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Praveen Chawla
Praveen Chawla
Articles (73) 

HollySys Automation Technologies Is Still Cheap After Buyout Offer

This leading cash-rich Chinese automation company has received a low-ball offer from a private equity firm. Shares are likely headed higher as negotiations start.

December 11, 2020 | About:

HollySys Automation Technologies Ltd. (NASDAQ:HOLI) is a Chinese holding company that has shares listed on the Nasdaq. Through its subsidiaries, the company provides integrated solutions for industrial automation and rail transportation.

In industrial automation, HollySys delivers automation hardware, software, and services spanning field devices, control systems, enterprise manufacturing management, and cloud-based applications. In rail transportation, it provides signaling control and supervisory control and data acquisition systems for high-speed rail and urban rail. Internationally, the company provides mechanical and electrical solutions in design, engineering, procurement, project management, construction, and commissioning, as well as maintenance to a range of industries.

The company has been listed on the Nasdaq since 2007. Founded in 1993, it currently has approximately 2,100 employees with operations in 21 cities in China. It went public following a reverse merger with a special purpose acquisition company called Chardan North China Acquisition Corp. that was formed in 2005.

Chardan raised $34.5 million in an initial public offering of its securities in August 2005 and merged with HLS Systems International Ltd. and listed its shares on the Nasdaq in September 2007. HollySys has made a few tuck-in acquisitions along the way, acquiring the Concord Group and Bond Group, both of which were done in part to help the company in its efforts to improve sales outside of China.

Business segment breakdown

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Industrial automation accounted for 49% of the company's revenue in 2019-20. The company's solution has been widely used in process industries involving the continuous flow of material handling, such as power generation and petrochemical, metallurgy, building materials, pharmaceutical, and food and beverages. The company's client base includes large state-owned enterprises, multinational companies, and other domestic Chinese companies. The company has also obtained customers from India and Southeast Asia within similar industries.

HollySys operates in the Chinese nuclear power automation and control market as the only qualified local automation and control product provider to the non-safety control for both the "nuclear island" and the "conventional island" of nuclear power reactors.

The rail transportation segment provides signaling systems and train protection systems in the railway and subway segments. It is one of the five qualified train control center providers in the 200 kilometers per hour rail segment and one of the two qualified providers in the 300 to 350 kilometer per hour segment. The company provides a subway supervisory control and data acquisition integrated platform.

Through the mechanical and electrical solutions business, the company has established a foothold in Southeast Asia. It acquired Concord Group in 2011 and Bond Group in 2013. The two companies provide mechanical and electrical engineering solutions, including design, engineering, procurement, project management, construction, commissioning, and maintenance. Concord Group mainly focuses on railway transportation in Singapore, Macau, and the Middle East, while Bond Group mainly focuses on factories, data centers, banks, hospitals, airports, power stations, gas and instrumentation plants, hotels, commercial centers, residential buildings, and infrastructure works in Malaysia. Through the acquisitions, HollySys is seeking to expand the existing distributions and marketing channels to sell its existing product lines to the fast-growing Southeast Asia and Middle Eastern markets.

Business performance

The company has posted double-digit increases in revenue, net income and cash flow from operations over the past decade, though revenue and income growth have been modest in the last several years.

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Cash flow is very robust, and the company's operations generate a lot of cash. About 18% of revenue in 2019 came from the service of the installed base and that proportion is growing. The company has about a year's worth of revenue in its backlog. HollySys reported a weak recent quarter because of Covid-19, but that should prove to be only a temporary blip.

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Balance sheet

HollySys' balance sheet is extremely robust. The company has approximately $613 million in cash and equivalents while its market cap is only about $850 million. The company's debt is minuscule at only $22 million. (Why the company needs to hold that much cash is perplexing. Perhaps there is some foreign exchange or regulatory reason specific to China as to why so much cash needs to be held.)

The company is currently selling below its tangible book value, which has grown at a rate of 16% per year over the last decade.

Dividends

HollySys has paid a small dividend since 2015 (current yield around 1.7%). Clearly, the company can afford a much better dividend given its robust free cash flow and the mother lode of cash on its balance sheet.

Ownership

Davis Selected Advisers, a well-known U.S. firm run by guru Chris Davis (Trades, Portfolio), is the largest shareholder with over 11% of the outstanding stock. Eastspring Investments is the second-largest shareholder. Co-Founder & Former CEO Baiquing Shao is the third-largest shareholder.

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Source: 2018 Annual report.

Discussion

As the regions where the company operates continue to grow and develop, I believe HollySys has a long runway for creating value for shareholders and is an example of a Chinese business that is largely insulated from the U.S.-China trade war given the geographies it serves. It is also trading at a single-digit valuation today.

With a free cash yield of 15%, the company is very cheap compared to similar western businesses. Since the Covid-19 pandemic has cast a pall over economic activity, HollySys reported its third-quarter revenue declined 35.5% year over year to $80.8 million while adjusted net income fell 50.4% to $13.9 million.

In addition, contract bidding and project execution were delayed for the industrial automation and rail businesses and only started to recover in March. I am not concerned as this slump should pass in time.

According to GuruFocus, the stock is trading very cheaply based on several valuation multiples.

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Buyout Offer

HollySys announced on Dec. 7 it received a preliminary non-binding proposal to acquire all publicly held shares for $15.47 per share in cash. The offer came from a consortium including co-founder and former HollySys CEO Baiqing Shao and a Chinese private equity firm, CPE Funds Management.

It is likely that bidding will go higher as the buyers and company negotiate. Logically, the company should sell for somewhere in the low to mid-$20 range, which would be at least a 30% premium from where the shares are currently. Of course, China is still a developing market where shareholder rights are not fully established. This would explain why the share price has not yet caught up with the buyout offer. As I stock is trading about 7% below the proposed buy-out price. With large shareholders like Davis & Eastspring on board, it is unlikely the buyers will get away with this low-ball offer. It looks like the price is headed higher.

Disclosure: The author owns shares of HollySys Automation Technology.

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About the author:

Praveen Chawla
I am a full-time investor now, investing my own money. I spent most of my working life in the pharmaceutical industry.

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