Hollysys Automation Technologies (NASDAQ:HOLI) designs and manufactures automation and control systems and has been listed on the NASDAQ since 2007. Founded in 1993, it currently has approximately 2,100 employees with operations in 21 cities in China. It was listed on the NASDAQ following a reverse merger with a SPAC called Chardan. Chardan North China Acquisition Corporation ("Chardan"), was a special purpose acquisition company ("SPAC") formed in 2005. Chardan raised $34.5 million in an initial public offering of its securities in August 2005 and merged with and into HLS Systems International Ltd and listed its shares on the Nasdaq in September 2007. HollySys has made a few tuck-in acquisitions along the way, acquiring the Concord Group ($43mm, rail industry electric solutions) and Bond Group ($73mm, mechanical and electrical solutions for industrials, banks, hospitals, airports, etc.), both of which were done in part to help the company in its efforts to improve sales outside of China. Those firms are headquartered in Singapore and Malaysia respectively.
Business Segment Breakdown
Industrial automation
This major business segment accounted for 49% of the company revenue in 2019-20. The company's solution has been widely used in process industries involving the continuous flow of material handling, such as power generation and petrochemical, metallurgy, building materials, pharmaceutical, and food & beverage, etc. The co's client base includes large state-owned enterprises, multi-national
companies, and other domestic Chinese companies. The company has also obtained customers from India and Southeast Asia within similar industries.
The Company provides the Chinese nuclear power automation and control market as the only qualified local automation and control product provider to the non-safety control for both the "nuclear island" and the "conventional island" of nuclear power reactors in nuclear power stations. In a nuclear power station, the nuclear island operates to transform nuclear energy to heat energy and pass on the steam generated by the steam generator to the conventional island, where steam drives the turbine to generate the electricity, and pass on to the transformer for loading onto the grid.
Railway signal system
Co. provides signaling systems and train protection systems in the railway & subway segment. It is one of the five qualified train control center providers in the 200km/h rail segment and one of the two qualified providers in the 300–350km/h segment. Co. provides a subway supervisory control and data acquisition integrated platform.Mechanical & Electrical Solutions
The Co. has established a foothold in Southeast Asia through the acquisitions of Concord and Bond Groups in 2011 and 2013 respectively. Concord and Bond Groups mainly provide mechanical and electrical engineering solutions, including design, engineering, procurement, project management, construction, commissioning, and maintenance related services. Concord Group mainly focuses on railway transportation in Singapore, Macau, Qatar, UAE, and Saudi Kingdom markets, and Bond Group mainly focuses on factories, data centers, banks, hospitals, airports, power stations, gas and instrumentation plants, hotels, commercial centers, residential buildings and infrastructure works in Malaysia. Through the acquisitions, the Company is seeking to expand the existing distributions and marketing channels to sell the Company’s existing product lines to the fast-growing Southeast Asia and the Middle East markets.
Business Performance
The company has posted double-digit increases in revenue, net income, and cash flow from operations in the last decade, though revenue and income growth has been modest in the last few years.
Source: Author with data from Gurufocus.com
Cash flow is very robust, and the company operations generate a lot of cash. About 18% of the company's revenue in 2019 came from the service of the installed base and that proportion is growing. The company has about a year's worth of revenue in its backlog order book. The company reported a weak recent quarter because of COVID-19 but should be a temporary blip.
Source: 2020 Investor Presentation
Balance Sheet
Balance Sheet is extremely robust. The company has ~$613 million in cash & equivalents while its market cap is only ~$850 million. The company's debt is minuscule at only ~$22 million. (Why the company needs to hold that much cash is perplexing. Perhaps there is some foreign exchange or regulatory reason specific to China, as to why so much cash needs to be held.)
The company is currently selling below its tangible book value. Tangible book value (the bulk of it is cash etc.) has grown at a rate of 16% per year over the last decade.
Dividends
The company has paid a small dividend since 2015 (current yield ~1.7%). Clearly, the company can afford a much better dividend given its robust free cash flow and the mother lode of cash on its balance sheet.
Ownership
Well known US Value fund, Davis Selected Advisers is the largest shareholder with over 11% of the shares. Eastspring Investments (a subsidiary of Prudential PLC) is the second-largest shareholder. CEO Baiquing Shao is the third-largest shareholder.
Source: 2018 Annual report.
Ernst & Young Hua Ming LLP Beijing, The People’s Republic of China are the auditors of the Co.
Discussion
As the countries and greater regions where the company operates continue to grow and develop, I believe Hollysys has a long runway for creating value for shareholders and is an example of a Chinese business that is largely insulated from the US-China trade war given the geographies it serves and is trading at a single-digit valuation today.
With a Free Cash Yield of over 15%, the company is very cheap compared to similar western businesses. Part of the reason being the coronavirus epidemic has cast a pall over economic activity. Hollysys reported a 2020-Q3 revenue decline of 35.5% Y/Y to $80.8M, and adj. net income decline of 50.4% Y/Y to $13.9M. The company mentioned that COVID-19 has had a negative impact on business. Contract bidding and project execution were delayed for the Industrial Automation and Rail businesses and only started to recover starting March. I am not concerned as this slump should pass in time.
According to Gurufocus the company is selling very cheaply based on several valuation multiples.
Hollysys announced that on Dec 07 it received a preliminary non-binding proposal to acquire all publicly held shares for $15.47/share in cash. The offer comes from a consortium including co-founder and former Hollysys CEO Baiqing Shao and Chinese private equity firm CPE Funds Management.
The group also urges the Hollysys board to take necessary action to render the company's shareholder rights plan inapplicable to the proposal.
There are some big-name investors like Davis and Eastspring Investment/Prudential PLC involved with significant dollars at risk. A majority of the shares are held by institutions. It's been listed in the US since 2007 and no scandal has surfaced. The company does a lot of business with the public sector in China.
