Ryoyo Electro (JP:8068): Anatomy of a Hostile Takeover Battle that Has Gone Awry

Introduction

The stock was first mentioned on the blog in March 2012 at a price of 944 Yen as a deep value idea.

Little did I know that this simple deep value investment would turn out being a full- blown fight over corporate control between two Japanese companies.

On August 31st I got a poisoned birthday present. Ryoyo announced that it would buy back roughly 27% of its shares at 2’990 Yen via a Tender Offer. The repurchase amount is ¥22 billion, exactly the entire cash at hand as of Q2 2020.

The Journey

The investment faced a rocky start, with huge price swings in 2012- Volatility abated a little in 2013, but the stock was not really moving, and the yen depreciation severely depressed the performance in Euro terms.

Operationally everything went smoothly. Although, profitability remained low the company was not burning any cash and NCAV remained stable. The price action started to enter and establish a longer- term raising trend sparkled with some severe short-term draw downs. The company kept on buying back its shares at favorable terms, albeit in an annoyingly low quantity. Dividends were not increased.

In the middle of my holding period, around 2015-2016, news wise things turned interesting. An activist called Simplex Asset Management built up a significant stake in the company reaching 20% of the outstanding shares at the peak. Along with the buildup of shareholdings by Simplex the company took a more liberal stance regarding distribution to shareholders. For the foreseeable future it was paying out 100% of net income.

Then in March 2019 the bomb shell. Simplex sold its entire holding to Restar Corporation (JP:3156). another Japanese semiconductor and electronics trading boutique.

Apparently, Ryoyo was taken by surprise and the management caught with its panties down with this unsolicited and obviously hostile approach by Restar. It responded by hastily introducing an even more liberal shareholder return policy based on dividend on equity (DOE). It promised its shareholders that 3% of net- assets would be cashed out in dividends in the foreseeable future, resulting in a significant dividend increase.

During the corona crisis and the subsequent sell off in Ryoyo’s stock Restar loaded up on the share. Making it plain clear to Ryoyo’s management that Restar’s management was d serious about taking over the company. Ryoyo responded by increasing the DOE rate to a whopping 5%, more than doubling the dividend in the blink of an eye. Suddenly the stock yielded over 10% enticing market participants buying massively into the situation. In the following months, the stock rose almost 100%. Apparently, too much for Restar going through with the takeover attempt.

The Outcome

Abovementioned on August 31st Ryoyo announced a partial tender offer for its shares at 2’990 Yen. The quantity of this partial TOB roughly matches Restar’s shareholding (27%) in the company. Restar agreed to tender all its shares.

This smells a lot like greenmailing Murakami style. I am much kinder to Restar as I am under the impression that the company was seriously considering taking over Ryoyo.

I am less kind to Ryoyo’s management fending off Restar’s approach. Firstly, because I view consolidation in this overcrowded segment of the Japanese corporate landscape, with its painfully meager rentability, as urgent and warranted.

Furthermore, Ryoyo’s management handled the unsolicited approach by Restar unprofessionally. Jazzing up the value of the company to an elevated EV (excl. Investments)/ Nopat of 24 is a good thing for shareholders when the management is intending to accept the take-over eventually. But buying back the shares at insane valuation levels that only came about by the very short- term action the management has taken to fend off a hostile takeover is sheer madness! Ryoyo’s management has totally lost its mind. All under the disguise of increasing capital efficiency, A subject, if had been tackled before would have prevented the management finding themselves in this awkward situation.

With this massive stock repurchase Ryoyo’s management is not only hurting remaining shareholders and severely weakening the company’s financial standing as the entire cash balance will be depleted to finance the repurchase.

Why I sold the shares roughly 10% below TOB offer?

Basically, because the TOB offer by Ryoyo’s management is a lottery ticket. I fear that the tendered shares will be significantly higher than 27%. Thus, I will not be able to unload all my shares into the TOB.

Furthermore, the corporate action is severely impairing value for remaining shareholders.

Regarding shareholder value destruction the picture at Ryoyo and the imminent corporate action is the following:




As of Q2 2020 Ryoyo had an NCAV (inc. Investments) of 2’208 Yen per share on its balance sheet.



After the transaction the NCAV (incl. Investments) will immediately shrink to 1’855 Yen per share.

So I made up following calculation: Successrate of tendering shares into the Tob at 2’990 Yen (=0,5) + worst case scenario at which reaming shares (=0,5) can be unloaded on the open market.

= 0,5*2’990 + 0,5*1’855 = 2’ 422 Yen

Given that 2’683 Yen > 2’422 Yen, I reasoned it was rational to sell out even at a discount to the partial TOB offer.