Japanese investors becoming the life of the party

OLYMPUS

21/03/2024 24:00

(The authors are Reuters Breakingviews columnists. The opinions
expressed are their own.)
    By Jeffrey Goldfarb and Una Galani
       NEW YORK/MUMBAI, March 21 (Reuters Breakingviews) - It
has taken 35 years to restore faith in the earning power and
decision-making of Japanese companies. This confidence is
reflected in the Nikkei 225 Index  .N225  reaching, and
surpassing, the same record high as during the peak of the
country’s economic power in 1989. The painstaking structural
changes contributing to the turnabout are evident in the
achievements of three U.S. investors: Warren Buffett’s Berkshire
Hathaway  BRKa.N , ValueAct Capital and Elliott Management. More
importantly, domestic fund managers look poised to keep the
momentum going.
    For a long time, Japan was frosty to outside providers of
capital, epitomized by the arrival of T. Boone Pickens back when
Tokyo-listed companies accounted for nearly half the world’s
market capitalization. The Texas oil tycoon and corporate raider
stormed Koito Manufacturing  7276.T  after Japanese buyers had
scooped up American assets, including Rockefeller Center and
Columbia Pictures, without providing reciprocal access to
foreigners. He accumulated 26% of the headlight-maker and
pressed for board seats and disclosure about special treatment
given to Toyota Motor  7203.T , a major shareholder and
customer, in the first overseas siege of its kind for Japan Inc.
    Pickens had his 10-gallon hat handed to him. He stormed out
of the annual shareholder meeting and Koito executives scoffed
at his demands. Pickens sold his stake in 1991 after Tokyo’s
stock market bubble had deflated.
    Recent interlopers have received a more gracious welcome.
Endoscope-maker Olympus  7733.T  invited ValueAct
representatives onto its board in 2017, and the fund manager has
since disclosed seven additional investments in Japanese
companies that account for about a fifth of the $10 billion it
oversees. Elliott, a firm with a more antagonistic reputation,
has deployed at least $4 billion in Japan in the four years
since it urged changes at Masayoshi Son’s SoftBank Group
 9984.T . And Buffett put his valuable imprimatur on the
country’s sprawling trading houses, with his Berkshire Hathaway
recently adding to holdings worth $19 billion at year-end.
    The trio’s success, in their distinctive ways, underscores
fresh enthusiasm for spotting hidden value in Japan that builds
on efforts by closer-to-home aggressors such as Yoshiaki
Murakami and his former colleagues at Singapore-based Effissimo
Capital Management. The potential to shake up stodgy and cozy
boards, unlock vaults of hoarded cash and lift profitability
went unrealized for years. Then-Prime Minister Shinzo Abe
renewed hope in 2012 when he fired his proverbial three arrows
to revive the stagnating economy, one of which targeted
corporate governance.
    While the latest outsiders bring high-profile clout, it’s
their ability to find common ground with local funds that’s
turning the tide. Japanese portfolio managers are increasingly
expressing displeasure at the ballot box and initiating their
own dissident campaigns, as foreign activist investors and their
tactics steadily become just as integral to the financial
firmament as in the United States and Europe.
    Some of the changes are striking. Widespread board shakeups
have led to a dramatic increase in the proportion of members
deemed independent. At the same time, more directors are facing
greater opposition in shareholder votes, according to tallies
from proxy adviser Georgeson. Among them was Canon  7751.T 
Chairman Fujio Mitarai, whose support fell below 51% as
influential shareholders including BlackRock  BLK.N  voted
against his reappointment. Top brass at electronics group
Kyocera  6971.T  encountered similar resistance when
Institutional Shareholder Services took issue with its stake in
a telecom company. Such cross-shareholdings, a legacy of the
country’s interlocking corporate structures, have been
dwindling. Neither Canon nor Kyocera were up against any public
pressure from overseas investors. 
    After Abe’s government championed a series of better
