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12-25-2006, 11:44 PM   #1
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Busting a few Pentax (& Hoya) myths - long read

Wasn't sure whether to post here or to News forum, but here goes. Sorry if I'm in the wrong spot Mo.

On the different websites there is much talk & angst about the Pentax-Hoya merger. On top of the recent torrent over "that review" this is getting a bit much. So I'm going to put on my Boston Consulting Group hat and break a few myths about the merger. Hopefully this will help settle things down.


1) Myth 1: Hoya bought Pentax just for the medical business and will get rid of, or close, or do something to the camera division.

That was from the first meeting over a year ago when Pentax rebuffed Hoya's wedding ring. At that time Pentax clearly said they were committed to the camera business. With hindsight Pentax was correct. The camera business is much healthier than a year ago. Pentax's camera/lens plants are running at full capacity.

1a) Myth 1a: Pentax's camera business is only barely profitable, and profits happen sporatically.

Pentax started restructuring several years ago. They lowered costs and sold assets. The eyeglass division was sold off. Manufacturing was moved to lower cost geographies. The path was bumpy. There was a logistics snafu that caused screams of anguish amongst Pentax users about the lack of lenses a couple years ago (remember?). The first D had poor sales. The medical business even had a period of below expected performance, which didn't help things. But with the DS things turned around and that momentum has been carried by the K10/K100.

Now how do you think Pentax can deliver the K10 for $900 and still have a PROFITABLE camera division? It was a combination of lowered cost structure plus making a product people wanted.

So you can't extrapolate the past trend in the camera business into the future. Yes Pentax got caught flatfooted in the digital wave but now they've pulled up their socks.

Someone on PDML once said that Pentax has been going bankrupt since the 1980s and Everyone knows that. Except Pentax.

1b) Myth 1b: Look at all the other failed mergers between camera makers. How can this one succeed?

What happened to Minolta is well known. But Hoya is profitable and redeploying excess cash into a related business. And Pentax is profitable.

The unhappiness with financial analysts who cover the stock wasn't the financial solvency of Pentax. Gearing ratios were well within safe boundaries. Their concern was valuation relative to earnings growth... and Pentax is growing again.

Who says mergers haven't worked? Look beyond 15-20 years and there were successful mergers. Isn't Nikon part of Matsushita now?


2) Myth 2: The head of Pentax is being replaced by the head of Hoya. Hoya will remove all about Pentax that is Pentax, or shut down Pentax, or do Something Bad.

Huh? Didn't you read the press release? Unless I misread things the head of Pentax becomes the Chairman of Hoya-Pentax and the head of Hoya also becomes President (CEO?) of Pentax.

The path of responsibility is pretty textbook here. The Pentax employees report to their new (Hoya) president, but the chief executive reports to the board... and the board is chaired by a Pentax guy! I don't know for sure but I suspect the chairman will be pretty actively involved with the new company (just an educated guess).

p.s. This isn't really normal in a merger. You don't often see the acquired company's president become chairman of the combined company, especially when Pentax is a fraction the size of the acquiree. Doesn't this tell you something about the importance of Pentax, medical & imaging, to Hoya?


3) Myth 3: This is all just financial engineering. The end customers will just get shafted and the management will get rich.

You've watched "Wall Street" too many times. This is not a leveraged/privatization financing. LBOs are what makes people rich and this isn't one. This merger is quite straightforward. Just a share swap. No cash changes hands. Pentax shareholders just get a distribution of Hoya shares.

Plus it's a bit more complicated than just financial engineering. i) Pentax is growing its business again. But it needs capital (money) for that. ii) The BoJ has been doing everything but the hula to signal that interest rates are going up - Japan is finally coming back to life, economically speaking. iii) Yes banks are lending money for expansion again but if bond yields go up then capital becomes incrementally more expensive. iv) Hoya generates more cash than it needs. And there ain't no capital cheaper than internally generated funds. Hoya can put its cash into a bank paying less than 1% interest or it can put it into company and earn a higher return than a measly 1%. And yes, funding Pentax's R&D or growth plans is riskier than putting into a CD.

3a) Myth 3a: But what about the customer getting shafted?

