The Net Debt/EBITDA was 1.6x at 1Q FY2025/1 and is expected to be 1.8x after NEN’s M&A, which is approaching the upper limit of 3.0x, but can the company maintain its M&A pace going forward?

Even if Net Debt/EBITDA rises temporarily due to M&A, Deleveraging will proceed rapidly due to the utilization of the target company’s Debt Capacity, EBITDA growth through PMI of the target company, and ample cash flow from existing businesses. With the M&As announced today, we expect that the ratio will temporarily be 2.0x at the end of this fiscal year, but if there are no additional M&A in the future, the deleverage will accelerate and we expect the ratio to go down to 1.5x at the end of the next fiscal year and 1.1x at the end of the year after that.

The wholly owned subsidiary of C’traum through partial share exchange announced today is the first M&A project utilizing GENDA shares. This has the following advantages, which we will take advantage of this opportunity.

(1) M&A can be conducted while preserving Debt Capacity.

At the time of our IPO, the Company’s Net Debt/EBITDA was 0.1x, which meant that it was virtually unable to utilize its debt, resulting in a low level of capital efficiency. From this point on, we have achieved a certain level of improvement in capital efficiency by utilizing appropriate leverage through debt-financed M&A. However, from this point on, we will need to manage M&A activities while controlling debt capacity rather than focusing solely on borrowing. As an intermediate method between debt and equity financing, we believe that M&A with stock deal is an effective way to promote M&A while preserving our debt capacity.

However, from Cash EPS standpoint, entry valuation is more important for stock deal M&A than M&A solely with debt. This point is explained in section (2) below.

(2) If PER of GENDA is higher than the PER of target, Cash EPS will increase even with stock deal M&A.

The above is our approach to PER and Cash EPS in stock deal M&A, which is described in detail in the appendix of M&A materials released today. In addition, when the M&A consideration is a mix of stock and cash (borrowings), the PER of the target company multiplied by the percentage of the acquisition via stock is compared with our PER, and the hurdle for increasing Cash EPS is lowered. For example, for the C’traum acquisition, Cash EPS will increase significantly by acquiring 80% of C’traum’s PER of 5.9x by acquiring GENDA shares at a PER of 20.6x (20% of the shares have already been acquired through debt).

As we place importance on Cash EPS in M&A, we will limit our stock deal M&A to companies with lower PER (after taking into account the acquisition ratio) compared to our own PER. In the future, we will continue to consider M&A by way of shares as an effective means to (1) preserve Debt Capacity while pursuing our M&A strategy, and (2) improve Cash EPS if our PER is high compared to the PER of the target company.

In addition to (1) and (2), the M&A of the partial share exchange to C’traum has further advantages.

(3) It will also be an incentive after participation in GENDA.

The representative of C’traum, which is also the seller, will continue to be the representative of C’traum after the participation in GENDA. Therefore, this M&A with GENDA shares can be used as an incentive to increase the value of the shares after joining GENDA. Thus, if the seller of the target company’s shares continues to promote its business in GENDA after the completion of the M&A, it will be able to enjoy an upside by receiving GENDA shares as consideration, and will have an incentive to increase the value of GENDA’s shares after the M&A is completed.

(4) A partial share exchange to C’traum, which is largely net cash, is effectively funded by equity.

In a typical M&A transaction, since the target company usually has interest-bearing debt, even debt minus cash will be positive (net debt position), and thus even a stock deal M&A will usually result in the addition of incremental target company’s debt.

However, in this M&A of C’traum via partial share exchange, the subject company was “debt free” as of the end of the most recent fiscal year with cash on hand of ¥2.02bn, and had negative net debt (net cash position). As a result, the EV of the target company was ¥1.98bn and a equity value of ¥4bn. Therefore, with regard to the ¥4bn equity value of C‘traum’s shares, the 20% cash consideration on May 1 plus the current 80% acquisition via new GENDA shares, ¥1.98bn is the consideration for the acquisition of C’traum’s business, and the rest of ¥2.02bn is effectively consideration for the company‘s cash and deposits itself.

This has the same economic impact as if GENDA had completed equity financing. Furthermore, in this case, GENDA will be able to improve its Cash EPS while, practically raising funds through equity. In addition, from the subject company owner’s perspective, it is more reasonable from a tax perspective to sell the target company’s cash, rather than withdrawing the cash as dividends from the target, and we believe that this will have a certain level of replicability in the future.

We will continue to utilize equity M&A from the perspective of (1) and (2) alone, but we will also make good use of projects like this one, which have all the elements of (3) and (4), to control Debt Capacity. We will continue to manage our business with an awareness of “continuous and discontinuous growth” and Cash EPS through M&A.

Tag: 2024/6/27