☀️☕️ Kokusai IPO: a Private Equity Ten-Bagger?

📝 Focus

• Kokusai IPO: a Private Equity Ten-Bagger?

📊 In the Markets

• Skies clear for Microsoft’s AI Cloud

📖 MoneyFitt Explains

🎓️ Leveraged Buyout (LBO)

What We’re Reading 📚

📝 Focus

Kokusai IPO: a Private Equity Ten-Bagger?

Specialist semiconductor-equipment maker Kokusai Electric popped 28% in its Tokyo Stock Exchange debut on Wednesday in Japan's largest initial public offering (IPO) since SoftBank’s listing five years ago. The stock was priced at ¥1,840 and closed at ¥2,350, valuing the company at ¥541.5 billion ($3.61bn.)

Despite high exposure to both China and the weak memory sector, and generally soft demand for chip related stocks outside of AI, the portion available to foreign investors was more than 10 times oversubscribed.

Storied US private equity firm KKR sold ¥108bn ($721mn) of the shares in the company it had bought in a Leveraged Buyout (LBO)🎓 for ¥257.1bn in 2018. KKR still owns 48% now worth ¥258.3bn, slightly more than the valuation it paid for the whole company five years ago.

..... ▷ American private equity firm KKR acquired the semiconductor-equipment unit from Hitachi in 2018 as the conglomerate streamlined operations. The deal valued the business at ¥257.1 billion.

Plan A for KKR was to sell the business to US-based Applied Materials in 2019, but the $3.5bn deal failed when blocked by Chinese regulators in 2021. Applied Materials still owns 15% of the company.

So instead, KKR launched Plan B, an IPO, which, just five years after the buyout, valued Kokusai at ¥424bn at the IPO price, withdrawing some of its investments and reducing its stake from 73.2% to 47.6%.

This already looks like a huge win for KKR, with a 65% gain in such a short span of time.

But the return to KKR is even larger as it already sold off one division of the original business and used a lot of leverage (loans) for a substantial portion of the purchase price. This makes the equity investment itself much smaller, as is usual in leveraged buyouts.

Bloomberg calculates that KKR’s return on the deal is more than 10 times, using the strike price for options granted as incentives to management as an indication of the original investment.

..... ▷ Private equity firms such as KKR and Bain Capital have long identified rich investment opportunities in Japan.

Many conglomerates have a history of retaining underperforming subsidiaries, even when lacking the necessary management skills, focus or resources to unlock value.

Bain Capital, for instance, led the buyout of Toshiba's memory chip division, which has since been rebranded as Kioxia Holdings.

..... ▷ The Kokusai IPO was the biggest in Japan since SoftBank’s ¥2.4 trillion listing with a market value of ¥7.2tn in December 2018.

The IPO market since then slumped, but Kokusai's debut comes on the back of a broader recovery in Japan, with the Topix trading near a 33-year high.

Equity offerings in Tokyo have surged with Japan benefiting from lower interest rates than other countries, pressure from local and foreign activists on management to improve corporate valuations, backing from billionaire Warren Buffett and rotation by investors out of China.

The country even surpassed China as a driver of equity fees for investment banks for the first time in 25 years.

..... ▷ Kokusai is an important but small firm compared to dominant player Tokyo Electron in making machines for depositing films on silicon wafers. It counts the likes of Samsung Electronics, TSMC and Micron among its customers, partially as all semiconductor companies require secondary suppliers.

Chip equipment makers have generally been suffering from a downturn in the market for electronics such as smartphones and PCs, particularly hitting the highly cyclical DRAM memory space, which Kokusai is heavily exposed to.

Kokusai also has high exposure to China as machines for deposition and heat treatment are included in the list of 23 semiconductor production equipment export restrictions announced by the Japanese government in July.

📊 In the Markets

Asia-Pacific markets on Wednesday were largely up following a strong Tuesday in the US as investors focused on a generally decent set of earnings reports while Treasury yields eased back from the 5% level the 10-year bonds hit on Monday.

Chinese property developer Country Garden reportedly defaulted on its dollar bond, and semiconductor equipment firm Kokusai Electric, bought by PE giant KKR from Hitachi, surged 30% on the biggest debut on the Tokyo Stock Exchange in 5 years (above.)

European markets were flat though Deutsche Bank surged on strong earnings as a result of the higher rate environment. Deutsche Bank said it could raise dividends and share buybacks by more than a third over the next two years. Other banks across Europe, like Lloyds and Santander, reported similar updrafts and traded firmer too, but Barclays continued to slide as investors sold it off on charges related to cost-cutting measures, despite beating the best guesstimates of The City’s Finest the day before.

But then the US resumed its selloff, triggered by both Alphabet's disappointing earnings and US Treasury yields resuming their upward march. The S&P 500 index closed down for the fifth time in six days, while Nasdaq saw the single biggest drop (in %) since February 21, with the SOX (The Philadelphia SE Semiconductor index) logging its biggest one-day drop all year.

Interest rate-sensitive megacap tech stocks weighed heavily on the Nasdaq, with 6 of “The Magnificent Seven” trading down. Google parent Alphabet was the worst of them at nearly a 10% loss after it reported disappointing cloud services revenue. Only Microsoft, boosted by its early move in AI, gained (below).

And late on Wednesday, UAW and Ford reached a tentative agreement that could end the high-profile and nearly six-week long strike with 25% pay increases.

Skies Clear for Microsoft’s AI Cloud

Microsoft posted its strongest sales gain in six quarters, bolstered by recovering cloud-computing growth amid demand for new artificial intelligence products. Unlike some of its tech peers, most notably Google, Microsoft's cloud expansion has defied industry-wide predictions of slowing growth.

The company's investment in generative AI start-up OpenAI has allowed it to add AI to its services while maintaining controlled spending on R&D, which rose less than 1% in the same quarter.

Microsoft's strong performance in its Intelligent Cloud unit, with a 19% increase in revenue in the last quarter, demonstrates the growing global demand for compute power driven by generative artificial intelligence.

..... ▷ Companies can integrate OpenAI's tools via Microsoft's Azure cloud computing platform, and AI assistance has been incorporated into products like Word and Excel, stretching the generative AI use case far from the search space.

..... ▷ Before becoming CEO, Nadella was the executive vice president of Microsoft’s cloud and enterprise group, responsible for building and running the company’s computing platforms, so integration into the wider suite of products and Microsoft’s cloud offerings was always part of the game plan.