Metrica Partners Pte. Ltd. (“Metrica”) is the manager of, and adviser to multiple funds (the “Metrica funds”) that own shares in LINE Corp. (“LINE”, Securities Code: 3938). LINE is currently the subject of a tender offer (“the Joint Tender Offer”) by SoftBank Corp. (“SoftBank”, Securities Code: 9434) and NAVER Corporation (‘NAVER”, Securities Code: 035420), which is to be followed by a business integration with Z Holdings (Securities Code: 4689) (the “Business Integration”).
Metrica will not be tendering the shares held by the Metrica Funds into the Joint Tender Offer, and furthermore, it intends to dissent to the subsequent Share Consolidation and exercise its appraisal rights:
- Metrica considers that the procedures leading up to the LINE Board’s decision to recommend the Joint Tender Offer fall short of the required standard of fairness.
- The Special Committee has not demonstrated a sufficient degree of independence from the transaction.
- One of the acquirers ultimately ends up with much higher value from the Business Integration than the price offered to minority shareholders of LINE. The excess value is a tangential benefit deriving more from financial engineering rather than from synergies related to the Business Integration, in Metrica’s view.
- The other acquirer is a major client of the financial advisor, which may affect the perceived independence of its valuation of the target company.
- The deal is missing a minimum acceptance condition, depriving shareholders of an important opportunity to exercise their rights.
- Metrica believes that the Joint Tender Offer price of JPY 5,380 is inadequate.
- It represents a very low premium when compared with historical precedents.
- It is below the mid-point of the financial advisor’s DCF valuation, which does not incorporate any projected synergies.
- The valuation has not been updated to reflect the pandemic’s favourable impact on LINE’s business, nor the substantial increase in comparable company valuation multiples.
- The joint acquirers are privatising the company just before the point at which it turns profitable on an operating basis, according to management’s own forecasts.
Metrica’s reasoning behind the above conclusions is as follows:
Firstly, Metrica believes that the procedures for carrying out the Business Integration, including the Joint Tender Offer, do not meet the definition of having secured fairness from the perspective of the minority shareholders of LINE.
1. In Metrica’s view, the Special Committee does not meet the definition of “a deliberative body that is voluntarily established as an independent organ to supplement or substitute for the role that the Board of Directors of the target company was originally expected to perform” specified in the 28 June 2019 Fair M&A Guidelines issued by the Ministry of Economy, Trade and Industry (“METI Guidelines”, p. 21, English translation).
Two of the three members of the Special Committee, including the Chairman, are outside directors of LINE who, at the time of LINE entering into the Definitive Integration Agreement on 23 December 2019, knew that they would as part of the Business Integration be in the future appointed as directors of Z Holdings, the ultimate acquirer of the LINE operating business according to the terms of the Business Integration.
In other words, a majority of the Special Committee reasonably expected to receive future remuneration in the form of Director’s Fees from the ultimate acquirer of their company.
According to the METI Guidelines, “persons who will become Special Committee members should be required to maintain independence from (1) the acquiring party and (2) the success or failure of the M&A transaction (in other words, they should have no significant interest in the success or failure of the M&A transaction different from that of general shareholders)” (p. 24, English translation).
Metrica believes that the chain of transactions encompassed in the Business Integration should be viewed as a whole, meaning that the “acquiring party” should be interpreted not as SoftBank and NAVER but instead as Z Holdings, the ultimate acquirer of LINE upon the completion of the transactions.
A person who has been engaged to advise on the fairness of a tender offer proposal while simultaneously maintaining an expectation of future remuneration from a chain of transactions dependent on the proposal cannot legitimately be described as independent from the proposal, in Metrica’s view.
This point is only further reinforced when considering that the appointments of the two Special Committee members were subsequently confirmed by the shareholders of Z Holdings in the Annual General Meeting of Z Holdings on 23 June 2020, following which the Special Committee of LINE advised the Board that it did not see a need to revise its original December 2019 finding that the Board should support the Offer.
In other words, at the time when the Special Committee was asked to re-assess its opinion of the Offer, two of the three members of the Committee had already been appointed as directors of the ultimate acquiring company.
In Metrica’s view, it would be a challenge for any such person to modify their opinion for such an Offer while benefiting from a remunerative contractual relationship with the ultimate purchaser.
2. NAVER, the majority shareholder of LINE, is ultimately ending up with much higher value for its shares in LINE than the price offered to minorities, and much of this excess value is a tangential benefit not related to the Business Integration.
