Quick Pitch: 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.

holi new financials 1

 

38 Comments

38 thoughts on “Quick Pitch: Hollysys Automation Technologies (HOLI)”

    • 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.

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  1. 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

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  2. Yesterday HOLI announced the formation of a special committee of directors to run a formal sale process. The committee will engage in discussions with the buyer consortium led by Recco and will also begin “an expedited process to solicit additional acquisition offers”. This seems to be a positive development, indicating that the pressure from the group of shareholders is yielding results. However. There is around 25% spread to the $25.6/share bid, reportedly considered by management, and the $25/share proposal from Recco consortium.

    With all these new developments, it is a bit puzzling that management still hasn’t yet unveiled its offer. Maybe it will get announced shortly.

    HOLI also reiterated that the special meeting requested by the activist shareholders will be held if the required threshold to call the meeting has been met. It is a bit strange, however, that they are taking so long to calculate the votes of the activist group.

    https://www.bamsec.com/filing/119312523248004?cik=1357450

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  3. HOLI’s privatization setup has finally started gaining some speed, and so far, everything is going according to plan. This week, the company announced a non-binding $25/share bid from its co-CEOs, matching the latest rumored $25.6/share price tag and the $25/share bid proposed by the Recco buyer consortium.

    Interestingly, the share price has barely moved, with the remaining spread still standing at 23%. After years of this disappointing privatization saga, the market is clearly fatigued and remains skeptical that any transaction will get carried through to the finish line. Nonetheless, I think the market is overly cautious here, and the outstanding spread seems too wide.

    Management’s offer came shortly after a large group of activists started pressuring the board into launching the sale process. The activists want to overhaul the board and are asking for a special meeting, which management must comply with given the group’s reported combined stake is above the 30% threshold..

    The recent announcement of the non-binding proposal also mentioned that on October 20, management received some updated materials regarding the special meeting. I don’t think management will have an easy time trying to wiggle out of this situation, especially when they also have another potential buyer lurking around with an identical offer price.

    The incentives to privatize the company and relist on a domestic stock exchange remain strong, given that HOLI trades at a steep valuation discount to its local peer, Zhejiang Supcon, listed in Shanghai.

    One nuance worth mentioning is that the non-binding offer came directly from the co-CEOs and did not include any other members/sponsors, despite multiple rumors previously mentioning various state-owned financiers interested in joining the consortium. However, it is quite common for other parties to join the buyer consortium only after the initial non-binding proposal, so maybe that’s what will happen here as well.

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    • I think it is co-COOs, not co-CEOs. Initially I assumed that the CEO was involved, but now I am not so sure. His name is not anywhere in the offer. It seems like this bid is designed to lure Recco out to make another bid so the CEO can swoop in at last minute with a slightly higher bid, after which management will quickly award the CEO the winning bid and sign a definitive agreement. It is really strange that the two COOs make a bid alone. But it would explain why there is no mention of how the bid is going to be financed.

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  4. New developments in HOLI privatization saga continue to pile in – see links above by Terence and jrallen. The stock continues to trade at a 20% spread to offer prices. After last week’s $25/share non-binding bid by management, the company announced that it has received multiple indications of interest from both financial and strategic buyers, other than the Recco consortium and the management team bids. According to the special committee, the sale process is at an advanced stage, and they expect to announce a preferred bidder by the end of December.

    Management also seems to have found a way to avoid calling special shareholder meeting that was requested by holders of more than 30% of shares. They are now disputing ownership by one of the shareholders in Hong Kong High court and the board decided to hold off calling the special meeting until after the court decided on the ownership matter (expected on November 21).

    Recco consortium and other shareholders quickly responded that any further delay in calling the meeting is unlawful and that the decision of the Hong Kong High Court has nothing to do with the British Virgin Islands jurisdiction where the company is incorporated.

    It looks like management is trying to get rid of all the other bidders and arrange a preferential deal for themselves. The market seems to be skeptical we will have any deal at all.

