Hollysys Undervalued Ahead Of Going Private, But Risks Remain

seekingalpha06-20

Shareholders voted in favor of a buyout offer from Ascendent and the CEO, but the shares trade below the offer price and there is no announced closing date.Current operating conditions in China are ...

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Management did not offer a closing date then, nor have they done so subsequently as best I can tell. Given the complexities of overlapping legal jurisdictions , I’m not surprised it’s taking some time to close the deal. In my experience it usually takes around three to four months to close a deal after a vote, and we’ve only just exceeded four months now . Still, I would note that management noted in the release of the shareholder vote result that given that shareholders representing 10% or more of the shares had not withdrawn their dissent,","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"SIEGY":"西门子","SG9999003800.SGD":"Nikko AM Global Dividend Equity Acc SGD-H","HON":"霍尼韦尔","YASKY":"Yaskawa Electric Corp.","ABBNY":"ABB Ltd.","BK4161":"工业机械","BK4534":"瑞士信贷持仓","EMR":"艾默生电气","SG9999011175.SGD":"Nikko AM Global Dividend Equity Dis SGD-H","BK4585":"ETF&股票定投概念","BK4157":"电子设备和仪器","FANUY":"发那科","BK4533":"AQR资本管理(全球第二大对冲基金)","BK4206":"工业集团企业","BK4550":"红杉资本持仓","BK4588":"碎股","IE00B1BXHZ80.USD":"Legg Mason ClearBridge - US Appreciation A Acc USD","IE0034235188.USD":"PINEBRIDGE GLOBAL FOCUS EQUITY \"A\" (USD) ACC","LU0315179316.USD":"EASTSPRING INVESTMENTS ASIAN DYNAMIC \"A\" (USD) ACC","HOLI":"和利时自动化","BK4096":"电气部件与设备","BK4580":"工业 4.0"},"translate_title":"和利时私有化前估值被低估，但风险依然存在","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"EMR":1,"YASKY":1,"SIEGY":1,"HON":1,"HOLI":1,"FANUY":1,"ABBNY":1},"content_text":"Shareholders voted in favor of a buyout offer from Ascendent and the CEO, but the shares trade below the offer price and there is no announced closing date.Current operating conditions in China are challenging for industrial automation companies, with many clients leering of committing to large capex projects amid economic turbulence.If the deal fails to close, I expect the shares to sell off sharply on assumptions that it means operating conditions have materially worsened for HollySys.I do see near-term risks from weaker industrial automation and rail infrastructure markets in China, but believe the fundamentals can support a mid-$20's standalone price long term.   simonkr/E+ via Getty ImagesThe long, strange, and often frustrating odyssey of HollySys Automation Technologies (NASDAQ:HOLI) may be nearing its end … or maybe not. Given the history of this company and the bad-to-inconsistent track record of communicating with shareholders, it’s hard to say for sure. I can say that shareholders voted strongly in favor of a buyout offer from a company led by the CEO and that the shares currently trade about 20% below the offer price. At the same time, though, the company has not provided any definitive closing date and the CEO recently sold a meaningful chunk of his personal holdings at a price below the offer price. I’d also note that current operating conditions in China are challenging for industrial automation companies, with Western companies like ABB (OTCPK:ABBNY) and Siemens (OTCPK:SIEGY) warning of destocking and hesitancy to commit to new projects and Chinese players posting very erratic results (some showing healthy growth, others showing real weakness). Considering all of the above, I’m not inclined to step in and risk capital to win that remaining $5/share or so that will come if the go-private deal closes. I’m not expecting the buyers to abandon the deal, but I can’t rule it out, and a deal collapse could leave investors exposed to a shakier capex environment in China, no visibility on a potential replacement M&A offer, and even less reason to trust company management. Will The Deal Close? Probably … Maybe?  HollySys announced in early February that a large majority of shareholders who voted on the $26.50/share go-private offer from Ascendent voted in favor of the deal (87% in favor of 77% who voted). Management did not offer a closing date then, nor have they done so subsequently as best I can tell. Given the complexities of overlapping legal jurisdictions (namely China and the British Virgin Islands), I’m not surprised it’s taking some time to close the deal. In my experience it usually takes around three to four months to close a deal after a vote, and we’ve only just exceeded four months now (and again, this could be a more complex deal to close). Still, I would note that management noted in the release of the shareholder vote result that given that shareholders representing 10% or more of the shares had not withdrawn their dissent, the buyers could either waive that as a condition of closing the deal or elect not to complete the deal. In other words, there’s an escape hatch available if the buyers get cold feet. Will they get cold feet? I can say that the current environment for industrial automation in China is not great, but recent results from HollySys haven’t been terrible (revenue was up 4% year over year and down about 13% sequentially for the Industrial Automation business in the March quarter) and HollySys has ample cash on its balance sheet to weather a downturn. On the other hand, it seems a little strange that the CEO (whose is part of the buyer consortium) would sell close to $24M worth of his holdings (about 20% of the total) so close to the close of the deal. The press release about the sale mentioned “personal financial planning needs” and … well, fair enough. We don’t always have the luxury of making financial moves at the optimal time, but it’s still a little strange to think that he was willing to leave $4M on the table and couldn’t find other alternatives. Then again, it’s much easier to sell the shares of a relatively liquid publicly-traded company than to monetize a stake in a privately-held company, so perhaps this was the best chance to generate some personal liquidity ahead of deal close. What Happens If The Deal Fails? If the deal goes through, investors have little to do or worry about – they’ll get