HK activism fund manager Protocol Asset Management initiates friendly engagement with Ferrotec

12 Nov, 2019 10:00
source: Singularity Financial

Hong Kong – November 12, 2019, a Hong Kong shareholder activism fund manager Protocol Asset Management (HK) Limited just initiated a friendly shareholder request letter to the board of Japanese semiconductor maker Ferrotec Holdings Corp.( 6890 JT), to bring active suggestions to Ferrotec management in order to avoid potentially turbulent financial headwinds.

Ferrotec is a semiconductor company with a worldwide presence in a broad array of end products, manufacturing systems, and industries.

The full context of the email request to the board is released as below –

November 12, 2019

Mr. Akira Yamamura
President and CEO
Ferrotec Holdings
5F Nihonbashi Plaza Bldg., 2-3-4 Nihonbashi
Chuo-ku Tokyo 103-0027 Japan

Dear Yamamura-san:

We are Protocol Asset Management Hong Kong Limited (“PAM”), a friendly Asia shareholder activism investor.  Collectively, as a firm, we have over 50 years investing in the global equity markets.  Your accomplishments, from heading Ferrotec during its early days to growing the company into a robust, cash generative business, has indeed captured our attention.  We know that some of the major business decisions you have made throughout your journey, such as leading the management buyout in 1987 and the acquisition of the former parent company through a friendly takeover bid in 1999, were all prudent and successfully executed despite staggering challenges.  Seeing where Ferrotec is today, we admire and commend your achievements.

We fully support Ferrotec’s decision to discontinue the Photovoltaic (PV) segment, especially given the destructive pricing in the industry.  We are also in agreement on your company’s ambitious goals for sustained growth going forward.  However, we believe that a sense of urgency is needed towards finding safer alternatives in financing the expansion of the heavily sought-after and highly profitable wafer business.

Due to the emergence of future technologies, we are aware that the wafer market is very lucrative, expected to grow in sync with positive long-term demand trends for IoT, 5G, AI and overall advances in semiconductors. However, we believe for Ferrotec to shoulder the immense capital expenditures (larger than its own market cap) required to expand its presence in the wafer business, it would be meaningful to seriously consider financially safer approaches.

Our research indicates that if Ferrotec were to continue with its announced CAPEX spending plans (JPY 71.0bn over the next three years), the company could potentially face turbulent financial headwinds, possibly financial distress.  What’s more alarming is that Ferrotec’s balance sheet has become highly leveraged in recent years – (doubling more than 2x from 2018 to 2019 in total interest-bearing debt) and expected to increase unless alternatives are pursued.  With a combination of other factors, we believe there is a strong possibility for Ferrotec to be in financial jeopardy.

The anticipated issues we have observed are as follows:

– Possible financial distress due to deteriorating free cash flows. As you know, this could be exacerbated by a deep cyclical downturn.

– While in a weaker financial state, decreased or no access to financing alternatives (e.g. borrowing) could prove to be catastrophic.

– Further declines in stock performance and a possible cut in dividends, resulting in lost value for shareholders.

– Increased risk and impact on Ferrotec’s China business, which we believe high potential to deploy a major rollup strategy

Under your stewardship, Ferrotec’s share price appreciated 1,115% from a post financial crisis nadir of JPY 226 to a peak of JPY 2,748 in January of 2018.  However, due to a confluence of factors (i.e., U.S.-China trade dispute and memory market inventory concerns), but especially the weight of your capital expenditure requirements on the company’s risk profile, Ferrotec’s shares have experienced multiple contraction.  Investors have accorded you a lower valuation (EV/ EBITDA of 10x to EV/EBITDA of under 4x) resulting in share price depreciation of 69% to JPY 841 as of September 30, as they believe aggressive investment is detrimental to equity value.

While PAM supports Ferrotec’s agenda for future growth, we also believe that to succeed going forward, there needs to be a Stronger Ferrotec.  In line with strengthening of you company, we strongly believe Ferrotec’s shares will once again experience multiple expansion, possibly to exceed EV/EBITDA of 10x, which translates to at the minimum a double in share price from the current level.

In the essence of partnership, we humbly request to have a meeting with you so that we may offer our plan to help strengthen Ferrotec and, consequently, improve shareholder value. We hope that the brief recommendations shared with you in this letter will be considered by your Board and adopted as a thoughtful approach to strengthening Ferrotec.

Our Proposal

Wafer Business

Ferrotec has had substantial business success thus far.  However, to maximize Ferrotec’s future success, we believe the company should deeply consider strategies that not only alleviate financial burdens associated with growth, but also positions itself for maximum market success.