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  5. “Buyer Consortium Led by Recco Control Technology and Dazheng Group Increases Its Offer to Acquire Hollysys to US$26.50 Per Share”
    “Ascendent has publicly requested that the Board hold the special meeting by December 1, 2023. Shareholders holding 46% of the shares are now demanding that the Board convene the requested special meeting. “

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  6. HOLI privatization saga is turning into a bidding war with two new/improved bids announced this week. Chinese PE firm Ascendent Capital Partners became the largest HOLI shareholder amassing 13.7% stake and made a takeover proposal at $26/share. Shortly after, Recco consortium increased its bid from previous $25/share to $26.5/share. Management remains silent with the strategic review previously guided to wrap up at the beginning of December. The market stays cautious with HOLI trading at 19% spread to the currently highest $26.5/share offer.

    One interesting point is that Ascendent Capital Partners previously tried to acquire HOLI in 2021 in a consortium with the founder Changli Wang for $23/share. Wang wasn’t a part of HOLI’s management at the time, but he later resumed the CEO role and abruptly halted evaluation of all buyout proposals (see more background here and here). Ascendent’s reemergence as a lone bidder raises eyebrows, particularly considering the recent rumors that Wang himself is considering a privatization proposal for HOLI.

    Ascendent also supports the shareholder group, which aims to convene the special meeting and overhaul the board. Total combined ownership of the activists is now 46%. The board has implemented some delay tactics, yet it remains under material pressure not to screw up the ongoing sale process.

    Previous history of HOLI privatization saga suggests that management/Wang probably doesn’t want to sell the company to outsiders. Therefore, it’s quite strange that Wang hasn’t made the rumored privatization offer himself yet. If management eventually decides not to sell and keep the status quo, things could get messy as ousting a defensive Chinese management with hostile actions has so far proven to be very difficult (as previously illustrated by the unfortunate NTP saga).

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  7. This whole saga is so incredibly strange. First the rumours, then the bid by the 2 COO’s. Now Ascendant. If CEO really does not want to sell, why wouldn’t he fire his 2 COO’s for participating in the bidding war?

    Makes me think this is all a smoke screen, and Recco and a possible CEO bid are the two only serious bidders here. If this is true then CEO will probably come in late November with a $28-30 bid of his own, Ascendant (and maybe Recco?) joins him and the buyout is finalized as quickly as possible to prevent further bidders.

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    • That’s a pretty optimistic view and I hope it will play out along those lines. However, I’m worried about the lack of concrete action from the CEO, although he had all the time in the world to make a bid already and even reportedly secured financing. Yet we’ve heard nothing from him so far, while even the COO’s somehow managed to present an offer. Maybe it’s all a smoke screen as you say, but I’m starting to worry its purpose might be to deflect attention from the special meeting process, etc. instead of just finalizing a serious management buyout.

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      • What would in case be the intention/end goal of deflecting attention from the process?

      • Management might simply be interested in keeping their jobs/empire instead of ‘selling out’ to Recco & Co or being outvoted in the special meeting that the activists are trying very hard to push.

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      • There is an incentive to get your bid in last. By bidding early other bidders will have to bid higher to get a potential winning bid in. And you have to bid twice to get your own winning bid in (at a higher price).

        There seems to be a deadline of early December set:

        https://www.sec.gov/Archives/edgar/data/1357450/000119312523265652/d560460dex991.htm

        “The sale process is targeted to be at an advanced stage, with a preferred bidder identified, as soon as early December.”

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  8. Several positive updates from HOLI. The board has caved under shareholder pressure and confirmed that the required 30% threshold to hold the requested special meeting has been met. The meeting to vote on the increased the board size (from 5 to 11) and addition of six directors put forward by activists will be held during the week commencing January 22. Record date is set to November 27.

    HOLI also said that the sale process is progressing well with certain bidders proceeding to confirmatory due diligence and negotiating definitive agreements. The company expects to be in a position to execute merger agreement by mid-December.