their $26.50/share and then need to reinvest that cash. If the deal falls apart, the situation gets more complicated. If the Ascendent, et al elect not to complete the deal, I definitely expect an adverse reaction in the market as investors will almost certainly assume that something is wrong with the business such that they didn’t want to go ahead with the offer. That may not necessarily be true, as there could be issues related to financing and so on that may have little to do with the company. In any case, if the deal falls through, I wouldn’t necessarily assume that another offer will fill the breach. A group led by Dazheng made an offer of $29/share and reiterated their commitment ahead of the shareholder vote, but management was not really willing to engage constructively with Dazheng. HollySys management claimed that there were significant concerns about Dazheng’s ability to finance and close the deal, but Dazheng and both Institutional Shareholder Services and Glass Lewis countered that Dazheng was held to an unfair and arbitrarily stringent standard, with the implication (at least to me) that the board was giving Ascendent and its CEO a “sweetheart deal” by freezing out Dazheng and going with the lower Ascendent offer. If the Ascendent deal falls apart, I have no idea if Dazheng will step up at the same price, and/or find a more welcome reception from the board and shareholders. I’d note that in the past there were various buyout offers that offered a premium to shareholders, but the board elected to stop entertaining offers (and that held true for close to two years), so I have no idea if a credible offer from a completely independent buyer will get a fair shake or not. Challenging Conditions Today, But A Trend in HollySys’s Favor If the deal falls apart and HollySys remains independent, what then? In the near term, that’s not a great outcome. Many automation companies that do business in China (including ABB, Fanuc (OTCPK:FANUY), Siemens, and Yaskawa (YASKY)) have talked about operating conditions that are still quite weak, and it seems as though there’s growing caution regarding spending on capex (industrial automation included) in many industries. For HollySys, that caution has yet to really show up in the numbers. While March quarter IA revenue was down 13% sequentially, new orders nearly tripled and the backlog rose 12% sequentially; while it’s absolutely not an apples-to-apples comparison, not many industrial capital equipment companies showed strong backlog growth in the March quarter of this year. A few things are possible. It’s possible that HollySys has yet to see the same weakness in their numbers, but that it’s coming (and it’ll show up in the next earnings reports). It’s also possible that the company is small enough and has enough organic growth opportunities (particularly in replacing Western automation providers with large Chinese clients in the energy, resources, and manufacturing sectors) to grow despite the weak macro backdrop. It’s also possible that this is just a lot of transitory “noise” and that the Chinese market will be on better footing heading into 2025. In any case, while the outlook over the next six to 18 months is cloudy, I like the long-term opportunity for HollySys within China’s growing industrial automation market. The company has proved to be a credible supplier of a range of automation systems, including distributed control systems (or DCS), manufacturing execution systems (or MES), safety instrumentation systems (or SIS), and so on. The company hasn’t had quite the same success in discrete automation (programmable logic controllers), but there is evidence that HollySys has taken some share from companies like ABB, Emerson (EMR), and Honeywell (HON). I’d also note that HollySys’s legacy is built on automation, control, and safety systems for power plants, including nuclear plants. Say what you will about China and its government, but they don’t really have a track record of playing fast and loose with sectors they see as vital to their growth targets (and reliable power is a pretty fundamental need). I have less to say about HollySys’s Rail business mostly because it has long been, and likely will always remain, a more volatile and hard to model business. HollySys has lost share in areas like automatic train protection and train control systems, and that has been exacerbated by volatile order patterns. Given budget challenges in many localities in China, I’m actually more worried about this business over the next 12-18 months, as I see an elevated risk of project and order pushouts or cancellations. The Outlook Should HollySys somehow remain independent, I think mid-single-digit long-term revenue growth and low double-digit free cash flow margins can support a fair value in the mid-$20’s, and that includes the roughly $10/share in cash on the balance sheet. While readers often make a big deal about this large cash balance, it’s important to note that repatriating this cash is very difficult – China hasn’t gotten in the way of any dividend payments, but has in the past objected to repatriations meant to fund ex-China M&A. All told, I think the pending deal for HollySys is a reasonable one that gives shareholders a respectable price relative to the risks (including management execution and shareholder communication). Were the deal to fail, I think the fundamentals of the business would eventually support a recovery in the share price, but it would take some time. The Bottom Line As I said in prior articles on HollySys, I don’t like to mess with companies with shaky track records regarding shareholder communications and where there may be overly cozy relationships between the board and key executives/shareholders. That’s my preference and yours may be different. I’m happy to see what looks like a positive outcome for shareholders on the horizon, but I don’t feel the need to make a trading play here on the difference between the deal price and current share price, as I just don’t want to deal with the hassles of the bear case scenario.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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