As a journalist with the Financial Times I lost count of the sheer number of times I attended presentations by fund managers keen to sell the press on the idea that this time the Japanese equities markets and economy were about to be resurrected, that the Japan investment outlook was improving. Following the famous bursting of the Japanese market bubble in 1989-90, dozens of analysts and fund managers have tried to call the return of Japan to its previous position of economic strength in the 1980s, but to no avail.
Japanese companies typically have too much cash on their books, and are wearing too much leverage. While management will change at the top of Japanese companies every four of five years, the same habits remain. This creates both problems and opportunities for Japanese companies.
Yet the government of Japanese prime minister Shinzo Abe is devoting an impressive amount of effort towards resurrecting the country’s so-called ‘animal spirits’. Japanese government bond yields are at zero, while many Japanese executives remain content to obediently serve out their time in big corporations that are simply going nowhere.
What is different in the Japan investment outlook is the enhanced scrutiny on corporate governance. High profile frauds and simple corporate malfeasance are becoming harder to defend in Japan, as they are elsewhere. In addition, there is emerging a new breed of home grown fund managers who specialise in short selling and holding companies to account. They are prepared to get noisy about this, and in such a static corporate culture as exists in Japan, this creates both waves and opportunities.
The Japanese government is encouraging this, as it wants to see some of these monolithic corporate entities held to account. We have already discussed the pressure Toshiba has been under recently in Short of the Week.
“They’ve gone ahead and had such public exposures of trading companies that made enormous amounts of acquisitions in 2011-12, when commodities were really high,” says Seth Fischer, CEO of activist hedge fund Oasis Management Company. “You have all these European and US commodity companies that took the pain in 2013-14, took the pain, and have since recovered. Whereas in Japan it takes such a long time to take the pain, and they haven’t taken the pain yet. So now you’ve got people who have gone and scrutinised these assets, and have said they are not worth the current valuation.”
Toshiba, for example, purchased Westinghouse and avoided writing it down for years, mainly due to a need to avoid the embarrassment of making a disastrous purchase. Toshiba is not alone (take a look at Mitsui for example); several major Japanese trading companies have made bad deals in the last six or seven years, have not written these down, and are consequently under scrutiny.
There is also now a real attempt to tackle the so-called holding network, where big Japanese companies take stakes in each other subsidiaries. It is considered to be a mutual protection pact between the big bosses, helping them to look after each other’s careers, watch each other’s backs. But this has created a structural crisis for Japan.
There are also a lot of Japanese subsidiaries which have been listed for the wrong reasons – one example given to Fischer was so that employees could get a mortgage and the company could boost recruiting. He now sees a situation where large Asian private equity funds will become more aggressive in the Japanese market, they have the cash and can raise more to finance leveraged buy-outs. In the meantime, some Japanese companies are looking to buy back some of those listed subsidiaries and/or buy out minority shareholders. With changes to the Japanese corporate governance, this could be harder than it was historically.
Panasonic, for example, is seeking to buy PanaHome, one of its subsidiaries, a Japanese house builder. A month ago it was trading at JPY 1032, and it is now at 1237 at time of writing (Japanese market close on 28 April). Yet 60% of PanaHome’s market capitalisation is in cash and the company’s management has been determined not to deploy it effectively. Ultimately, it seems as if Panasonic wanted to buy PanaHome and its cash pile back cheaply and quietly. The valuation, says Fischer, was determined by a committee of two lawyers, an HR director and an accountant, none of them very qualified to reach that figure.
Fischer feels passionately enough about the poor offer to create a web page, www.protectpanahome.com, where he outlines his views on the value of Panahome.
“It’s a live conversation,” says Fischer. “What is interesting is that I’m getting paid to do this now, as it’s trading 3-3.5% over the offer. Maybe the market gives us a 10% chance of winning, but I think our chances are higher. We’ll see what actually happens. At the end of the day, if we don’t win now, the nice thing about Japan is that we’re very robust and we’ll pursue this to the courts.”
The advent of more activist investment in Japan is bound to shake up the cosy environment of cross-holdings which, possibly more than anything else, has been keeping Japanese share prices in deep freeze and undermining the Japan investment outlook. After all, why let something get too expensive if you plan to buy it back cheaply in the future? Investors in Japanese stocks will need to keep a very close eye on the activity of alternative fund managers interested in this market, as they are more likely to shake things up than more passive, long only funds.
At The Armchair Trader we’re big fans of activist funds and their efforts to generate more shareholder value. We’ll be revisiting this theme, both in Japan and further afield, in future articles.