    Spread to Recco consortium’s $26.5/share offer stands at 18%.

    The company has also released pretty strong FYQ1 (ending September) results with revenue up by 18%, operating income up by 2x, and net income up by 48% YoY.

    Meeting/sale update – https://www.bamsec.com/filing/119312523282314?cik=1357450
    FYQ1 earnings – https://www.bamsec.com/filing/119312523277966?cik=1357450

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  9. Couple more developments on HOLI front:

    – On Nov 24, Ascendent Capital Partners, one of the bidders and the largest shareholder (owns nearly 14%), filed an amended 13D. They entered into a confidentiality agreement with HOLI potentially indicating ongoing due diligence / negotiations. This agreement also contained standstill provision, limiting Ascendent’s ownership to not more than 15%.

    – On Nov 27, Recco Consortium reiterated the $26.5/share offer and raised concerns that HOLI’s management is planning the special meeting in January while the merger agreement is expected to be executed by mid-December. Recco calls for a special meeting to be held before any binding agreement is reached.

    Furthermore, as the leading bidder for Hollysys with a bid of $26.50 per share, we have to wonder if the Board is, at the expense of shareholders, seeking once again to create a situation that is more favorable for a management buyout rather than supporting a higher third party bid. Any attempt by the Board to prematurely seal a deal potentially undermines the maximization of shareholder value.

    Hard to guess what is actually happenings behind the curtains but it seems management is trying very hard to sideline Recco Consortium. Ascendent’s offer might be a sideshow that will later fold into buyout by management at a lower price. The confidentially agreement with Ascendent and continued ignoring of Recco seem very suspicious.

    As a quick reminder, three parties have expressed their intent to acquire HOLI:
    – The management team representatives offered $25 per share (9% spread).
    – Ascendent Capital Partners offered $26 per share (13% spread).
    – Recco Consortium increased the offer from $25 to $26.5 per share (15% spread).

    Link to Ascendent’s filing: https://www.bamsec.com/filing/110465923121009?cik=1357450
    Link to Recco’s filing: https://www.businesswire.com/news/home/20231127866994/en/Buyer-Consortium-Led-by-Recco-Control-Technology-and-Dazheng-Group-Issues-Statement-on-Hollysys’-Announced-Special-Meeting

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  10. Buyout at $26.50. Trading at 24.50 now, 8% upside, subject to shareholder and regulatory approvals.

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      • No info on the expected closing date, but I assume it will take at least a few months, given the required shareholder and regulatory approvals. As the agreed price is in line with the updated Recco’s bid, I assume they won’t be able to object much.

        The case has largely played out and HOLI is up 31% since this pitch was posted 3.5 months ago.

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  11. As was rumored, Recco’s consortium submitted an offer to buy HOLI at $29/share, 9.4% higher than the offer made by Ascendent Capital.

    Then several days later, on December 27, the company announced the end of the go-shop period. Management also stated that, despite several offers during the go-shop, none of them have been fully financed; therefore, they are sticking with the Ascendent’s bid. The termination fee stands at $33 million.

    At this point, it’s tough to say if there were any tangible reasons to reject Recco’s bid or if management simply continues to ignore Recco and wants only to sell to a preferred buyer.

    Recco consortium bid: https://finance.yahoo.com/news/1-dazheng-group-consortium-announces-203340310.html

    Go shop end: https://www.bamsec.com/filing/119312523303425?cik=1357450

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  12. HOLI posted a proxy for the merger vote and the meeting is set for 8th of February.