It's a competitive world. If there truly was a bad camera or camera component company, they would have gone bankrupt already. Yes there are some corrupt figures in the business world -- eventually their world falls apart. But the vast majority aren't and they have to be focussed on providing new and better products to their customers every day. Why? Because most executives of successful companies DO care about providing the best products and services to their end customers. That's why they are successful.


4) Myth 4: I don't care what you've said about 1 and 2 above. You're just reciting a press release. I still think that Pentax will lose it's unique character under Hoya.

i) Umm... both companies have been around a long time. When I looked into Pentax's financial condition a few years ago I discovered Pentax is a conservatively managed company. I haven't looked into Hoya much but Hoya has been around just as long as Pentax and I wouldn't be surprised if it was pretty conservatively run as well. Oh, and see Myth 1.

I like conservative. Just as I like steak to sizzle. I own a saloon car and a minivan. I buy my suits off the rack. Give me a well designed, good quality, decently priced camera any day. That's Good Conservative. On to ii below...

ii) Umm... Pentax has been changing via their self-restructuring in the last 5 years. And it will continue to change in the next 5 years. And after that. But will the fundamental corporate culture of Pentax change? Show me evidence that Hoya is a radically different culture from Pentax.

Hoya. Kenko. Tokina. Hoya's subsidaries have their unique brand character under the same corporate umbrella. And Hoya continues to roll out new products under those subsidiaries. So how much will Hoya mess with Pentax's "character"? I don't know for sure. But the best judge of what management will do is what they've done in the past. On to iii...

iii) Hoya and Pentax are public companies. Someone please show me prima facie evidence of a track record of managing a merger badly. (I'm not talking about product missteps or mistakes, by the way.)

p.s. Pentax is still changing. The announcement that they are getting out of p&s cameras is good news. Good, I say. I've always thought p&s was a business that had awful industry fundamentals.


5) Myth 5: Every merger I've been involved in or witnessed has been messy and screwed up and the customer/brand have suffered.

I've been involved in mergers too. It's bloody and I found my last one quite unfun. So I have sympathy for that view.

But there is a difference between a horizontal and vertical merger. The horizontals are the bloody ones. That's when you have overlaps in i) products, ii) expenses, and iii) people. In the ensuing mess the customer often gets forgotten.

This is more a case of vertical integration. That's when a company acquires another company in the value chain. Such as a glass maker buying a medical instruments & camera company. Now let's look at where things can get bloody: Firstly Pentax has already cut a lot of its expenses. See Myth 1. Not too messy. Secondly there isn't a whole lot of overlap in product (except Tokina) or people either. See Myth 4. Whew, not bad either.

Of all the reasons why I think the customers won't get forgtten, this is to me the most important. Acquisitions into related industries have the greatest chance of success. It doesn't mean that things can't go wrong (all mergers entail risk), just the risk is lower.

To me the big change is that Pentax will now be held to account for how they invest their capital by Hoya. What's wrong with that?

Sidebar: Hoya supplies glass blanks to all the camera makers - Nikon, Canon, Pentax, etc. There is a worldwide shortage of high quality silica and the worldwide price of that raw material has been going up. I do not know if this is a reason for any lens shortages at Pentax. But at the very least Pentax will get a stable supply of glass.


6) Mth 6: Samsung will buy either a part of or all of Hoya-Pentax eventually. Recycle Myths 1-5.

Maybe. If I can predict the future with that degree of accuracy I'd be very rich.

Sidebar: Samsung is one of the biggest semiconductor makers in the world (ie. future sensor suuplier). They are also stronger in consumer electronics than Hoya-Pentax, in my view. So if there is an eventual tie-up with Samsung, is that bad?


7) Myth 7: These people that are defending Pentax-Hoya-whatever are just a bunch of fanboys.

"Fanboy" is being used in a context to connote a person who is ignorant, unwilling to think, and naive. It's a term used to demean someone else.

When you were in primary school maybe there was a kid who was different for some reason. So other kids picked on that kid and called him names. Those bullies must have grown up and become cyberbullies. And I have absolute contempt for bullies, whether in the schoolyard or cyberspace.

The fact is I am not a stupid drone. If Canon made the same great products at a great price, I would be a Canon user. I am not a pro and I can't write off my gear against my income. I like Pentax because the price to performance ratio can't be beat. And I wish I had bought a boatload of shares 3 years ago... sticks and stones can break my bones but I could have been richer than any name caller out there.


