increasing for the last 3 years. HOLI guides at $895m revenue for FY24 at midpoint, implying a 15% growth from this year. More detailed financial performance is presented in the table below.
May I ask why you didn’t include $HOLI in the portfolio this time?
The new developments definitely look interesting, but I’m really on the edge on this one and can’t bring myself to pull the trigger yet. Despite a couple of successful trades on this one already, the whole saga has been disappointing for so long, that it’s getting harder and harder to believe something will eventually happen. I mean, the same situation looked very attractive last year as well. But nothing has came out of it and instead we’ve been put into 9 months of information vacuum. This year, it is the same setup based only on some additional rumors. The rumors do appear more intriguing now, sure, but they might be followed by the information vacuum once again while the stock gradually drifts down to pre-rumor levels. The fact that the rumored buyout offer price just keeps getting lower is a bit concerning as well.
Nonetheless, I want to give it a bit more thought. Maybe this could still work, but as a short 1-1.5 month trade only.
Some further positive developments on HOLI’s privatization saga. Management confirmed that it had received a notice from a group of equity holders asking to convene a special meeting. The group is frustrated with the lethargic development of this privatization saga and wants to get control of the board by appointing 6 nominees and increasing the number of seats from 5 to 11. Management has agreed to review any written requests as long as it comes from shareholders that exercise at least 30% voting power. This threshold is unlikely to be an issue as recent Reuters report noted the group to have a 32% combined stake. HOLI has also finally acknowledged the $25/share bid from Recco consortium and said it is evaluating options to maximize shareholder value. If the rumors are true and HOLI’s insiders are also preparing a management buyout offer, the mounting pressure from shareholders and other suitors could finally bring this long saga to the finish line. The spread to the $25.6/share price tag that is reportedly mulled by management is 37%.
https://www.bamsec.com/filing/119312523228103?cik=1357450