Summary
- Cybernet Systems shares have risen 35% YTD, given the pressure on its parent company Fuji Soft by activist investors.
- We assume the parent will conduct a tender offer for Cybernet Systems, making it a privately-held company. To date, there has been no official announcement.
- Timing-wise we expect the latter half of FY12/2023, as activist fund 3D Investment Partners continues to progress with a turnaround agenda.
Investment thesis
With activist pressure on its parent company Fuji Soft, we assume Cybernet Systems (CBSZF) will be made private into a 100% owned subsidiary in the short to medium term - to date there has been no official announcement. As a tender offer generally involves a double-digit premium to the market price, we believe the shares are a buy.
Quick primer
Cybernet Systems is a specialist software reseller for overseas companies such as Ansys ( ANSS ) for CAE (computer-aided engineering) tools and services, as well as IT security solutions such as end-point solutions by CrowdStrike ( CRWD ), Symantec ( AVGO ), and Check Point ( CHKP ).
Its parent Fuji Soft (9749) has a 52.4% holding in the company which fully acquired the company back in 1999, followed by a listing in 2003. Fuji Soft is under market scrutiny as it is currently embroiled in an argument to adopt a business turnaround plan by activist investors 3D Investment Partners. This plan was unveiled initially in September 2022 , and the activist fund is the largest shareholder of Fuji Soft at 21.45%.
Key financials with earnings estimates from Toyo Keizai and Karreta Advisors
Our objectives
Despite weak trading in FY12/2022, Cybernet Systems' shares have risen 35% YTD (on the Tokyo Stock Exchange), outperforming the TOPIX index by 39%. The share price performance appears to be at odds with the fundamentals. In this piece, we want to assess whether the earnings outlook into FY12/2023 warranted a major positive re-rating, or whether activist pressure on its parent Fuji Soft is impacting the share price.
Recent trading and outlook
Expectations for FY12/2022 were not high, given that the company announced that it would halt reseller activities for Synopsys optical design solutions in October 2021 . With a change in revenue recognition accounting for maintenance contracts, sales and profits are expected to drop double digits YoY (see Key financials table above) with EPS growth expected to fall 35.1% YoY. Q1-3 FY12/2022 sales dropped 17.9% YoY, with operating profit similarly falling 55.8% YoY.
The company caters to a diverse customer base, but the key verticals are electrical equipment and machinery/precision equipment which together made up 39% of Q1-3 FY12/2022 sales ( page 16 ). With Synopsys' optical design business now absent, the drop in telecommunications sector sales dropping 27.5% YoY makes sense to us, but a steep decline across the board does not even if the revenue recognition policy has been changed.
We note that the company's disclosure of parent sales by contract type (new or renewal, page 17 ) highlights a negative scenario whereby both types are seeing a decline YoY. Q1-3 FY12/2022 renewals dropping 19.2% YoY can be pinned on Synopsys business, but new contract sales dropped 11.6% YoY which highlights the loss of market share, potentially driven by Cybernet Systems not being viewed as an ideal vendor due to problems with its parent. We look at this next.
Implications from parent Fuji Soft and activist fund 3D Investment Partners
Cybernet Systems' parent company Fuji Soft has long been viewed by institutional investors as a value trap, with the PBR multiple historically around 1.0x or under. This was before it gained the attention of activists 3D Investment Partners who began to build a stake in Q1 FY12/2022 and now hold 21.45%. The key problems with Fuji Soft's management are its focus on sales growth versus profits, and its fixation on investing in real estate assets (it owns its multiple offices nationwide) with an approximate market value of JPY199 billion/USD 1.5 billion - this equates to nearly 80% of its own market capitalization. In essence, activist investors are stating that Fuji Soft can vastly improve its capital allocation and sell its real estate assets (and conduct lease and buyback deals), and any excess capital should be returned to shareholders.
A rising trend in corporate Japan has been the structural conflicts of interest and information asymmetries that are harmful to minority shareholders in listed subsidiary structures. Many listed subsidiaries have undertaken going-private transactions - and Cybernet Systems may now be in the frame. Taking Cybernet Systems private could be argued as better capital allocation by the parent, as well as better governance. The situation reminds up of what happened to Secom Joshinetsu (SJOHF), a listed subsidiary of security company Secom (SOMLY) which was taken private in May 2021 at a 66% premium.
3D Investment Partners makes direct mention of Cybernet Systems in their revised proposal , talking about how Fuji Soft should reconsider whether to maintain listed subsidiaries as it impairs corporate value (page 72). The activist makes a direct reference to either conducting a full acquisition or total disposal of all listed subsidiaries, including Cybernet Systems plus three other companies. If the parent had 100% control of the company, any restructuring would be easier to conduct. Also, displaying better governance would go some way in demonstrating that management is becoming more proactive in addressing the better treatment of shareholders. To date, there has been no official comment from either Fuji Soft or Cybernet Systems on a potential course of action.
With a cash-rich balance sheet, we assume that in the short to medium term that Fuji Soft has the financial flexibility as well as the motive to make Cybernet Systems a 100% held private company. However, even if this does not transpire, the company is now viewed as a pending transaction by the market. With the activist fund slowly forcing changes at the parent, we believe this will be reflected in a rising valuation for Cybernet Systems.
Valuations
Cybernet Systems' shares are trading on PER FY12/2023 21.1x, and a potential free cash flow yield of 6.1%. The business is not capex intensive and has a strong track record of free cash flow generation. The prospective dividend yield of 3.3% is interesting, as it implies a generous 70% payout ratio.
Risks
Upside risk comes from Fuji Soft announcing a 100% tender offer for Cybernet Systems at a premium. Cybernet Systems may also be forced to essentially part-fund a tender by conducting share buybacks beforehand.
Downside risk comes from Fuji Soft's management making no progress in improving its capital allocation or shareholder returns and continues to resist activist pressure.
Conclusion
Where value investors have failed in the past, we believe 3D Investment Partners can realize higher corporate value in Fuji Soft, and consequently to its subsidiary Cybernet Systems. In terms of timeline, we expect shares in Cybernet Systems to remain at current levels until a positive catalyst emerges in the form of a tender offer from the parent in the latter half of 2023. We recommend buying the shares.
For further details see:
Cybernet Systems: Tender Offer Candidate By Parent Fuji Soft