On that note, Merry Xmas everyone.
-George

12-25-2006, 11:56 PM   #2
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Relax! Ho-tax has already been found a few years ago:-

RiceHigh's Pentax Blog: Just for Some Funs - HOTAX!

;-D
12-26-2006, 12:02 AM   #3
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I just hope that the new DA* lenses won't be branded as Hoya-Pentax, since the roadmap says that DA* is a tentative name!

Tranq, you said it all in this post:

QuoteOriginally posted by tranq78 Quote
Why so upset? This is good news. As a businesss merger this a lot of sense. Firstly, you already bought Hoya products when you bought your Pentax lenses. Hoya supplies glass for Pentax. Also - and this point is important - there is little product overlap between the 2 companies (except a little bit at Tokina), so the risk of the merger going badly is relatively low. Hoya has been spinning off free cashflow and wanted to redeploy it into a related business. Pentax's medical business is profitable and their camera business has clawed its way back to profitability. Hoya would be crazy to do anything to damage the profitability of Pentax, after they just paid a premium to the recent share price. So they will not be offering premium Pentax lenses like the Limiteds in other mounts. The point I'm making is that if you & I buy a business we do not then immediately go about trying to make it worth less than we paid, and I doubt that business executives will do the same.

Hoya gets the medical business and Pentax's R&D strength. Pentax gets shielded from the volatility of the business environment because it's part of a bigger company - it really isn't very big as a standalone. It also gets a stable and hopefully cheaper source of high quality components (glass).

What is interesting and hasn't been commented on in the various fora is that Hoya will now be competing directly with its customers. That is, the Pentax subsidiary will compete with Canon, Nikon, Sigma, etc but Hoya will be selling glass components to them at the same time. This doesn't seem to be a big deal though. Witness Sony and their digital sensors and the fact that Hoya already had their Tokina subsidiary. But it will be interesting to see how this dynamic plays out.

P.S. Hoya (7741 JP) is a public company and info on their business is available.
Pentax's photo division will never die- they've been around for so many years!

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12-26-2006, 12:12 AM   #4
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I even don't want to see a "Hoya Pentax HD Corporation" under *any* Pentax camera, but the reality is that it *will* appear!

Well, that's called "reality".

Actually, I love "Asahi" most, but it was in past tense..

QuoteOriginally posted by Mo Quote
I just hope that the new DA* lenses won't be branded as Hoya-Pentax, since the roadmap says that DA* is a tentative name!

Tranq, you said it all in this post:



Pentax's photo division will never die- they've been around for so many years!


12-26-2006, 08:13 AM   #5
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Thanks George for a measured, informed intelligent response. I refused to join in the "feeding frenzy" over at DPR because it looked like just that; a feeding frenzy, with no one stopping to think. Just a bunch of emotions all over the place. Nice sound analysis like yours is a refreshing change from the "storm und drang" happening every where else. Thanks. I think you are correct, but even if you are not I'm OK. My DS still works the same as it did before the merger announcement. I imagine it will still be working after the merger is finished. If a worst case scenario happens and pentax folds, I have enough different kinds of lenses so that I'm still able to take most any photograph my limited talent allows. What's to worry? Eventually my DS will break, it's a given but that may be 10 years down the road! I will survive.

NaCl(I'm not about to commit hari kari just because somewhere down the line I MAY have to change systems)H2O
12-26-2006, 08:56 AM   #6
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Hi George,

I wish I had the same degree of optimism you have. They are all reasoned arguments and I certainly will continue to hold out hope that you are right.

I've lived through two mergers of technology companies and both went badly for the employees and the product lines. I know every merger occurs for its own reason and it's not fair to look at one and use it as the measuring stick for another, but tell me, how many times have successful, healthy companies merged? It's never about "creating synergy", despite what the press reports read, it's always about "increasing shareholder equity" and that usually is bad for everyone except the shareholders.

Best light.

-E
12-27-2006, 09:23 PM   #7
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Is it snowing outside?

Hi George,
Quiet day at home huh? lol

You have obviously put a lot of thought into this, and having met you and knowing your background I would give your thoughts a high degree of credibility.

