New Portfolio Idea — 6736.T

Activist campaign at a Tokyo-listed company trading at a 59% discount to NAV

In this newsletter, I share summaries of attractive investment ideas sourced from the Value Investors Club and incorporated into my personal portfolio. These summaries will be complemented by regular updates on key developments impacting investment theses. My aim with Idea Hive is to document my own portfolio management process while also enabling readers to quickly grasp and follow attractive investment opportunities.

In this post, I am excited to share the latest portfolio idea, Sun Corporation (6736.T). A pitch on Sun Corporation was published on VIC in March. You can find the full write-up here. I believe this setup is among the most compelling currently actionable 'discount to NAV' setups given the involvement of several activists whose actions might help close the wide discount. Moreover, company’s management has stated that it would be willing to consider various alternatives to maximize shareholder value.

A quick note: Given that Sun Corporation’s key asset is its stake in CLBT, a publicly-listed company in the US with plenty of borrowing available, I have initiated a hedged position, with a hedge ratio of 4.3 (short 4.3 CLBT shares for each 6736.T share bought).

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Sun Corporation (6736.T)

• Elevator Pitch: Activist campaign at a Tokyo-listed company trading at a wide 59% discount to NAV.

• Current Price: ¥3300

• Target Price: ¥8000+

Sun Corporation is a Japan-listed company with three core assets:

• A 47% stake in the US-listed digital forensics software company Cellebrite (CLBT). At current levels, this stake in CLBT is worth ¥7349/share versus Sun Corporation’s current price of ¥3300/share.

• Net cash of $94m, or ¥665/share, as of Mar’24.

• A small operating business that manufactures hardware for several end-markets, including data intelligence, gaming, and IoT.

Ascribing no value to the operating business, Sun Corporation is currently trading at a 59% discount to NAV. This is close to the higher end of Sun’s historical discount to NAV range of c. 0-70% over recent years (see the chart below). Note that the discount narrowing in late 2022 was driven partially by a combination of 1) Japanese Yen depreciation against the US Dollar and 2) Sun Corporation’s authorization of a sizable share buy back in Nov’22.

Source: Author’s calculations.

There are admittedly a number of other Japanese 'discount to SOTP value' stories with comparable or even larger discounts, with the main uncertainty being if the underlying value can ever be realized. However, the key aspect of this setup is that there are two activists on Sun’s shareholder register who might help close the valuation discount. One of the activists, Leopard Activist Management, has already publicly pressured management to distribute the company’s stake in CLBT to equity holders. Another firm, the prominent Asia-focused activist hedge fund Oasis Management, owns 19% and holds one board seat. The presence of these two activists suggests that the underlying value might eventually be realized.

Here’s a brief timeline of recent developments explaining the situation:

• October-November 2023: Leopard Activist Management initiated communications with Sun Corporation’s management, aimed at unlocking the valuation discount. The activist urged the company to distribute excess cash and CLBT shares as a dividend to Sun’s equity holders.

• January 2024: Leopard sent additional letters to Sun’s management, highlighting the company’s lack of response to the activist’s suggestions.

• February 2024: Sun Corporation issued a public letter stating that a special dividend would not be the optimal path, given Sun’s significant Japanese individual investor base, which generally does not have accounts to hold US-listed securities and thus would be unable to receive CLBT shares. Management also highlighted that the dividend distribution in-kind would be classified as dividend income and thus taxable at the shareholder level. However, Sun’s leadership stated that it would be open to “considering various measures to enhance Sun shareholder value” and would be willing to discuss such measures with the activist.

• March 2024: Leopard launched a public activist campaign (you can find the campaign’s website here), highlighting its suggestions and detailing previous communications with Sun’s management.

While it is not clear how the situation will play out, what gives some additional confidence that the situation might be unlikely to end in a stalemate is the impressive activism track record of Oasis Management. It is an Asia-focused activist hedge fund with $3bn in AUM that boasts a number of successful activist campaigns over the recent years:

• In early 2023, Oasis accumulated a 6.5% stake and pushed for management changes at the Restaurant Group. The activist subsequently increased its stake in the company, buying shares from several of TRG’s largest shareholders. The company eventually agreed to be acquired by Apollo Global Management in Oct’23, with Oasis reportedly recording £40m profit on its position in the company (c. £900m at the time of the acquisition).

• In Apr’21, Oasis opposed CVC Capital Partners’ takeover bid for Toshiba, claiming it undervalued the company, and pushed for the company to solicit offers from other firms. Eventually, Toshiba launched a full sale process in Apr’22, with a number of bidders emerging. Subsequently, the company agreed to be acquired by a buyer consortium led by Japan Industrial Partners. Full timeline of developments at Toshiba can be found in this article.

• In Oct’20, Oasis launched an activist campaign at Tokyo Dome, calling for an EGM to replace company’s management. Shortly after, in Nov’20 the company received a takeover bid from property developer Mitsui Fudosan, valuing Tokyo Dome at a 24% premium to pre-announcement levels. The acquisition closed successfully in Jan’21.

• In Jan’17, Oasis, along with equity holders, opposed Panasonic’s acquisition offer for its housebuilding subsidiary PanaHome as undervaluing the company. Several months later, Panasonic raised its offer from ¥1009/share (all-stock) to ¥1200 (all-cash).

• Back in 2014, Oasis urged the Japanese console maker Nintendo to shift its focus to developing and selling mobile games instead of only developing games for its proprietary consoles. After facing activist pressure, the company dropped its console-only strategy and entered the mobile gaming market in 2015, initiating the development of several games, including Pokémon Go. After the game’s success, Nintendo shares soared in 2016, leading to significant gains for the hedge fund.

So what could be the outcome here? There seem to be several potential scenarios:

• CLBT might be sold to a PE firm. This is among the likely outcomes given that Thoma Bravo has acquired two of CLBT’s largest competitors over recent years. A potential acquisition would likely come at a significant premium, given precedent transactions and the fact that CLBT trades at approximately 5x ARR, an undemanding multiple for a company that meets the so-called “Rule of 40” (i.e., ARR growth + EBITDA margins above 40%).

• Sun Corporation might sell its stake in CLBT to a third party at the current market prices. While this would imply significant tax leakage (likely around 30%), this scenario would still yield a potential upside of over 70%.

• Sun Corporation might arrange a tax-friendly distribution of CLBT shares to equity holders. Another option, suggested by the activist Leopard, is Sun Corporation distributing an extra cash dividend (alongside CLBT shares), providing equity holders with funds to offset some of the potential tax liabilities.

It is far from clear what the value realization path will look like here. There is also a risk that Sun Corporation’s management could either 1) decide not to monetize or distribute its stake in CLBT, or 2) hoard cash if the CLBT stake is sold. Sun’s management holds a minimal stake and has displayed subpar capital allocation since selling part of its stake in CLBT as part of the late 2021 IPO. Despite announcing intentions to focus on shareholder value and returns at the time, the company has only returned 10% of the proceeds via buybacks from the partial sale of its stake. However, given the wide discount to NAV, the margin of safety while awaiting further developments seems sufficient.