M&A, Talking Point

A pre-nuptial panic attack

Will Taiwanese tech giant Hon Hai say “I do” to Japan’s struggling Sharp?

Terry Gou

Deal or no deal? Terry Gou, founder and chairman of Taiwan's Hon Hai, fields questions about Sharp takeover

In 2012 Taiwanese tycoon Terry Gou offered to do something that he hoped would patch up relations between China – where the bulk of his factories are based – and Japan. At a shareholder meeting for his firm Hon Hai Precision, the billionaire proposed buying a chain of islands in the East China Sea. Known to the Chinese as the Diaoyu and to the Japanese as the Senkaku, the islands have been a source of tension between the two countries for years, with their ownership loudly disputed (see WiC78 for our first mention of them). Gou offered to solve this seemingly intractable problem by suggesting that China, Japan and Taiwan jointly develop oil fields off the islands and then sell the disputed territory to him, thus neutering the sovereignty question.

The United Daily News reported that Gou claimed this would mean “all of us would become rich and there would be no need for war”.

The scheme didn’t receive much serious consideration. But earlier that same year Gou had made another bold foray into Japanese politics: a deal to help the struggling electronics giant Sharp. Like its famous logo, Sharp’s financials had turned red, and Gou was offering to buy 11% of the firm for $809 million.

Unfortunately, the proposed stock purchase proved anything but a done deal, as Sharp’s shares continued to plummet and Hon Hai looked to negotiate better terms. Through a separately brokered transaction Hon Hai did become more involved with Sharp’s Japanese operations (through a flat screen TV joint venture), but it soon became clear that rifts had opened up with Sharp’s headquarters. The breakdown in the 2012 bid strained trust, says the Wall Street Journal, highlighting concerns among Japanese executives about Hon Hai’s reliability (Hon Hai is better known in China as Foxconn, where it is the major assembler of Apple devices like iPhones).

The suspicions cut both ways. According to CBN, Gou told media last summer that “we were cheated by Sharp”, indicating how acrimonious the relations with the 103 year-old Japanese multinational had become. But he never lost interest. And last week the on-again, off-again romance with Sharp was back in the headlines. Indeed Gou’s efforts to get his Japanese bride to the corporate altar looked to have finally come off. Then, in a repeat of four years ago, Sharp suddenly discovered that its Taiwanese groom had some last-minute reservations.

What transpired?

Last Thursday the board of Sharp approved a deal to sell a 65.9% controlling stake to Hon Hai for ¥700 billion ($6.22 billion). The Wall Street Journal noted that it marked a “rare case of Japan Inc relinquishing a venerated brand to a foreign buyer”.

Hon Hai’s bid was almost double that of Sharp’s local rescuer, the government-backed fund Innovation Network Corp of Japan (INCJ). The latter’s bailout plan would have merged Sharp’s display business with that of its rival Japan Display to create a new national champion. As this seemed to enjoy government support, many had seen Gou as the underdog in the battle to take control. However, his bid won over Sharp’s board, not only because of the superior financial offer but also because he has pledged to avoid major layoffs, keep Sharp intact and use Hon Hai’s market position to reverse its steep losses. The Sharp brand would also be retained.

Only hours after Sharp’s board had approved the takeover, however, Hon Hai then revealed that a new stumbling block had emerged. The Taiwanese firm said it had received from executives at its Japanese target “material information, most of which was not disclosed during previous discussions between the two companies”.

This was a list that was emailed by Sharp’s managers to Hon Hai headquarters late on Wednesday, revealing potential financial exposures of up to ¥300 billion relating to tax claims and patent infringement cases. Reuters has since reported that the 100-point list was an “unverified study of worst-case scenario risks, rather than liabilities requiring disclosure”. But it was enough for Gou to call a halt. With the deal looking to have broken down (again), Sharp’s shares fell 11% last Friday and its boss Takahashi Kozo rushed to Shenzhen to meet Gou “with the aim of reaching a comprehensive understanding and resolution of the situation”.

Hon Hai stayed calm, advising that the deal’s deadline had been extended by a week to March 8 and adding that it still hoped to reach agreement. However, Reuters also hinted this week that Gou and his executives “felt violated”, having asked the Sharp board to delay its vote in response to the emailed list. Being ignored by the board “didn’t go down well on the Taiwan side”, Reuters points out.

Sharp – which has been bleeding cash for most of the past five years – is under intense pressure to find an investor before a portion of its debt comes up for refinancing at the end of the month. INJC, meanwhile, has dissolved its deal team, meaning that Hon Hai is thought to be the sole remaining bidder.

