Sharp's top-rated analyst: Foxconn delay raises liquidation risk

[TOKYO] Sharp Corp is facing an increasing risk of liquidation if a rescue deal with Foxconn Technology Group is delayed further, according to a top-rated analyst tracking the electronics maker.

Jefferies Group's Atul Goyal raised his estimated likelihood of Sharp's liquidation to a new threshold of 30 per cent to 40 per cent from less than 5 per cent, citing the potential violation of the Japanese company's debt covenants. The Singapore-based analyst, who shares the top spot in Bloomberg's absolute return ranking with two other peers covering Sharp, has a 100 yen price target on the company. The stock closed 1.6 per cent higher at 131 yen in Tokyo on Wednesday.

About a month has passed since Sharp's board chose Foxconn's bailout of more than 600 billion yen (S$7.3 billion) over a competing offer from the state-backed Innovation Network Corp of Japan. Foxconn Chairman Terry Gou has delayed signing a final agreement as he seeks to reduce the amount the Taiwanese company would pay for control of Sharp. With INCJ out of the picture, the threat of liquidation could force the company and its lenders to accept the new terms, giving Foxconn access to Sharp's liquid-crystal display technology at a lower price, Goyal said.

"Whether this goes to bankruptcy or the deal gets signed under new conditions, Foxconn gets what it wants - a lower price for Sharp's LCD technology," he said. "While the banks are under time pressure, Foxconn has all the time in the world." Toyodo Uemura, a spokesman for Sharp, and Toshimitsu Irie, a spokesman for INCJ, declined to comment.

SLOW BURN

Not all analysts following Sharp are as pessimistic. Yu Okazaki at Nomura Holdings Inc reiterated a neutral rating for the stock last week with a price target of 160 yen. INCJ may also be compelled to return to the fray.

"It's not impossible that INCJ could return to the negotiating table if Sharp and the banks ask for it, but it does seem rather unlikely," said Shigeru Nishiyama, a professor at Waseda University's graduate school of commerce.

The shares of Sharp have fallen 47 per cent in the past 12 months as the company posted five straight quarters of losses.

On Wednesday, Standard & Poor's trimmed its credit rating for Sharp's debt to CCC, meaning it's at risk of not meeting debt obligations, and kept it on negative watch.

Foxconn's month-old bid includes 489 billion yen for new shares in Sharp at 118 yen apiece, and 100 billion yen to acquire preferred stock from the company's main banks. The amount paid for new stock could be reduced by 100 billion yen, with Foxconn paying a lower price per share, the Nikkei newspaper reported. The purchase of the preferred shares may be delayed past summer, it said.

TICKING CLOCK

Sharp is also facing a potential cash squeeze because of the expiration of 510 billion yen in credit lines and loans on March 31, the end of its fiscal year. Mizuho Financial Group and Mitsubishi UFJ Financial Group, the company's banks, are pushing for a bailout agreement before those loans are renewed, people familiar with the matter have said.

Taiki Kitaura, a spokesman for Mitsubishi UFJ, and Masako Shiono, a spokeswoman for Mizuho, declined to comment. Foxconn did not respond to an e-mailed request for comment.

Foxconn is also in discussions with its lenders to reduce the interest it pays on credit lines and loans, the Nikkei reported. As a result, the banks may delay their deadline by a month, and may discuss rolling them over to long-term debt, it said.

TOUGH CONDITIONS

Under INCJ's original proposal, Sharp's appliances operations would join those of Toshiba Corp and its liquid crystal display business would be merged with those of Japan Display Inc, where the fund is a major shareholder. Since then, Toshiba decided to sell a majority stake in its home-appliance business to China's Midea Group Co.

Bloomberg's default-risk model, which considers factors such as share prices, debt levels and interest costs, put the company's probability of default in the coming year at 1.89 per cent.

While that's up from this year's low of about 1 per cent last month, the chances were as high as 3.82 per cent in January.

Mr Goyal's recommendations on Sharp have delivered a 47 per cent return over the past year, a performance rating that's on par with Daiwa Securities Group's Junya Ayada and BNP Paribas's Masahiro Wakasugi. Ayada shares Goyal's 100 yen price target, while Wakasugi sees the stock falling to 95 yen.

EXCEPTIONAL DEAL

Foxconn first said it would postpone finalizing its deal with Sharp only hours after the Japanese company's board voted to approve its bid on Feb 25.

Foxconn said at the time it needed to work through material new information it had received from Sharp. That information included about 300 billion yen in potential liabilities for restructurings and layoffs, people familiar with the matter said.

After examining the contingent liabilities, Foxconn's lawyers and bankers concluded earlier this month they would likely not require major changes to the deal, people familiar with the matter have said.

In another twist, Foxconn then sought to get more clarity on the Osaka-based company's financial performance in the current quarter, people familiar with the matter have said.

"It's OK for the negotiations to be tough, but major changes to the original deal require exceptional circumstances," said Waseda University professor Nishiyama. "There is a risk of a shareholder lawsuit if Sharp agrees to conditions that are deemed unreasonable."

BLOOMBERG