HONG KONG--(BUSINESS WIRE)--Oasis Management Company Ltd. (“Oasis”) is the manager to funds that beneficially own 9.9% of Alpine Electronics Inc. (TYO:6816) (“Alpine” or the “Company”), making Oasis the Company’s largest shareholder after Alpine’s parent company, Alps Electric Co., Ltd. (TYO:6770) (“Alps”).
On May 9, 2018, Alpine released an announcement opposing Oasis’s shareholder proposals to be voted on at the AGM on June 21. Far from being persuasive, the announcement by Alpine provided further evidence that supports Oasis’s position and proposals, and underscores that Alps and Alpine must revise the Share Exchange Ratio.
In fact, yesterday Institutional Shareholder Services (“ISS”) published its analysis and vote recommendations on the Oasis proposals, and has effectively agreed in principle with Oasis’s position on this matter, and specifically, has recommended voting in favor of Oasis’s dividend proposal and in favor of one of Oasis’s proposed independent directors. We are very pleased to see ISS’s analysis and conclusions, and believe that it should be meaningful and persuasive to shareholders when considering how to vote on these important issues.
Oasis reiterates that Alpine shareholders must vote for the Oasis proposals to protect their shareholder rights.
At the current Share Exchange Ratio proposed by Alps and Alpine, Alpine is being acquired at just 0.8x book value, which is illogical considering that it beat its operating forecasts by 111% this year and is expected to continue to grow strongly. Absolutely no value is being ascribed to Alpine’s excellent business, let alone the full value of the assets. This represents an acquisition price of just 1.8x Adjusted EV/EBITDA.
Setting the Record Straight
(1) Dividend Proposal
Alpine explains in its May 9 announcement that it opposes Oasis’s proposal for an increased dividend, citing its capital policies and a requirement to hold cash. We note that working capital can be financed by working capital lines (which Alpine has but has not used) and debt (which Alpine can easily raise) and does not require a net cash position. Alpine’s arguments for its cash balance are false and insincere:
|A.||Alpine claims it needs JPY35 billion to JPY46 billion of cash in hand for working capital, citing “current corporate finance theory.” However, contrary to Alpine’s assertions, current corporate finance theory, per Professor Nishiyama of Waseda University, and based on leading scholars and practitioners in published papers, as well as a survey of manufacturing companies in Japan, finds that either all cash is simply treated as non-operating cash, or only cash amounting to between 0.5% and 3% of revenue is to be considered operating cash. In Alpine’s case, this amounts to between JPY1.5 billion and JPY8.9 billion – well below the JPY35 billion to JPY46 billion claimed.|
|B.||Alpine argues that its global presence requires that its international subsidiaries hold certain deposits of cash. This working capital can be financed through Alpine’s undrawn working capital lines. Additionally, if necessary, Alpine could easily finance the debt by selling off part of its investment securities.|
|C.||Alpine claims it needs the cash to “pay dividends and taxes and be ready for responding to troubles and other issues, which is unique to the automotive industry”. Yet, despite its net income outperforming the prior year by 20% and the original forecast by 1,066%, Alpine did not increase its dividend, which amounts to only JPY2.1 billion. Taxes will be paid by operating cash flow. The cash for troubles unique to the automotive industry is nonsensical; the three comparable companies selected by SMBC Nikko for the valuation analysis -- Pioneer, Clarion and JVC Kenwood -- are all operating on a net debt basis. Alpine is unique in unnecessarily maintaining too much cash.|
|D.||Alpine insists that it is important to demonstrate its good financial standing to automobile manufacturers. Yet, many companies with OEM businesses operate with debt, including the three comparable companies selected for the valuation analysis mentioned above, along with Continental AG, Valeo SA and Magna International. Alpine could easily raise debt to replace the cash paid out as a dividend without any negative impact on its business. Oasis would be happy to provide a 5-year JPY30 billion bond at a 1% interest rate to provide that capital.|
|E.||Alpine also claims it needs at least JPY10 billion for M&A. Alpine could use debt to finance any M&A, or use the ample securities on its balance sheet.|
(2) Dividend Proposal & the Unfair Share Exchange Ratio
Alpine claims that the proposed Share Exchange Ratio is fair; therefore, the proposed dividend is unnecessary. This could not be further from the truth.