Step 1: Seek Outside Strategic Partners, Possibly Chinese Direct Investment to Fund CAPEX. A Stronger Ferrotec Would Be Deleveraged and Benefit From the Additional Resources and Network of Outside Partners.

Furthermore, this will also allow Ferrotec to focus on its repositioning, which is to continue to divest the PV segment and continue to harvest cash flows from its robust semiconductor and electronic device businesses – which are its core strengths.

Step 2: While Expanding and Scaling the Wafer Business, Create and Distribute Shareholder Value.

Balance cash generation with targeted growth and, when possible, return capital to shareholders, e.g. through share buybacks and/ or the issuance of dividends.  By doing these two intermediate steps, we foresee significant upside in Ferrotec’s share price, with 100% increase in value in two years or less.

Step 3: Eventually Spin Off the Wafer Business “Ferrotec Wafer” via a Separate Listing on the Hong Kong Stock Exchange or Shanghai Stock Exchange (or US NASDAQ Equivalent, STAR Market).

A large strategic investor can provide not only the capital to fund CAPEX permitting deleveraging, but also the know-how to spin off Ferrotec Wafer.  Spinning off the business would illuminate some of the hidden value of the wafer business, which has higher margins than the core business.  Both existing shareholders and the strategic investor would benefit from the step up in valuation of the wafer business as a separate company.  By doing so, we believe this would also make Ferrotec a capital-light, cash generative company – and ultimately improve Ferrotec’s balance sheet dramatically.

As a standalone public company, similar to Sumco and Siltronic AG, “Ferrotec Wafer” would attract dedicated investors keen to expand their exposure in this sub-sector, particularly mainland Chinese investors. Furthermore, Ferrotec Wafer could have a dedicated management team with total focus on its journey to market leadership in the wafer business.  And finally, although a lengthy process, we think that eventually listing Ferrotec’s wafer business as a separate company could be a viable long-term goal for sustained growth.

Cleaning Restructuring

As part of the recent restructuring of the cleaning business, Ferrotec had approved a proposal to make an additional capital contribution to FSTA via an in-kind contribution.  With this, we understand that the FTSA will also function as a holding company of the precision cleaning and recycling business in China.  Going forward, we see three possible options for Ferrotec to consider:

Option 1: Sell 49% or 51% of the China Business to Strategic Capital Providers

This depends on whether Ferrotec wants to consolidate its China business.

Option 2: Spin off the China Business via a Separate Listing on HKSE or SSE (or China’s US NASDAQ Equivalent Known as the STAR Market).

Similar to plans for the wafer business, we foresee considerable potential by listing in one of Asia’s top financial centers and largest capital markets.  Listing on either Chinese market would increase the company’s visibility as a China tech growth equity and provide capital to execute an independent China roll-up strategy in the highly fragmented regional cleaning business.

Option 3: Form a China Joint Venture (JV) with a Strategic Investor.

While Ferrotec contributes its China business to the venture, the strategic investor will provide capital.  PAM has a network of potential investors and contacts that could bring value, including making Ferrotec a key player in China’s 2025 strategy.  This would be substantially positive for Ferrotec’s long-term growth.

However, given Ferrotec’s over-leveraged financial position at this time, we think that the first option may be the most suitable.  However, if our recommendation to address leverage related to wafer expansion is address first, then options #1 and #2 become more attractive.

With the above recommendations, we believe the following could be achieved:

– Expand the wafer business in a safer way via access to abundant Chinese private capital, most of whom are keen to invest into the wafer sector

– Reverse Ferrotec’s struggling stock performance and capitalize on the upside of future growth opportunities

– Eventually create even greater shareholder value by separating the wafer business

– By easing the financial burden, achieve stronger fundamentals and obtain a safer company capital structure

The future has abundant opportunities and we still believe this is the right time and Ferrotec has the right team in place to make the proper executions. In our view, Ferrotec’s current stock price undermines its intrinsic value, but we are confident a re-rating can be achieved and share price performance can be reversed if our strategies are deployed correctly.

Beyond PAM’s willingness to introduce strategic investors for both your wafer and cleaning businesses and our help to facilitate proper introduction and selection, we offer our assistance to implement our proposal and would highly value a personal meeting with you.  We believe Ferrotec and its stakeholders can benefit from our experience, our China business restructuring expertise and network, and sound advice on strategy and capital allocation.

We would not have made the substantial efforts to learn and to better understand your company if we did not believe in a bright future for Ferrotec’s growth potential and dedicated employees.  We are confident that by acting as partners, Ferrotec will grow stronger. We look forward to the possibility of meeting with you soon.

For Ferrotec to be Strong, Ferrotec Must Embrace.


Bing Lin
Chief Executive Officer
Protocol Asset Management (Hong Kong) Limited