Earlier this week there were a number of articles in the local and international press suggesting Toshiba Corp (6502 JP) was changing its tune, and would recommence negotiations with the bidding consortium which included Western Digital Corp (WDC US) with a hope of signing a deal at the earliest possible date so the company might have some hope of staving off delisting as a result of closing a deal for Toshiba Memory prior to the end of March 2018. 

A significant number of these articles suggested the main banks, who had put forward some ¥680bn of lending to Toshiba in the last several months, were much less keen on continuing to lend if Toshiba could not get its act together. In the last two days that type of noise has gotten stronger with an article in the Nikkei Thursday morning saying a major bank exec had threatened to pull lending. The company in lender meetings had even apparently proposed IPOing Toshiba Memory and had gotten smacked down hard. 

In addition, some articles suggest a change in personnel at the Ministry of Economy, Trade, and Industry this summer heralded a change in support back towards a deal with WDC. Western Digital execs are back in Tokyo this week negotiating and CEO Milligan is scheduled to arrive in Tokyo to speak with Toshiba and METI officials at the end of this week or early next week. 

The pressure is on. The turn of the tide appears quite sudden, but time is running out. This eventuality is as most insight providers on Smartkarma have discussed in recent months - it was likely going to have to go to Western Digital anyway.

Those interested in the musings from a couple of months ago and the grid of exposures can click here.

The Deal Quoted In The Press

This time, the grid appears to look like the following (if we use the Reuters article as the basis). Note that I am assuming the most conservative possible case - that the CB strike price is the same as the other buyers' buy price. They may forgo a coupon based on the higher senior leverage here, and there may be a cap on the payout which would allow Toshiba to buy the CBs and convert.

This deal seems to tick all the boxes for Toshiba except two. One is changeable now, the other not.

• It gets a deal which looks easily approvable by anti-trust authorities (WDC already owns 49.9% of the JV ops, and in this case would not own voting rights initially, and the terms of the CB will likely be designed with this goal in mind). The structure is important, the terms less so.
• This would mean it is reasonably possible, if not a certainty, that it could close by end-March 2018.
• It would, if effected, mean detente between WDC and Toshiba with regard to the JVs. For now. Toshiba's ask is that the arbitration suits and lawsuits filed by WDC would be withdrawn. I imagine WDC would want Toshiba's countersuits withdrawn too. I imagine also that some clarity would be required in the JV Agreements so that this deal is "approved" with WDC's consent, or not. If it is, that would leave in place the old regime Toshiba objected to (but didn't object to when WDC needed Toshiba's approval when it bought SanDisk). 
• It would get Toshiba a big chunk of money which, IF Toshiba CEO Tsunakawa's June 23 presser comments about the equity injection resulting from a 2.0trln yen sale being 700bn yen are correct, this would appear to lower the proceeds to say JPY 630bn. 
• It will give some comfort to Toshiba's beleaguered banks. 

But there are two boxes left over.

• The first box it does NOT tick is MONEY. Toshiba would love to be able to say that the Western Digital deal offered the same money. That way it can explain to shareholders that they did not select a lower-priced deal because they were effectively blackmailed into it.
  • This is changeable. The bidders can offer more money, or structure an earnout bonus, or if the deal does not iterate towards 2.0trln yen by the end of the month, the excuse may be something related to slightly different terms allowing Toshiba to earn more OP prior to the sale, or something about greater certainty of capex, or deal closure, or something.
  • It is possible that the difference in money terms from the idea that WDC had previously put forth a similar bid to the others (as disclosed in the CA Superior Court filings) (see Toshiba Memory Deal Changing Shape But Likely a Temporary Stalemate for links and references) is that without voting rights, WDC puts in less money. That makes eminent sense, but may not be to Toshiba's liking.
• The second box it does not tick is TRUST. Just because a deal is done does not remove the rancor so manifold and manifest on the Toshiba side over the past 6+ months based on what appears to be bad blood at the top, which has (if numerous Nikkei articles are to be believed) likely contaminated lower ranks as well.

Does This News Get Toshiba Out of Delisting Risk?

No.

As discussed in Wile E. Toshiba Avoids the First Anvil, there were three potential anvils to fall on Wile E. Toshiba's head.

• The first was The Anvil of Imminent Delisting Doom i.e. not being able to report earnings. That one is past as earnings were delivered within the extension granted by the Ministry of Finance.
• The second was The Erstwhile Anvil of Possibly Benign Officialdom, which is the possibility that Toshiba's Self-Regulatory Organization investigating Toshiba's Internal Management Systems report and internal restructuring will find that Toshiba had not, or has not (and noone is really sure to what standard the TSE's panel will hold them), sufficiently improved its internal controls. This risk remains as PwC gave an Adverse Opinion on Toshiba's internal controls. And it is not clear that PwC and Toshiba can salvage their relationship as long as that hangs over them (and as long as the past is not rectified, it would be difficult to have PwC not continue to see that as an issue). 
• The third anvil - The Anvil of Gross Corporate Incompetence -  may be swinging away out over the chasm. But is just swinging there. A burst of speed and a meep meep from the Roadrunner of anti-trust authorities could see the resulting whoosh! blow the balloon holding the anvil back over Wile E. Toshiba.

What Will Resulting Equity Be?

• In the June 23rd press conference where Toshiba presented its estimated FY2016 financials and announced the delayed filing of its Annual Securities Report (due and delivered August 11th), CEO Tsunakawa said that if the deal for Toshiba Memory went through, it would add "about 700bn yen" of equity to Toshiba. That would put equity to +JPY 118bn.
  • If the sale were at JPY 1.9trln, that would suggest something less (perhaps 630-650bn).
• The sale of Landis & Gyr is estimated to create a net profit of JPY 40bn for this year. 
• On a Parent-only basis, Toshiba's net negative net worth was -730bn yen as of 31 March 2017. On a Consolidated basis, it was -552.9bn yen. Net of minority interests it was -276bn yen. 
• The TSE looks at net assets, not equity, so there is plenty of space including minority interests if they get the sale done.
• The most recent full-year forecast which assumes Toshiba keeps Toshiba Memory for the full year suggests a 143bn yen reduction in net negative equity including the 40bn yen net profit from the Landis & Gyr disposal and a couple other smaller disposals. 
• The sale of Toshiba Memory would mean the money would not come in the OP and net category from an earnings perspective but would come in at the balance sheet level.
• I would note that in my opinion it is HIGHLY likely that the sale of Toshiba Memory at JPY 1.9trln or 2.0trln will be a headline reference number which will NOT include a "settlement amount" which will deliver additional net proceeds (and therefore profit and equity) to Toshiba based on profit earned this year. 

To be clear, I think the banks have successfully lit a fire under Toshiba Management Tuchuses and I believe this lowers delisting risk somewhat vs where I thought it was a couple of weeks ago. Delisting risk is not gone completely, but management making efforts to meet the aggressiveness of the timing required is a positive. This has been accompanied by an increase in stock price. 

But after you take out the "emergency measures" and the minority interest deduction of the listed businesses, the remaining businesses don't spin off a lot of OP, and there are LNG costs looming a couple years out.

This is not a self-evident home run here. Other efforts to improve the business will be required and therefore it behooves a look at what might be in the cards.

This insight is part of Smartkarma. For more follow this link.