To be clear, the Share Exchange Ratio is unfair, and has been determined unfairly:
- The merger was announced with the longest lead time from announcement date to proposed completion date for a merger in recent Japanese history. It appears that this was engineered to avoid including an increase in market price in the valuation. Only Alps and Alpine were aware that after two years of disappointing, lackluster growth, Alpine was about to launch into a period of spectacular high growth. Had investors been aware of these great expectations, then the stock price would have been significantly higher. This would have dramatically increased the Historical Price Ratio and the valuation of Alpine.
- Alps’ disappointing, poor performance in its main business lines has meant that the Share Exchange Ratio has capped Alpine’s stock price at a low value. By contrast, Alpine beat its original operating profit forecasts by 111%. Had Alpine’s stock been able to trade freely, the stock price would be significantly higher today, and Alps would have to pay substantially more to minority shareholders.
The valuation carried out by SMBC Nikko Securities was fundamentally
flawed, and, we believe, biased to result in a low merger ratio. A
fair value opinion from BVCJ, an independent valuation expert, prior
to the revision upwards in Q3 and the strong beat in Q4, valued
Alpine’s shares at JPY4,943 on a DCF basis and between JPY3,516 and
JPY6,734 per share on a comparable companies basis. Following the
additional revisions upwards we expect the valuation to be
significantly higher. Flaws in SMBC Nikko’s valuation include:
- SMBC Nikko employed the historical market price as part of its valuation, which clearly undervalues Alpine, as the stock price did not have an opportunity to react to the 111% increase in operating profit in FY18 and higher growth in FY19 and FY20.
- SMBC Nikko selected comparable companies that were trading at low multiples, and that are all their either loss-making or pursing substantial restructuring of their product portfolios. These unfair comparisons reduced the valuation, both in the comparable companies analysis and the Discounted Cash Flow (“DCF”) EBITDA multiple method valuation. If there are no good comparable companies, then this analysis should be excluded.
There is limited disclosure around the DCF valuation, but some
points to make:
- The calculations must be repeated in light of Alpine’s continued outperformance and Alps’ underperformance.
- JPY30 billion was wrongly removed from the valuation.
- SMBC Nikko employs an inappropriately short projection period with high growth, which is then suddenly reduced to zero; they should use a longer projection period.
- We question what other assets have been excluded from the DCF valuation.
- The discount rate of 7.8-8.8% is far too high – and has a large impact on the valuation.
a. Unfairness of the Share Exchange Ratio & Revisions to Financial Forecasts
Alpine says it does not need to renegotiate the Share Exchange Ratio in light of its outperformance and significant upward revisions to forecasts, and Alps’ reduced forecasts for next year. This raises serious concerns about the independence and credibility of its management, board of directors, Third-party Committee and SMBC Nikko Securities, its valuation advisor.
Alpine has completely ignored the fact that they did not just revise up guidance twice, but easily beat the twice-revised guidance. Any truly independent Third-party Committee would surely demand a price revision following Alpine beating its original operating profit forecast used in SMBC Nikko’s model by 111%. The Share Exchange Ratio should also be amended because Alps has reduced its operating forecasts for next year by 17%, raising serious questions about the valuation it was given in the SMBC Nikko model, particularly in light of the unexpected slowdown in Alps’ smartphone business.
b. Unfairness of the Share Exchange Ratio & “Operating Cash”
Alpine claims that Oasis’s main argument for the unfairness of the Share Exchange Ratio is the JPY30 billion of cash that Alpine has arbitrarily allocated to operating expense.
We believe that Alpine is worth in excess of JPY4,000 per share, compared to the current value of JPY1,790. The JPY30 billion translates into just JPY400 per share. To be clear: the JPY30 billion is just part of our argument.
Alpine says that it is a mainstream approach to take necessary operating cash into consideration when conducting a DCF analysis. As we discuss above, we do not disagree, but in terms of magnitude, Alpine is ignoring corporate finance theories and standard practice by allocating far too much to operating cash.
c. Unfairness of the Share Exchange Ratio & SMBC Nikko Securities
A fair value opinion from BVCJ, an independent valuation expert, prior to the revision upwards in Q3 and the strong beat in Q4, valued Alpine’s shares at JPY4,943 on a DCF basis and between JPY3,516 and JPY6,734 per share on a comparable companies basis. Following the additional revisions upwards we expect the valuation to be significantly higher. The only way SMBC Nikko could have possibly arrived at their very low Share Exchange Ratio of 0.68 Alps’ shares for every one (1) Alpine share, is as the result of a flawed process and flawed valuation, as seen in our comments on the Historical Price Ratio, Comparable Companies, and DCF analyses.