Why is Gou interested in Sharp?

Hayakawa Tokuji founded Sharp to produce mechanical pencils in 1915. This product became known as the ‘Ever Sharp Pencil’, hence the company’s famous brand name. Later, it maintained its reputation as a pioneer, producing the first generation of Japanese radios, then moving into television sets in the 1950s, before launching the world’s first electronic calculators in the 1960s.

More recently Sharp has invested heavily in LCD panel manufacturing. But business conditions for flat screen TVs have been tough and its share price today is around a tenth of what it was in 2010. Indeed, when Gou first expressed an interest in buying a stake in 2012 he was set to pay ¥550 per share. According to Bloomberg, the deal agreed last week priced Sharp’s stock at just ¥118.

What most interests Gou is Sharp’s flat panel technology, which is the basis for the displays in items like smartphones and tablets. Sharp is one of the three liquid crystal display suppliers to Apple, alongside Japan Display and LG Display. Currently, Gou’s Foxconn assembles a large share of Apple’s iPhones in China, but as we reported in WiC194, he has been trying to capture a more lucrative portion of the value chain by moving into the production of more technical components.

Hence Hon Hai’s ‘Project Eyeball’ envisages the company becoming a leading player in display technology (a field currently dominated by Samsung, which has 34.7% share of the mobile phone display market, versus 18.3% for Japan Display, 14.2% for LG Display and 10.4% for Sharp, according to research outfit IHS).

Until now Hon Hai’s presence in the TFT-LCD industry has been confined to its stake in Taiwan-based Innolux. But an investment in Sharp would transform its position, particularly as it could push to use more of Sharp’s displays in the Apple products that it assembles.

As the Japan News puts it: “Gou has spent roughly five years courting Sharp and if a deal goes through, it would boost Hon Hai’s position as Apple’s main contract manufacturer.”

In fact, Apple seems to support Gou’s interest in Sharp. The US firm was said to be concerned that Japan Inc would force through the INJC bid and that two of its display suppliers would consolidate (Japan Display and Sharp). The outcome: two manufacturers rather than three – and thus less negotiating leverage.

Apple also keeps a keen eye on what its main competitor Samsung is up to. Given their rivalry in smartphone sales, Apple wants to avoid becoming too reliant on the South Korean firm’s components. And Samsung Display has been investing heavily in OLED (organic light-emitting diode) displays, which are thinner, lighter and more flexible. It is thought Apple also plans to use OLED technology in its future iPhones. Should it want to avoid buying from Samsung, it could turn to LG Display, which has also pushed into OLED. But an advantage of the pending Hon Hai purchase, says the Japan News, is that new funding would allow Sharp to start producing OLED screens by 2018, around the time Apple is expected to adopt these next-generation displays for its iPhones.

Analysts estimate that the display represents 20% of the production value of an iPhone.

(When you pull apart a phone the ‘screen’ looks like a single component but it is actually a display plus a glass screen. The display handles the pixels, and the glass provides the protective covering and has a coating that detects fingers. China-based companies like LENS Technology and Biel – see WIC313 – have become key suppliers of glass to Apple and Samsung, but their contribution is less technologically advanced than those like Sharp making displays.)

A smart move by Gou?

CBN thinks the deal makes sense: “Sharp is almost a perfect takeover target: their businesses complement each other… Hon Hai, the world’s largest IT products foundry, consumes an amazing number of LCD panels each year, while Hon Hai’s subsidiary Innolux is also a sizable LCD panel company.”

Buying Sharp may also make Foxconn more important to its top client, Apple. As one tech blogger surmised: “With access to Sharp’s displays, Foxconn can make more money in the making of iPhones, while Apple also frees itself from the trouble of buying displays from LG and Samsung and other rivals, and may enjoy lower prices.”

But as has become apparent from the long courtship of Sharp, there will be plenty of practical and cultural challenges in managing the struggling Japanese firm. As the eleventh-hour arrival of the contingent liabilities also indicates, misunderstandings abound even after months of talks.

That means that some see the Sharp deal as the biggest bet of Gou’s career. The Wall Street Journal notes: “Analysts remain sceptical about the financial logic of the deal for Foxconn, which reported net income of NT$37.9 billion ($1.16 billion) and revenue of NT$1.07 trillion in the third quarter. The Taiwanese company has given few details of how it plans to stem Sharp’s losses beyond saying it can help bring clients to Sharp’s component business due to its broad customer base.”

Meanwhile Gou’s irritation with the Sharp board may be making him think twice about those financial risks. In the coming days it’ll be his call as to whether the takeover will go ahead – perhaps on revised terms (yet again).

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