According to Metrica’s analysis, NAVER stake in LINE was worth JPY 802 billion at LINE’s closing price of JPY 4,585 on 13 November 2019, which is “regarded as the price not influenced by speculative reports about the Business Integration by some of the media” (FORM 6-K, 23 August 2020) (in other words, the undisturbed price).
NAVER is also expected to contribute about JPY 196 billion of cash to the Business Integration, consisting of about JPY 186 billion as part of the Joint Tender Offer, and a further JPY 10 billion as part of the JV Conversion Transaction (note: some amounts may not agree precisely with those stated in the Tender Offer documents, due to rounding and assumptions about dilution from outstanding convertible bonds and share options etc. However, the conclusions are unchanged in any case.)
In return, through its 50% stake in the new LINE JV, NAVER ends up with an effective 32.7% stake in Z Holdings, which is worth more than JPY 1,444 billion at the 21 August 2020 closing price.
(Note that although the Business Integration has not yet been implemented, the current share price of Z Holdings must necessarily reflect the perceived value of Z Holdings after the Business Integration, as the related transactions were approved by the shareholders of Z Holdings at an Extraordinary General Meeting on 17 March 2020. It is therefore appropriate to use the current share price of Z Holdings as a benchmark for the value to be received by NAVER).
This equates to a profit for NAVER of more than JPY 446 billion, which is equivalent to JPY 2,548 for each share that NAVER currently owns in LINE.
It means that NAVER ultimately ends up with value equivalent to at least JPY 7,133 (the “NAVER Transaction Value”, = JPY 4,585 + JPY 2,548) for each of its shares in LINE, according to Metrica’s analysis.
Is it fair according to basic principles that the controlling shareholder in a public tender offer ends up with substantially more value per share than minorities?
The METI Guidelines state that “[t]heoretically, the value realized in an M&A transaction can be separated into two types: (a) value that can be realized without executing the M&A transaction, and (b) value that cannot be realized without executing the M&A transaction. … [I]n cases where an M&A transaction is conducted through a squeeze out of general shareholders … value that can be realized without executing the transaction (case (a) above) should be enjoyed by all shareholders .. and … with respect to value that cannot be realized without executing the transaction (case (b) above), although general shareholders will be squeezed out by the transaction, it is fair that general shareholders should also enjoy an appropriate portion of such value.” (Metrica emphasis).
In other words, the controlling shareholder should be entitled to the extra value resulting from synergies etc., as long as some of this is shared with the general shareholders prior to the squeeze-out.
However, Metrica believes that in the case of the LINE transaction, the difference between the NAVER Transaction Value of JPY 7,133 and the Joint Tender Offer price of JPY 5,380 cannot accurately be described as “value that cannot be realized without executing the transaction” (i.e. synergy benefits).
Instead, much of the difference results from the substantial run-up in the Z Holdings share price since the announcement of the transaction, which is mainly the result of improvements in Z Holding’s business rather than the anticipation of the synergies resulting from the Business Integration, according to Metrica’s analysis.
In other words, the excess value is mostly the result of factors outside NAVER’s control, and has nothing to do with the transaction at hand.
In this respect, the additional JPY 1,753 in value that NAVER stands to gain from the Business Integration (= JPY 7,133 – JPY 5,380) is more in the nature of a tangential “financial engineering” benefit and thus should be much more substantially shared with the minority shareholders of LINE, in Metrica’s view.
3. A question arises as to the perceived independence of the financial advisor to the Special Committee.
The Special Committee has noted that: “… taking into account the nature of the services to be provided by [the advisor] to other parties involved in the Business Integration in transactions other than the Business Integration reported by [the advisor], … the Special Committee determined that the fact that [the advisors] are providing those services to other parties will not prevent [the advisors] from giving their independent advice regarding the Business Integration to the Special Committee … “ (3 August 2020 announcement).
And yet in another document: “[f]rom December 1, 2017 through November 30, 2019, [the advisor] and its affiliates received aggregate revenues from [SoftBank Group], SoftBank and their respective affiliates of approximately U.S. $250 million for investment and corporate banking services.” (SC TO-T/A, Exhibit (a)(1)(i), 19 June 2020).
This is a figure which would potentially place the SoftBank Group and its affiliates among the top tier of global clients for most securities companies, according to Metrica’s research.
Despite undoubtedly strict compliance rules in place to preserve the independence of teams preparing financial advisory reports for Special Committees as with the LINE Business Integration, in practice it is conceivable that such teams will perceive implicit pressure or influence to prepare a valuation which will be viewed favourably by an important client of the firm – in the current case, one of the acquirers of LINE in the Joint Tender Offer – and that even if in reality this is not the case, it will be very hard to dispel the perception that such conflicts of interest are present.
