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Business

Hon Hai CEO determined to grab Sharp, debt and all

Terry Gou

TAIPEI/TOKYO -- Taiwanese tycoon Terry Gou is once again defying his deputies with his determination to acquire embattled Japanese electronics titan Sharp, but whether his colossal gamble will pay off remains to be seen.

     A yearslong effort by Gou's Hon Hai Precision Industry to acquire Sharp and its advanced panel technology appeared to bear fruit on Feb. 25, when the board of the Japanese conglomerate voted in favor of a 700 billion yen ($6.2 billion) bailout proposal from its Taiwanese suitor, rather than the 300 billion yen rescue offered by the Japanese government-backed Innovation Network Corp. of Japan.

     But that was not the final twist in the tortuous saga. Hon Hai, also known as Foxconn Technology Group, immediately said it would postpone signing the deal to review a list of contingent liabilities totaling 350 billion yen submitted by Sharp on Feb. 24 before deciding on its next step. Contingent liabilities are those that are realized under certain conditions.

     Gou appears unfazed by the setback and has been pressing his team to finish a new round of due diligence at Sharp's headquarters in Osaka and wrap up the deal as soon as possible, brushing aside concerns about the strain on Foxconn's finances. The two sides are striving to sign an agreement by March 7.

     "Even though some executives are worried that the gigantic cost of the acquisition to Foxconn will take a toll on the company's financial health, Chairman Gou has made it clear that he wants Sharp and no one will be able to challenge that order," a person familiar with the talks told The Nikkei. "But it is possible that following the acquisition, Foxconn will be forced to reduce its near-term investments."

Gut instinct   

Current and former Foxconn executives have pointed out that when Gou and his executives and advisers disagree on a major project, very often Gou will disregard their opinions and go after what he wants. Although this gut-instinct approach has served Gou well over the years, the executives' concerns regarding Sharp have merit.

     Alberto Moel, an analyst at Sanford C. Bernstein, said in a note on Feb. 25 that while the deal is structured to lessen the burden on Taipei-listed Hon Hai, the company is probably "overpaying" for the transaction with a premium of perhaps 250 billion yen. "This deal is at best neutral for Hon Hai, if the company can manage to realize some synergies. However, we would like to highlight that it is a rather bullish assumption, given the substantial execution risks this deal carries," Moel said.

     Vincent Chen, an analyst at Yuanta Securities Investment, said that the Sharp deal could burn through Hon Hai's cash. "Hon Hai's net cash was around 300 billion New Taiwan dollars ($9.02 billion) at the end of September, and the deal will eat into its cash position significantly and possibly affect the company's future investments and cash dividend," Chen said.

     Before the latest hiccup, Foxconn executives were hoping to wrap up the deal last week. They had to postpone the signing after Sharp sent Foxconn a list on Feb. 24 of some 100 items containing contingent liabilities totaling 350 billion yen, including pensions, government subsidies and possible penalties for breaching existing contracts, according to people familiar with the talks.

     Foxconn said the liabilities were "new material information" that the company was previously unaware of. Sharp countered by saying it had made the proper disclosures in its financial reports. At the same time, Gou upbraided his staff for not spotting the liabilities sooner.

     After receiving the new document, Foxconn contacted Sharp, asking for more details. Sharp President Kozo Takahashi described the liabilities as "an unfortunate misunderstanding" in an email, and said the potential additional liabilities only come to 50 billion yen. Foxconn financial adviser JPMorgan Chase also suggested a significant portion of the contingent liabilities are low risk.

     Still, Foxconn eventually demanded that Sharp not hold a board meeting, previously scheduled for Feb. 25, before the two sides could clarify the actual amount of the liabilities. The Japanese company ignored the request.

     Sharp's board approved Foxconn's offer on the morning of Feb. 25 and revealed that Hon Hai, together with its two subsidiaries and Gou's personal investment arm, SIO International Holdings, will spend a total of 489 billion yen to buy newly issued Sharp shares for 118 yen each. This will give Hon Hai and Gou about a two-thirds stake in Sharp.

     Hon Hai will also purchase half of the 200 billion yen in preferred Sharp shares held by Sharp's main creditors, Mizuho Bank and Bank of Tokyo-Mitsubishi UFJ, and buy back some 25 billion yen in preferred shares held by the Japan Industrial Solutions Fund at a negotiated price.

     After Sharp's announcement, Foxconn held an emergency video conference, with Gou presiding over the sessions from Nanning, China, where he was due to sign a pact with the local government.

     Later that day, Foxconn said in a statement that it will hold off on signing the agreement until it can get a clear understanding of the contingent liabilities. At the same time, Gou pressured company executives to complete their investigation as soon as possible so he could seal the deal. Sharp also dispatched a delegation that day to Foxconn's China headquarters in Shenzhen to discuss the new development.

     On Feb. 26, Takahashi also went to Shenzhen to meet Gou and his deputies, including Foxconn's Japan chief Tai Jeng-wu. Takahashi apologized to Foxconn and the two sides decided to aim for a March 7 signing date. Foxconn sent its staff and external consultants to Osaka to begin a new round of due diligence a day later.

Becoming clearer   

Gou's attempt to grab hold of Sharp is part of his effort to secure more orders from Apple, whose orders account for half of Foxconn's revenue, at a time when the Taiwanese tech powerhouse is grappling with slowing growth in the global smartphone market. In January Foxconn's revenue dropped 15% on the year.

     David Hsieh, senior director at research specialist IHS Technology, said Foxconn needs Sharp's advanced low-temperature polysilicon (LTPS) technology display technology for its new panel plants in China. LTPS offers higher resolution and brighter colors with less power consumption than traditional thin-film transistor (TFT) LCDs. The technology is used in Apple's popular iPhones, and Sharp is a supplier to the U.S. gadget maker.

     But there is speculation Apple wants to shift to active-matrix organic light-emitting diode (AMOLED) technology, an advanced display system controlled by South Korea's Samsung Electronics and LG Display. To produce AMOLED panels, a manufacturer first needs superior LTPS technology, according to Hsieh, because AMOLED incorporates elements of LTPS.

     "Foxconn-controlled panel maker Innolux lacks superior LTPS technology. It would be a disaster for Foxconn to build two new LTPS facilities in China, together with another one in southern Taiwan, without matching technology," Hsieh said. "That is why Foxconn is offering a hefty 700 billion yen for Sharp. It needs Sharp's LTPS technology." 

Nikkei staff writers Kazunari Yamashita and Cheng Ting-Fang in Taipei contributed to this report.

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