We have, unfortunately, seen this type of valuation-model gymnastics before from SMBC Nikko, which provided the valuation for the privatization of PanaHome Corp., a listed subsidiary of Panasonic Corp. That valuation analysis included smaller firms that weren’t true peers of PanaHome as “comparable companies,” and a DCF analysis that based the lower end of its range on the assumption that the company’s profitability would decrease substantially, even as analysts at the time were predicting an expansion in profitability. In the end, in response to our engagement and challenges to SMBC Nikko’s analysis, Panasonic raised its buyout offer, in a step toward fairness and justice for minority shareholders. We urge Alps and Alpine to do the same.
Further, as Alpine confirms, SMBC Nikko Securities is in the same group as SMBC Bank, which is Alpine’s main commercial bank. Yet, Alpine continues to claim that SMBC Nikko is independent.
We note that the conditions and amount of SMBC Nikko’s remuneration has not been disclosed. Additionally, their original valuation was exceedingly low. SMBC Nikko’s subsequent re-examination of the Share Exchange Ratio after Alpine’s two revisions upwards appears to have been designed to ensure that no renegotiation was necessary, and to our knowledge no mention has been made of renegotiating based on the strong earnings beat in Q4 which substantially outstripped the revised up forecast.
We know that SMBC is a large lender to Alps, and their treatment of the valuation raises further doubts over SMBC Nikko Securities’ true independence.
d. Unfairness of the Share Exchange Ratio & the Perpetual Growth Method
In takeovers, it is common to perform a 5- to 10-year financial forecast until the business is stabilized, then calculate the terminal value using the perpetuity method. In the case of Alpine, with the Company growing quickly, it would be prudent to also use an extended time period until profits stabilize, and then apply a growth rate into perpetuity. In light of the excellent results and dramatic growth in FY18, the valuation should be recalculated for a longer period of time. A 3-year projection is just too short.
We note, without irony, that the Company justifies the 0% growth rate applied in the calculation by saying that SMBC applied the same growth rate to Alps. Somehow, Alpine believes that it is fair that Alps, whose operating profit will substantially decline next year, should have the same growth rate as Alpine, which beat its original forecast by 111%.
e. Unfairness of the Share Exchange Ratio & Synergies
Alpine justifies the lack of synergies reflected in the calculation by claiming that the Share Exchange Ratio is at a premium to the stock price. Does Alpine not realize that, as of June 4, 2018, the value of the Share Exchange Ratio was JPY1,803 per share, which is a premium of just 5%? Again, had the stock been allowed to trade freely, rather than being capped by its connection with Alps, Alps would have to pay substantially more even without a premium.
f. Unfairness of the Share Exchange Ratio & “Comparable Companies”
Alpine wants to have its cake and eat it too. On the one hand, it claims that JVC Kenwood, Pioneer and Clarion are all comparable businesses in the Car Navigation System industry. On the other hand, it claims that it needs to maintain a large net cash position because of the industry in which it is in, whereas all three competitors are all net debt. Alpine is clearly cherry-picking what it wants to compare.
Alpine claims that the three comparable companies were selected based on objective criteria and similarities in the business, and in consideration of any circumstances that would impact the price. Yet, SMBC seems to have simply ignored that Clarion was in the process of restructuring its portfolio, JVC Kenwood was loss-making, and Pioneer was loss-making and is expected to continue making losses.
(3) Proposal of Independent Directors
Alpine has opposed Oasis’s proposal to elect Mr. Okada as director by claiming that the corporate governance structure of its current board of directors is “functioning fully.”
As we have demonstrated, there is a severe lack of real corporate governance at Alpine. A functioning corporate governance structure would not have allowed the Company to accept such a low Share Exchange Ratio at the outset, and continue to refuse to renegotiate as Alpine’s fundamentals improve and Alps’ fundamentals deteriorate.
Alpine also says they do not need to elect Mr. Okada because they are nominating a different candidate, Mr. Satoshi Kinoshita. But Mr. Satoshi Kinoshita was already named a future director of the merged Alps Alpine entity on April 26, 2018. We have no doubt that to gain the position in the merged entity, Mr. Kinoshita would have had a substantial number of meetings with management and directors at Alps, the surviving entity, in the lead up to his nomination. Moreover, he is interested and incentivized to be an independent director of the merged company. As a result, we believe that Mr. Kinoshita already has a bias, however small, to Alps over Alpine’s minority shareholders, and recommend that shareholders vote for Mr. Okada as a director.