    The proxy includes a very extensive background of the merger and all the ongoing negotiations with various parties, especially during the final stages in December. The board / legal team appears to be putting all efforts into showing that they had clear reasons to accept a lower $26.5/share bid, when two higher offers ($29/share and $30/share) were on the table. Reading this background, it seems that Recco’s (later renamed Dazheng) offer really lacked certainty/clarity on funding. This is the final detail on funding that was received by HOLI from Recco:

    “On December 29, 2023, representatives of S&C sent an email to representatives of Davis Polk in relation to the proposal by the Dazheng Consortium, enclosing a draft equity commitment letter contemplated to be signed by a TFI entity and an executed equity commitment letter by an investor for a contemplated back-to-back equity commitment by such investor to the Dazheng SPV to support Dazheng SPV’s equity commitment to Merger Sub. The equity capital to be provided by such back-to-back investor would constitute more than a majority of the equity funding for the Dazheng Consortium, but it was not previously named as a member or funder of the Dazheng Consortium or disclosed as such to the Special Committee or in public disclosure made by the Dazheng Consortium. The email also included certain introductory materials for each of TFI and such back-to-back investor and on certain affiliates of such entities. Representatives of Davis Polk reported to the Special Committee regarding the email and the materials received from representatives of S&C.

    On December 30, 2023, representatives of Davis Polk and Deutsche Bank had a call with representatives of S&C and UBS to clarify terms and conditions of the proposal by the Dazheng Consortium. On December 31, 2023, representatives of Deutsche Bank reported the call to the Special Committee, noting that there continued to be insufficient information as to the Dazheng Consortium’s financing sources and certainty, and in particular, insufficient information on the structure of the consortium and in connection therewith the financial substance of the entities that would provide equity commitment and the uncertainty relating to the required regulatory approvals to consummate the proposed acquisition. After careful consideration, the Special Committee remained of the view that the Dazheng Consortium’s proposal did not constitute and would not reasonably be expected to result in a Superior Proposal.”

    I think the disclosure of this background info, removes any hopes the market might have had for a further overbid. The merger is likely to be approved in February.

    https://www.bamsec.com/filing/119312524002939?cik=1357450

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  13. EGM due February 8 to vote on Ascendent’s $26.5/share bid. Spread stands at 4.5%. Assuming shareholder approval, which seems likely, and the absence of regulatory hurdles (I think this is the main reason for the spread), the deal is anticipated to be finalized in Q1. Management seems to be fully backing this offer by saying that it has “committed financing and high closing certainty”.

    https://www.bamsec.com/filing/119312524011749?cik=1357450

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  14. I think HOLI buyout setup is interesting again – this time as a short-term play on shareholder vote results on Feb 8. Assuming my prediction about the share price’s reaction to approval/rejection is accurate, this situation resembles a classic “heads I win, tails I don’t lose” scenario with a short timeframe.

    Next week shareholders are set to vote on Ascendent’s $26.5/share bid. The stock currently trades at $25.15, or a 5% spread to the offer price. However, this buyout has received pushback not only from some other interested parties, but also from proxy firms ISS and Glass Lewis, which recommended voting against Ascendent’s offer, calling the sale process “rushed,” “flawed,” and lacking in “price maximization efforts”. Subsequently, the competing buyer group led by Recco has raised its bid from $29/share to $29.5/share, complaining, that the sale process was disingenuous and unjust, and calling shareholders to block Ascendent’s offer in the upcoming meeting. Despite this pressure, HOLI’s board remains steadfast in its support for Ascendent’s offer, citing concerns about Recco’s own financing structure.

    So there is a non-zero chance that Ascendent’s buyout at $26.5 will fail. I would expect HOLI shares to jump above the offer price upon rejection. Management would have to start dealing with the activist shareholder group which at the end of last year was pressuring the company to accept higher bids or reshuffle the board (management had even scheduled a special shareholder meeting for Jan’24 to vote on the board – this meeting later became void due to the signed definitive agreement). The two other offers on the table are $30/share from an undisclosed buyer and $29.5/share from Recco.

