Hollysys automation
This is not the promised special situation write-up, I am still buying shares in that one.
I thought Hollysys (HOLI) deserves its own write-up. I first mentioned this stock in October last year at ~$15/share and have kept a small position in it all this time. And have recently ramped up my position to almost 14% of my portfolio. I think it’s very likely HOLI will be taken out in the next few months for $26-29 vs the current share price of just over $17. 70% of the market cap is in net cash by now and the stock trades at about 8x forward earnings. Backlog is $900 million vs previous backlogs of around $600 million in 2019-2021.
I think the market perceives this as not happening since there has been no official communication by the company about the $29 bid that was made last year. And all the previous bids have failed as well. So the market is now very sceptical, which I think is unwarranted as I will explain below.
There have been multiple parties who made a bid for the company at a significantly premium to the current share price after the former CEO made two lowball bids:
Then Changli Wang came back to lead the company and put an end to the bidding war. I think what may have happened is that the previous CEO underinvested in the business as capex was significantly lower than D&A:
As soon as Wang got the lead, capex spending was ramped up. As well as R&D spending. This under investment coincided with declining margins as EBIT margins collapsed from a peak of 23% in 2019 to 12% in LTM. As well as slowing revenue growth. One of the stated goals of the new CEO was to restore margins.
Then:
Despite the bidding war being shut down by Wang, there was a rumour that Beijing’s state owned rail and subway company was considering a bid for $31/share. But this did not materialise.
Finally last month there was a news release with more info based on 4 sources. Maybe I am reading too much into that, but I find it quite credible. According to those sources the buyout will happen at $1.6 billion ($26/share) by company management and CITIC (a Chinese state owned conglomerate) somewhere in Q3 this year. Where management will own a majority of the shares after the merger. Followed by an IPO on the Shanghai stock exchange in H1 2024.
So what is the market seeing here? Accumulated failure to take this private and poor communication.
What am I seeing? A bidding war where Changli Wang along with CITIC has come out as a winner. And also poor communication.
If he is not serious, why would he make 2 offers and buy 1 million shares on the open market? The incentives are perfectly aligned here to make a deal happen. The founder can make a nice profit by uplisting this in Shanghai where competitor Zhejiang Supcon trades at 50x LTM earnings (vs 10x EV/earnings for HOLI at $26/share). The Chinese government probably wants this company listed in China and not in the US for many different reasons. Western investors will probably not see this trade for more than $26/share any time soon, so they will accept the offer. As they probably have little leverage to force the CEO into an auction. So why would this merger not happen? Especially given recent news? It makes no sense to me that the spread is as wide as it is.
And downside is minimal with their fat order book. I think if this offer fails, another offer might materialise from one of the other parties. Either way HOLI is expected to grow revenue in the double digits and earn about $1.8/share in 2024 (with fiscal year ending in June). In the last 10 years the mean LTM earnings multiple was around 12x, with the occasional dips to 6-8x earnings. Which would imply a base case of about $14-17/share if nothing materialises. Or roughly where the shares traded before the CEO made his $29 bid last year. The market prices the probability of this deal happening at around 10-20%. I think the odds are closer to 70-80%.
Ironically deteriorating margins in the quarters before a Chinese merger gets a definitive agreement can be a sign it will close soon. As HOLI’s latest quarter wasn’t great. While Q3 was exceptional. Which I found a bit suspicious. I saw a similar pattern with 51Job.
I think the best course of action is holding this throughout 2023, and then start opportunistically selling it in December if the price is right and be out of the stock in 2024 if nothing happens.
For the above reasons I am long HOLI at ~$17/share.
It is advisable to do your own due diligence since this is a Chinese stock. I may sell or buy my shares at any time.
This is old, but should be read. http://brontecapital.blogspot.com/2011/07/hollysys-blog-post-inspired-by-railway.html
This reads even worse than Magnachip (MX).