Returning to the METI Guidelines, “if such third party valuation advisor has a serious interest in the success or failure of an M&A transaction, … there will be a considerable degree of concern with respect to the advisor’s independence and it will generally be considered undesirable to have the advisor perform the functions described above.” (p. 37, English version).
While the Special Committee’s financial advisor may have little direct involvement with the Business Integration at hand, Metrica believes that the historically high level of fees paid by one of the acquirers to the advisor may support a perception that the advisor has “a serious interest in the success or failure of [the] M&A transaction.”
4. LINE shareholders are being deprived of an opportunity to exercise their rights.
SoftBank and NAVER have chosen not to impose a “majority of the minority” condition on the Joint Tender Offer, with the reason given as “in light of the fact that NAVER owns 72.64% of the Common Shares, the majority of minority condition enables a comparatively small number of shares to be used to interfere with the Offers, which may not be in the interests of ordinary shareholders who wish to tender into the Offers” (23 August 2020 announcement). The same announcement states that “The Special Committee found this point to be reasonable.”
Metrica believes that the Special Committee was incorrect in reaching this conclusion.
Instead, given the overwhelming dominance of the majority shareholder in this case with a stake of 72.64%, ensuring substantial and widespread support for the proposed Tender Offer price is all the more important, in Metrica’s view.
Where a controlling shareholder already has not just a majority (50%+) but a supermajority (66%+) position, the risk that minority shareholders will be squeezed out at a disadvantageous price is extremely high.
Given the lack of a minimum acceptance condition in the Joint Tender Offer, the scenario exists where a full 100% of LINE’s minority shareholders could disagree with the Tender Offer price, and these shareholders would have no recourse except through a potentially lengthy and costly court process.
In Metrica’s view, this is manifestly not a realistic option for vast majority of LINE shareholders, who are individuals in Japan with small holdings and who would not be expected to have the time or financial resources to pursue a court case.
Metrica does not view refusing to tender as “interference”. If shareholders are motivated to not tender into a transaction with a “majority of the minority” condition, it is because they believe they are not receiving fair value for their shares, and that they are willing to risk the non-completion of the deal because of this. Rather than “interference”, it constitutes the basic exercise of shareholder rights in an advanced economy with a well-functioning and developed capital market.
Furthermore, the classification in the above statement of “interfering shareholders” versus “ordinary shareholders” is also misleading in Metrica’s view, as it suggests that shareholders who do not tender into the offer are not “ordinary”.
According to the METI Guidelines, “if a majority-of-minority condition is not established, it is important to compensate by enhancing other Fairness Ensuring Measures so that, overall, the fairness of the transaction terms are secured.” Metrica can find no evidence from the LINE company announcements that other Fairness Ensuring Measures have been correspondingly enhanced.
Secondly, Metrica believes the tender offer price of JPY 5,380 is inadequate.
1. The premium offered over the undisturbed price is low.
From the 23 August 2020 announcement: “[t]he price includes a premium of 17.34%… added to the closing price of JPY 4,585 of the Common Shares on the First Section of the TSE on November 13, 2019, which is regarded as the price not influenced by speculative reports about the Business Integration by some of the media.”
According to analysis by DealReporter (“LINE’s JPY 5,200 buyout provides a low premium based on precedents – analysis”, 6 December 2019) which was released before the price revision to JPY 5,380, the mean premium to the undisturbed price for all cash privatisation deals in Japan since 2006 where the bidder had a stake above 50% was 38.0%, and the median was 37.8%.
On this basis, the offered premium of 17.34% (following the revision to JPY 5,380) is extremely low by historical standards, and Metrica can find no reason to justify such a low premium.
2. The Joint Tender offer price is below the midpoint (JPY 5,497) of the financial advisor’s DCF valuation, and this is a valuation which does not incorporate any synergies from the Business Integration.
According to the financial advisor’s analysis relied upon by the Special Committee (23 August announcement), the DCF valuation produced a fair value for LINE of between JPY 4,701 to JPY 6,293, and it was stated that the “…. business plans and free cash flows … reflected in the DCF Analysis do not include synergies from the Business Integration.”
Despite the METI Guidelines which state that “it is fair that general shareholders should also enjoy an appropriate portion of [the value of synergies],” it does not appear that the Special Committee has thought it appropriate to incorporate these considerations into its valuation and subsequent decision to recommend approval of the Joint Tender Offer.
3. The valuation relied upon in the Special Committee’s August decision to reaffirm their support for the Joint Tender Offer was out of date.
