Alliance between Sharp, Hon Hai tested by severe share-price drop

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Hon Hai Precision Industry Co., the assembler of Apple Inc. iPads, may seek to renegotiate a planned ¥133 billion alliance with Sharp Corp. after the Japanese TV maker’s shares fell to their lowest in 34 years.

Hon Hai agreed to buy 9.9 percent of Sharp, Japan’s largest maker of liquid-crystal displays, for ¥550 a share. Sharp shares have plunged 30 percent below that to ¥386, meaning if the deal closed Monday at the agreed price, Hon Hai would have a paper loss of $255 million, equal to 51 percent of the Taipei-based manufacturer’s net income last quarter.

“With the current stock price, Hon Hai won’t be willing to pay that much, and given Hon Hai has more say in this alliance than Sharp, the Taiwanese company may request a review,” said Takashi Watanabe, an analyst at Goldman Sachs Group Inc.

Sharp fell to its lowest level since 1978 after the Osaka-based company forecast a wider than expected annual loss for the current fiscal year because of its unprofitable solar, panel, and audiovisual and communications divisions.

Sharp Display Products Corp. is counting on a separate ¥66 billion tieup with Terry Gou, whose Foxconn Technology Group includes Hon Hai, and related investment companies to return to profitability.

Simon Hsing, the spokesman for Hon Hai, said the company remains committed to the deal, and he declined comment on whether it would seek to renegotiate terms, including the price.

“This is the most important deal we’ve had recently to realize our goal of greater vertical integration in the supply chain,” Hsing said. “We worked on it for nine months and plan to proceed.”

Sharp “currently doesn’t have a plan to change the price,” spokeswoman Miyuki Nakayama said.

Hon Hai, flagship of the Foxconn group, and its affiliates will buy 121.65 million new shares in Sharp at ¥550 each, Sharp and Hon Hai said March 27. Gou and related companies will buy 46.5 percent in Sharp Display, a venture with Sony Corp., they said.

The alliance would give Hon Hai access to advanced displays as the Taiwanese manufacturer looks to expand beyond assembly.

Sharp’s shares, which reached a 34-year low of ¥366 on May 21, rose May 24 after Hon Hai said it may build a display factory with the Japanese company in Chengdu, China. The stock fell 2.3 percent to ¥382 at the close of trading Monday in Tokyo. Hon Hai slid 3.9 percent to 82 New Taiwan dollars in Taipei trading, the stock’s lowest close since Jan. 2.

Gou’s and Sharp’s stakes in Sharp Display will be diluted to 37.61 percent each after Sony said May 24 it will sell its entire 7.04 percent holding to the display unit by June 30, and Toppan Printing Co. and Dai Nippon Printing Co. said they would merge their operations in Sakai, Osaka Prefecture, with the display maker, giving them a 9.54 percent stake each.

“Hon Hai should try to renegotiate the price, because the loss on the value of the stake and capital expenditure to Sharp won’t be good for them in the short term,” said Laura Chen, a Taipei-based analyst at BNP Paribas who downgraded the stock to hold last month and cut her share-price estimate by 16 percent. “In the long term, Hon Hai still wants the deal because Sharp has strong technology in panels, solar and electronics components.”

Hon Hai’s second-quarter earnings per share may fall 61 percent from the prior period partly because of the decline in Sharp’s share price, KC Kao, who rates the stock buy at Deutsche Bank AG in Taipei, wrote in a May 21 report. The investment and Sharps’ financial situation also increase the risk that Hon Hai will need to raise funds, he wrote.

Based on the May 21 closing price of ¥366, Hon Hai would realize a loss of $210 million on the Sharp stake, Kao wrote. BNP’s Chen estimates the loss for this period would be at least $165 million if the transaction value remains unchanged.

The amount of capital injection needed by Sharp, coupled with a likely desire by Hon Hai to limit its equity exposure to the Japanese company, reduces the scope for them to renegotiate the deal, said Steve Myers of JI Asia, who rates Hon Hai as sell. The two sides have until March to close the transaction, and there is no immediate need to model for Sharp’s share-price declines in Hon Hai income statements because the deal hasn’t been completed, he said.

Gou has traveled to Japan seven times since the deal was announced, Hon Hai’s Hsing said, an indication of the importance he places on the transaction. The Foxconn chairman also plans to proceed with his own investment in Sharp Display, Hsing said.

“The deal with Sharp is not just about panels,” Hsing said. “They have many different products that are of interest to us.”

Sharp on April 27 forecast a net loss of ¥30 billion for the year ending next March 31, wider than the ¥7.6 billion average loss forecast of 23 analyst estimates compiled by Bloomberg. The LCD and solar businesses may contribute ¥10 billion in losses each, while the communications equipment and audiovisual unit may lose about ¥5 billion, Sharp said.

Sharp has ¥20 billion in bonds maturing in June and about ¥200 billion in convertible bonds maturing in September 2013, according to data compiled by Bloomberg. The company’s cash and near cash stood at ¥195.3 billion as of March 31, a drop of 19 percent from a year earlier.

A decreasing cash balance and forecasts for continuing losses may put Sharp in a weak position to refuse renegotiation, Watanabe said.