Central to the discussion of sub-liquidation value investing in Japan is the ability or willingness of shareholders to influence management, and management’s willingness to listen. As Ben Graham noted in the 1934 edition of Security Analysis, in the US:
The whole issue may be summarized in the form of a basic principle, viz:
When a common stocks sells persistently below its liquidating value, then either the price is too low, or the company should be liquidated. Two corollaries may be deduced from this principle:
Corollary I. Such a price should impel the stockholders to raise the question whether it is in their interest to continue the business.
Corollary II. Such a price should impel the management to take all proper steps to correct the obvious disparity between market quotation and intrinsic value, including a reconsideration of its own policies and a frank justification to the stockholders of its decision to continue the business.
The perception is that, in Japan, these two corollaries do not flow from that basic principle. As The Economist notes in a February 2008 article, Samurai v shareholders: Japan’s establishment continues to rebuff foreign activist investors (subscription required):
Japanese businessmen and politicians fear that the activists are short-term investors keen to strip firms of their cash. The conflict highlights a fundamental divide: companies in Japan are social institutions with a duty to provide stable employment and consider the needs of employees and the community at large, not just shareholders.
And therein lies the rub. Companies in Japan are social institutions with a duty to provide stable employment and consider the needs of employees and the community at large, not just shareholders.
Can foreign investors not subject to the cultural expectation that companies consider the needs of employees and the community at large succeed?
According to a 2009 Knowledge@Wharton article, How the Environment for Foreign Direct Investment in Japan Is Changing — for the Better, the environment for foreign investors in Japan is improving, but continues to be more bureaucratic than in the US:
Despite the support shown by elected officials for increasing [foreign direct investment] in Japan, foreign investors still face a substantial amount of bureaucratic red tape, particularly with respect to protected industries. [Direct investment] is principally governed by the Foreign Exchange and Foreign Trade Control Law, which specifically prevents foreign investors from acquiring a majority stake in Japanese companies within industry sectors classified as closely related to national security and public safety. This includes industries as diverse as aeronautics, defense, nuclear power generation, energy, telecom, broadcasting, railways, tourist transportation, petroleum and leather processing.
Foreign investors intending to make direct investments in certain industries must file with the Japanese Ministry of Finance as well as the respective ministry governing the specific industry of the investment target. If issues are found in relation to the investment, either the Ministry of Finance or the industry-specific ministry has the authority to issue an official recommendation to revise the investment plan or to put a complete stop to the acquisition. Industry-specific regulations that, for example, limit foreign ownership to one-third for airline and telecom companies, further constrain foreign investors.
It’s worth considering the experience of two notable activist campaigns in Japan. The first, Steel Partners’ campaign for Sapporo, the brewer, is described in the Knowledge@Wharton article:
Steel Partners has imported its U.S. activist investment model to Japan and has shown a willingness to question publicly the strategy of current management at its investment targets and to litigate disagreements.
As a result of Steel Partners’ posture, the firm’s take-over bid for household-brand Bulldog Sauce met with resistance from the media and Japan’s legal system. The court to which Steel Partners appealed a failed injunction to prevent Bulldog’s poison-pill strategy stated: “[Steel Partners] pursues its own interests exclusively and seeks only to secure profits by selling companies’ shares back to the company or to third parties in the short term, in some cases with an eye to disposing of company assets…. As such, it is proper to consider the plaintiff an abusive acquirer.”
The Economist article discusses the The Children’s Investment Fund’s (TCI) battle for the Japanese power provider J-Power:
The biggest showdown between the activists and the establishment is at J-Power, the former state-run energy firm, which was privatised in 2004. [TCI] a British fund, which owns 9.9% of the firm, has been politely but firmly lobbying J-Power to appoint two TCI representatives to its board, improve margins and unwind cross-shareholdings with other firms. Having been rebuffed, TCI now wants to double its bet. In January it asked for permission to increase its stake to 20% (any holding above 10% requires government approval). John Ho, the head of TCI’s Asian operations, says the deal is a test of the integrity of Japan’s reform agenda. And it would be, except that Mr Ho has chosen a remarkably hard case. Japan, lacking natural resources, is worried about energy security and is reluctant to hand more control over its power infrastructure to foreign investors.
The Knowledge@Wharton article concludes:
After applying for approval to increase shareholdings to 20%, TCI met a wall of resistance: J-Power management cautioned that TCI could cut maintenance and investment costs in nuclear plants, and the Japanese media relayed sensationalist warnings about the potential for “blackouts.” The result: The Japanese government blocked the investment.
These are not encouraging outcomes. The final word is best left to Takao Kitabata, the vice-minister of Japan’s powerful Ministry of Economy, Trade and Industry (METI):
To be blunt, shareholders in general do not have the ability to run a company. They are fickle and irresponsible. They only take on a limited responsibility, but they greedily demand high dividend payments.
High dividend payments? We’re a long way from liquidation as a matter of course.
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