I guess at the end of the day we will all just have to wait and see, these companies are going to do what they will for all the 'right' reasons, according to their gospel.

Evolution takes no prisoners and has little respect for heritage, but I'm willing to bet that out there in the future I will be able to buy something that suits my needs photographically...what name will be on it is anyone's guess.

Have a great New Years and look after yourself.
Grant
12-28-2006, 06:30 PM   #8
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George, thanks for the analysis. I tend to agree with much of what you say, plus there is another angle to this - Japanese companies have a history of "banding together" as a form of financial protection, and an equally long history of "big portfolio" companies with multiple product streams. Examples that come to mind include Matsushita, Mitsubishi and many others. Hoya and Pentax are very compatible in the sense that there are few areas where they directly overlap, but many where they compliment.
Pentax imaging has considerable cachet in the far east as a camera brand which they could exploit to build up their other optical products - plus it should introduce plenty of spin-off technology benefits to the medical products line. Provided it remains profitable, and the camera business as a whole looks healthy (which SLRs do at the moment) then there is no reason for them to pull out. Plus camera bodies leverage lens sales, and having ones "in house" brand (Pentax) plus a third party brand (Tokina) is a neat way of removing costs and leveraging sales in both businesses.
I cant imagine they would compromise the future of Pentax Imaging as a business or a brand unless the camera business as a whole really bombed, in which case they would all be in the same boat.

12-30-2006, 01:18 AM   #9
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Thanks everyone for your kind responses.

Today I took a quick look at Hoya Corp. I am busy right now but I will try to marshall my thoughts and put them down at a later time. So far I haven't seen anything that will make me change my mind about what I've said. I will probably not drill down into too much granularity on Hoya but I will try to get a few numbers to flesh out details. I can't read Japanese. Plus I'll keep any diatribe down to a minimum this time.
12-30-2006, 06:01 AM   #10
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Diatribe???? I don't think so. That is probably the longest post I've read from start to finish. You certainly managed to KEEP my attention.
01-04-2007, 05:39 PM   #11
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Hoya comments

One of the respondents in this thread wondered about the wisdom of mergers.
I can say that mergers and acquisitions happen all the time and quite often
for very legitimate reasons. It is just that you don't hear about the
successful acquisitions because they aren't really newsworthy.

Now, on to Hoya.

----------

Hoya is a precision components supplier for multiple industries, with strong market share.

Fiscal 2006 (March) Revenues = Yen344,228MM (100%)
Masks (LCD/semiconductor/blanks) = 25% revenues
Magnetic/optical disks = 20%
Optical glass = 14%
Vision care/eyecare = 30%
Medical care = 10%
Other = 1-2%

By way of comparison, Pentax's fiscal 2006 revenues were Y142,211MM and growing to about Y160,000MM for fiscal 2007. Approximately half of Pentax's sales is in the medical segment, which will boost Hoya's relatively small medical business. When you line them up there is little overlap between Hoya's and Pentax's products, the actual sales overlap perhaps low single digit %.

Part A - earnings statements
Its main lines of businesses are generally doing well and usually dominate their industry (ie. have large market share). On a consolidated basis this company has 30% operating profit margins and over 20% net profit margins. In plain english it is Seriously Profitable.

Hoya generates far more cash than it needs and over the last 3 years has converted about 15% of revenues per year into cash that it didn't need that year. And if that isn't impressive enough, on top of it all revenues over the last 3 years have grown in the double digits per year.

You do not see this combination very often. It's quite unusual. Good job!

Part B - balance sheet
At the last fiscal year end 23% of total assets was cash (was over 30% of assets for FYE2005!). Debt, pre-Pentax merger, is pretty much zero. Intangible assets are also immaterial.

1/4 of your total assets is cash. Nice!


Part C- Here's my thoughts

1) This is a conservative balance sheet.

2) I am not saying that Pentax is operationally poorly managed but after seeing these results Hoya could probably transfer some capabilities to Pentax.

3) Pentax's products complements Hoya's healthcare and camera divisions. In other words, Hoya can offer a more complete package of goods. There is also the opportunity for some streamlining of logistics & operations - for example, Hoya's distribution system can probably piggyback some Pentax SKUs.

