[Corporate Financing] Hanon Systems, 100 Billion Won Loan... Increasing Borrowings

Magna's Acquisition of FP&C Division Causes Sharp Increase in Debt Burden
Cash Generation Declines Due to COVID-19
Financial Improvement Difficult in Short Term Amid Parts Supplier Downturn
Hahn & Company Faces Headwinds in Equity Exit

[Asia Economy Reporter Lim Jeong-su] Hanon Systems, an automotive climate control parts company whose largest shareholder is the private equity firm Han & Company, is continuously increasing its external borrowings. Last year, the acquisition of the hydraulic control (FP&C) division of the global automotive parts manufacturer Magna caused net borrowings to rise to the 2 trillion KRW range. This year, with the spread of the novel coronavirus disease (COVID-19) pandemic reducing cash generation capacity, the company has been forced to keep increasing its borrowings. This is identified as a factor that lowers the valuation of Hanon Systems, which is mentioned as a potential M&A target in the market.

According to the investment banking (IB) industry on the 6th, Hanon Systems raised 100 billion KRW on the 19th of last month, underwritten by KEB Hana Bank. It is a 3-year maturity loan, with the option for early repayment one year after the loan disbursement. Conversely, if Hanon Systems’ long- and short-term credit ratings fall below BBB- and A3-, respectively, the loan must be repaid immediately. Currently, Hanon Systems holds an AA credit rating, providing considerable leeway before triggering forced repayment.

Hana Bank acquired all of Hanon Systems’ loans through a special purpose company (SPC) and then sold them to institutional investors in the form of securitized bonds and securitized loans. In this process, Hana Bank provided credit and liquidity support agreements to the SPC. This means that if the repayment resources for the securitized bonds and loans are insufficient, Hana Bank will bear the repayment funds instead.

Hanon Systems’ borrowings increased significantly last year due to the acquisition of Magna’s FP&C division. A substantial portion of the 1.4 trillion KRW acquisition funds was raised through acquisition financing, causing borrowings to increase by over 1 trillion KRW within a year. As of last year’s consolidated financials, borrowings approached 2.73 trillion KRW. Net borrowings, excluding cash equivalents, surged from 640 billion KRW to 2.05 trillion KRW during the same period.

This year, the need for external borrowings has increased as cash generation capacity declined due to COVID-19. Hanon Systems announced on the 29th that it would increase short-term borrowings by 150 billion KRW to secure funds for operating expenses and other uses. Consequently, Hanon Systems’ short-term borrowings rose from 220 billion KRW to 370 billion KRW.

Borrowing expansion is expected to continue for some time. Overseas major factories have shut down due to COVID-19, and a significant drop in finished vehicle sales is anticipated, leading to reduced cash generation capacity. Hanon Systems mainly supplies climate control devices to Hyundai Motor Group and Ford, but through diversification of its customer base, sales in the U.S. and Europe now account for over 50%. The spread of COVID-19 is expected to cause significant sales impacts not only in the domestic finished vehicle market but also in the U.S. and European markets.

Capital demand is also considerable. Hanon Systems executes annual capital expenditures (CAPEX) of about 500 billion KRW for research and development (R&D) and other purposes. Additionally, approximately 200 billion KRW annually is expected to be used as cash dividends. Last year, earnings before interest, taxes, depreciation, and amortization (EBITDA) were 860 billion KRW, which is not significantly insufficient for covering financial costs, investments, and dividends. However, with recent performance declines, external borrowing has become inevitable. A credit rating agency official predicted, "It will be difficult to expect financial structure improvement through internal cash generation for the time being."

This is expected to act as a factor lowering the valuation of Hanon Systems, which is mentioned as a potential M&A target. Hanon Systems is 50.5% owned by Han & Company’s subsidiary Han & Co Auto Holdings and 19.49% by Hankook Tire & Technology. In 2015, Han & Company and Hankook Tire acquired 70% of Hanon Systems (then Halla Visteon Climate Control), which was held by U.S. Visteon, for 3.8 trillion KRW. Last year, they expanded the company by acquiring Magna’s FP&C division for 1.4 trillion KRW.

An IB industry insider said, "Even after the normalization of COVID-19, it is difficult to guarantee an increase in global finished vehicle sales, so valuations of automotive parts companies in the M&A and investment markets are declining," adding, "Successful equity exits are unlikely for the time being."