    And if shareholders approve Ascenden’t offer, HOLI shares will likely stay flat to reflect some remaining uncertainty until closing, which is expected to happen in Q1’24. I believe the deal will ultimately be completed, resulting in a 5% gain over the next couple of months. Ascendent is a Chinese PE firm with $2.5bn AUM and owns 14% of HOLI. Financing is already secured (including debt commitments from state-backed banks). Regulatory approvals are unlikely to be an issue. While Ascendent does have a few holdings in rail components/control systems companies, those are relatively small and management sounds pretty confident about securing regulatory consent. Aside from the extended timeline and volatility of HOLI’s acquisition saga (it has taken 3 years already!) there do not seem any strong reasons to think that the buyout by Ascendent would fall through after it gets approved by shareholders.

    However, it’s a bit curious that the shareholder activist group holding 30%+ of shares (note: Ascendent had also been part of this group earlier, bringing the total vote count to 46% at the time) hasn’t voiced its opinion yet. This group had been pushing management to start the sale process or convene a special shareholder meeting, The silence might indicate these shareholders intend to support Ascendent’s offer without prolonging this saga any further. Although I’m not sure why would that be the case and why wouldn’t they want to push for a further 12% premium, especially when interested bidders are lined up. Maybe there are some wildcard risks involved in dealing with this hostile management and the activist group is simply happy with the $26.5 offer. Blocking the transaction could extend this saga once again, so I might be missing some important dynamics in the current setup. Look forward to seeing how the vote goes next week.

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      • Interestingly Dazheng also claims to have committed financing from the same bank as Ascendent:

        “The Consortium’s offer has enhanced closing certainty relative to the Ascendent offer and is backed by financing above industry standards,” the buyer group said in the statement. “The Consortium has secured a debt commitment letter for US$1.05 billion from a reputable PRC-headquartered bank’s Hong Kong branch, which is the same bank that issued a debt commitment letter to Ascendent Capital.”

        And I do not think it is too late ‘to sway the vote’. Just yesterday Ascendent issued an additional press release with a very high number of buzz words trying to convince shareholders to vote for the $26.5 offer. So the outcome of the vote on Thursday does not seem to be guaranteed:

        “Our proposal is the only viable offer, because of price, clarity, certainty of financing, and the collective reputation and experience of Ascendent and our equity partners
        <...>
        However, after we engaged with the Special Committee in its recent sale process, its independence, professionalism and focus on shareholder value were apparent. The quality, reputation and background of the Special Committee members underpinned our confidence in the integrity and transparency of the sale process. After an extensive, thorough, and robust negotiation process
        <...>
        The increasingly desperate allegations by other parties serve only to create uncertainty and mislead shareholders, distracting them from the concrete offer recommended by the Board that provides clarity, cash, and the most certain path to closing a sale.
        <...>
        As we approach the extraordinary general meeting on February 8th, in an environment of weakening market conditions and geopolitical uncertainty, let’s focus on the clear benefits of the Ascendent offer: all cash offer from reputable and seasoned investors, significant price premium, and highest certainty to close.”

        https://www.bamsec.com/filing/110465924010381/2?cik=1357450

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      • This should be interesting. It’s strange to me that if Dazheng were capable of getting USD financing, signing NDAs etc, which they eventually did, why play the sort of games that they are, risking losing the deal entirely if the vote goes Ascendent’s way?

      • Could you clarify what “games” do you have in mind?

      • Waiting till the last minute to agree to request like NDAs and getting USD financing when you know that that is important to complete a US listed deal and when your competitor in the bidding already has USD financing.

    • Dissent seems like the only potential risk left on the table. That said, PR states that condition can be waived.

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    • Ascendent’s bid passed with 87% support from the voting shareholders. My comment on Feb 2 stipulating that shareholders will object and force management to consider other bidders, was clearly off. I did not expect such overwhelming support for Ascendent’s $26.5 offer.

      The remaining spread is only 3%, I do not think it is worth the wait and I have closed the position. Finally, this saga is over.

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  15. Price has been steady at high 25+, but dropped to 25.50 last Friday with big volume. No news.

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    • Think it might be because they released their quarterly results the previous day AH that were less than stellar. Not sure what else it would be.

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