4) Existing Hoya customers should be happy if a good supplier like Hoya can offer a more complete suite of goods. For example, it's much easier & less administrative to order to order a bigger basket of goods from 1 supplier
than several.

5) Existing Pentax customers, whether imaging or medical, should be happy because their supplier is on a much sounder financial footing now that Hoya
is the parent company.

-----------

Let's tie everything together.

(I) Why would a company that has dominant market share in its electro-optics and 30% operating margins want to buy a small company with 30% market share in endoscopes (vs. Olympus at 70%), <5% in SLRs, and has much lower profit margin?

I can give you all sorts of glib reasons for why Hoya wants to buy Pentax. But let me be clear. I do not believe that Hoya management is unintelligent. One does not achieve those sorts of financial returns by being dumb.

The most logical is that there is something about Pentax that Hoya thinks it wants or needs. It's probably Pentax's technology portfolio and R&D capabilities. It is reasonable that Hoya will use some of their cash hoard to accelerate Pentax's R&D efforts and ultimately apply any technological innovations across multiple product lines. Hoya also stated that it wants to increase R&D money spend at Pentax and accelerate their new product launches... I suspect because cash has been in somewhat short supply at Pentax.

(II) One can't sit on one's laurels. Hoya must find a use for its excess cash. It can return it to shareholders, invest in more assets for greater growth (ie. capital expenditures), or achieve growth through an acquisition. The invest versus buy decision goes like this: One can spend $X and Y years building a new business or one can spend $X and buy an existing business that you want to get into. Each strategy has its own risks, but the latter gets you there
faster, plus sometimes there are businesses that you simply can not build in a timely manner (like a technology/R&D portfolio?).

Hoya has opted for the latter by buying Pentax. But it is also building up assets through capital spending. It has the luxury of being able to do both.

(III) Opinon: This is a fairly significant acquisition for Hoya. It may be setting up for future acquisitions by building some downstream bench strength and internal infrastructure now. There is certainly nothing to stop Hoya from doing more acquisitions to, for example, plug other holes in its product line.

----------

Nothing I have seen has changed my mind about what I said earlier. As an end user I'm happy this is a vertical integration as I still believe the risk of us being neglected is lowest (not zero, just lowest).

A word of caution. I am not making any investment recommendations on the shares. I am trying to get a sense of the merger's impact solely on us, the camera users. If you want to buy the stock, go lie down until the feeling passes, and then get the advice of your stock broker (I am not one).

Last thought just to tie something photography related into this. I want a FA200/2.8 or new DFA200/2.8. I don't really need one. I just want one.

Last edited by tranq78; 01-04-2007 at 05:45 PM.
01-04-2007, 07:55 PM   #12
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Just want to thank George (tranq78) for this thread and his informative and thoughtful posts. Before I bought my K100D I'd been using Canon cameras for years. I researched the K100D and knew that it was an excellent camera - and a super deal. I didn't research the company, since I've been aware of Pentax since forever and assumed it was a strong company. The news of the merger shortly after I made my purchase was a tad unsettling as I can see myself spending a fair bit of $$ in the next year or two on Pentax-compatible lenses and I'd like my next camera to be a Pentax, too. Anyway, while I'm no kind of business analyst, George's posts do sound reasonable to me. Thanks again, George.

Will
01-04-2007, 08:40 PM   #13
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Thanks again George for the addendum. Next time I'm up at my sister's (she manages pacific rim foreign investments) I'll ask her what she thinks. In any event thank you for taking the time to do this. I appreciate it.

NaCl(I'm resting easier)H2O
01-05-2007, 12:30 AM   #14
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Hi George.
Interesting read.
Would Hoya be eyeing of a bigger slice of the camera market? That would set a fox or two loose in the chook house!!

I guess what I read into it all (including the Samsung component) is that the future is actually pretty exciting and promises a lot. The picture is somewhat of a kalaidescope, forever changing, but pretty none the less.

Thanks for posting the research.
Grant
01-05-2007, 06:11 AM   #15
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A small question...
Given the fact that Hoya seems to like a safe portfolio with excellent margins and profitability, would the imaging division not seem to be a bit risky by Hoya standards? Of is there some technology spinoff between imaging and medical?
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