The initial valuation relied upon by the Special Committee was prepared by the financial advisor on 23 December 2019.
In late-June 2020, when all relevant approvals necessary for the Business Integration had been approved or were expected to be approved by the close of the Tender Offer Period, “the Company requested that the Special Committee review whether the Special Committee’s findings stated in the December 2019 Findings require revision, and if the statements do not need revision, report to the Company’s board of directors to that effect, and if the statements need revision, provide revised findings to the Company’s board of directors.” (23 August 2020 announcement).
On 3 August 2020, “as a result of confirming that there is no material change in the Company’s business conditions and environment surrounding the Business Integration, … the Special Committee unanimously agreed and submitted to the Company’s board of directors the August 2020 Findings to the effect that there are no changes to its views in the December 2019 Findings.” (same announcement).
Metrica finds the above statement puzzling for two reasons:
- LINE’s business has clearly been benefiting from the pandemic.
- In its 2Q results released on 29 July, LINE secured growth in ad revenues with sharply higher revenue from display ads and impressions +114.0% year-on-year. Therefore it does not seem accurate to state that “there is no material change in the Company’s business conditions.”
- Irrespective of whether there has been a material change in the Company’s business conditions, a valuation is not solely determined according to earnings or asset values etc.
- The multiple or discount rate to be applied to those earnings or asset values is also by definition a critical factor. The basket of comparable companies to LINE (PayPal Holdings, Square, Kakaku.com, CyberAgent, Dentsu Group, Hakuhodo DY Holdings, ZOZO, Rakuten, GMO internet and DeNA) prepared by the financial advisor to Z Holdings has returned on average 30% since the LINE undisturbed date of 13 November 2019, and according to Metrica’s analysis this is primarily from multiple expansion rather than earnings growth.
- If Dentsu and Hakuhodo are excluded from the basket due to their significant business weighting towards traditional media, which has been adversely affected by the pandemic, the basket return jumps to 44%, implying a LINE share price of JPY 6,621 in the absence of the Tender Offer (in other words, without any M&A premium attached).
- Metrica believes a similar conclusion would be reached with a DCF analysis. The appropriate discount rates cannot be set without reference to the general level of risk premiums in the market, which Metrica believes have substantially fallen since November 2019, in line with the rise in earnings and asset valuation multiples.
4. LINE shareholders are being deprived of an opportunity to participate in LINE’s growth, just as it is expected to turn profitable.
“LINE historically has not made public projections of revenues, earnings or other prospective financial results given, among other reasons, the uncertainties in the businesses in which LINE operates.” (SC TO-T/A, Exhibit (a)(1)(i), 19 June 2020).
Nevertheless, the same document discloses LINE’s management forecasts up to the fiscal year ending 31 December 2029, as well as NAVER’s forecasts for LINE up to the fiscal year ending 31 December 2024, both of which were prepared for the purposes of the negotiations leading up to the Definitive Integration Agreement.
Both sets of forecasts show LINE turning profitable on an operating profit basis in the fiscal year ending 31 December 2021, with profit rising sharply thereafter, driven mainly by contributions from the Strategic segment.
No public shareholders would have been aware of these projections prior to the announcement of the proposed Business Integration in November 2019, and thus it is unlikely that the projections were incorporated in the market price of LINE shares.
Given that the Tender Offer price was determined with reference to an undisturbed LINE share price as of a date before these forecasts were made available, Metrica believes that the effective premium being offered to LINE shareholders is in reality much lower than the declared 17.34%, and may conceivably be negative.
For the above reasons, Metrica will not be tendering the shares held by the Metrica Funds into the SoftBank and NAVER Joint Tender Offer, and Metrica intends to dissent to the subsequent Share Consolidation and exercise its appraisal rights by demanding that LINE purchase the shares held by the Metrica Funds at a “fair price”, while petitioning the court for a decision regarding the price of the Common Shares pursuant to the provisions of Articles 182-4 and 182-5 of the Companies Act and all other relevant laws and regulation.
Metrica strongly urges other shareholders of LINE to consult their own legal or other professional advisors to determine whether following a similar course of action may be in their best interests.
Metrica invites interested parties to contact it at the address below.
Metrica Partners Pte. Ltd. is a Singapore-based investment manager. Investors in Metrica’s funds include global institutions, family offices, high net worth individuals and its employees. Metrica promotes good corporate governance and works with its portfolio companies to enhance shareholder value. More information is available at https://metricapartners.com.
Curtis Man, Executive Director, Metrica Partners Pte. Ltd., +65 6904 1992, firstname.lastname@example.org