Alpine also opposed our proposal to nominate Ms. Miyazawa as a director, because they claim that they already have legal expertise on the board with Mr. Naoki Yanagida and Ms. Satoko Hasegawa as directors and audit committee members. As with Mr. Kinoshita, Ms. Hasegawa has also been chosen to be an outside director of the merged Alps Alpine entity, and as a result, may have a bias, however small, to her new future employers over Alpine’s current minority shareholders.
Both Mr. Yanagida and Ms. Hasegawa voted for the merger and accepted a low valuation from Alps. Later, they both voted in favor of NOT renegotiating the price with Alps after forecasts were revised up twice. Today, as far as we are aware, they have still not pushed Alpine to renegotiate – even in light of actual operating profit beating the revised forecast and exceeding the original forecast in the valuation by 111%, while Alps has reduced their forecasted operating profit for next year by 17%. It is clear that minority shareholders cannot rely on either of these directors to protect their rights. We recommend that shareholders vote for Ms. Miyazawa as a director and audit committee member.
(4) The Lack of Independence of Mr. Hideo Kojima
Alpine also attempts to justify the position of Mr. Hideo Kojima -- a member of Alpine’s audit and supervisory committee, an outside director, and a member of the Third-party committee entrusted with ensuring that minority shareholders are protected in the proposed merger -- as independent, even as they indicate his deep history working with Alps.
Further, until now Alpine has neglected to disclose that not only was he responsible for the accounting audits of Alps, but also of Alps Logistics, another listed subsidiary of Alps. He was, as Alpine now points out, the responsible auditor for Alps from 2001 to 2007, but note that Alpine did not comment on his other position at Alps Logistics. Alpine tries to obfuscate this relationship by claiming that his involvement with this transaction is more than 10 years after he left that position. Alpine conveniently forgot to mention that he joined Alpine in 2011, just four years later, and has held a role at Alpine since then. As an auditor and board member at Alpine, whose board contains Alps employees, it is far more likely that Mr. Kojima has strengthened his relationships with Alps over the last seven years, as opposed to becoming more independent.
Minority shareholders must vote for a candidate that has no existing relationship to Alps or Alpine and should vote for Mr. Okada and Ms. Miyazawa, who can be trusted to be truly independent and protect minority shareholder rights.
At the current ratio, Alpine, which beat its operating forecasts by 111% this year and is expected to continue to grow, is being acquired at just 0.8x book value. No value is being attributed to Alpine’s excellent business, let alone the full value of the assets. This represents an acquisition price of just over 3x EV/EBITDA!
- Shareholders were only made aware of Alpine’s excellent prospects once the merger was announced, and Alpine has continued to exceed these expectations. Had the stock not been capped by Alps’ poor stock price performance, Alpine’s stock price would likely be much, much higher.
- Alpine beat the forecasted operating profit used in the valuation by 111%, while Alps has reduced its forecast for FY19. Yet, Alpine has yet to even ask for a renegotiation of the Share Exchange Ratio.
- The valuations and process raise suspicions over the true independence of the valuation agent, the outside directors, and the Third-party Committee, who we now know all have reasons for more loyalty to Alps than Alpine.
Quite simply, Alpine’s minority shareholder would be far better off if the proposed transaction failed and Alpine continued as an independent company, or if an alternative buyer bought out the company at a fair price.
VOTE FOR THE OASIS PROPOSALS
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Oasis Management Company Ltd. (“Oasis”) is manager to funds that beneficially own 9.9% of Alpine Electronics Inc. (TYO:6816) (“Alpine” or the “Company”), making Oasis the Company’s largest shareholder after Alps Electric Co., Ltd. (TYO:6770) (“Alps”).
Oasis Management Company Ltd. manages private investment funds focused on opportunities in a wide array of asset classes across countries and sectors. Oasis was founded in 2002 by Seth H. Fischer, who leads the firm as its Chief Investment Officer. More information about Oasis is available at oasiscm.com. Oasis has adopted the Japan FSA’s “Principles of Responsible Institutional Investors” (a/k/a Japan Stewardship Code) and in line with those principles, Oasis monitors and engages with our investee companies.