corporate governance and stewardship practices, the drive to end
deflation and stimulate growth spawned more recent directives
requiring companies to acknowledge their cost of capital and
explain how they intend to lift valuations above 1 times book
value. By this measure, Japanese companies badly lag U.S. and
European peers, per investment firm Capital Group. In October,
the Tokyo Stock Exchange said even those at the 1 times
threshold should be aiming higher. It’s all a far cry from 2008,
when the vice minister of economy, trade and industry called
shareholders “stupid, greedy, adulterous, irresponsible and
threatening,” according to the Wall Street Journal.
    ValueAct has seized on the rectifications, seeking to
influence videogame developer Nintendo  7974.T , job-search site
operator Recruit  6098.T  and others with attractive gross
margins and substantial overseas profit. It persuaded Olympus to
make the seemingly heretical decision to sell its storied albeit
money-losing camera division and concentrate instead on more
highly valued medical devices. The fund did something similar at
chip materials maker JSR  4185.T , where ValueAct co-CEO Rob
Hale also joined the board. And while he has struggled to
persuade Seven & i  3382.T  to focus more on its 7-Eleven
convenience stores, ValueAct’s Japan fund, started in late 2022,
gained 32% last year, compared to 39% for its flagship fund and
25% in the Topix Index  .TOPX .
    Elliott is also generating success with its approach. It was
an instrumental combatant in the prolonged fight against
scandal-ridden Toshiba, winning a board seat and using the
position to ensure the conglomerate kept shareholders apprised
about a strategic review that ultimately led to last year’s $14
billion sale. In addition to advocating for better governance at
SoftBank and Dai Nippon Printing  7912.T , Elliott nudged both
companies into chunky stock buybacks. It is also targeting
Japanese companies less known internationally where domestic
shareholders have a bigger presence.
     Buffett, too, has his own agenda. Berkshire borrowed 1.3
trillion yen ($8.6 billion) in the bond market when interest
rates were near zero and plowed the cash into five Japanese
conglomerates – Itochu  8001.T , Marubeni  8002.T , Mitsubishi
 8058.T , Mitsui  8031.T  and Sumitomo  8053.T  – with dividend
yields around 5%. The Oracle of Omaha last month praised some of
their “shareholder-friendly policies that are much superior to
those customarily practiced in the United States,” namely
repurchasing shares “at attractive prices.”
    If the United States is any guide, there should be
considerable improvement to come across Japan Inc. Before
barbarians like Henry Kravis and Pickens turned up at U.S. gates
in the 1980s, many American companies were almost as hapless
with their governance, capital costs and balance sheets as
Japan’s pre-Abe.
    Goldman Sachs  GS.N  analysts now expect Topix members to
grow earnings per share faster through 2025 than peers in U.S.,
European and Asian benchmarks. Corporate profitability in Japan
also has room to catch up with other regions. Moreover, local
hedge funds accounted for almost two-thirds of the record
activist activity in 2023, up from about half over the previous
five-year span, according to investment bank Lazard  LAZ.N .
It’s a sign that while foreign investors are helpfully
illuminating opportunities, domestic ones will be leading the
charge.
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    <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Graphic: Japanese companies lag regional peers in important
metrics    https://reut.rs/3vfyEPc
Graphic: Nearly all Tokyo-listed companies now have boards where
at least a third of directors are classified as independent    https://reut.rs/3TGLCie
Graphic: Price-to-book ratios lag across Japan Inc    https://reut.rs/4ciEcJp
    ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
 (Editing by Peter Thal Larsen and Aditya Sriwatsav)
 ((For previous columns by the author, Reuters customers can
click on  GOLDFARB/  GALANI/ 
jeffrey.goldfarb@thomsonreuters.com; Reuters Messaging:
jeffrey.goldfarb.thomsonreuters.com@reuters.net; 
una.galani@thomsonreuters.com;  Reuters Messaging:
una.galani.thomsonreuters.com@reuters.net))