FREE KIC - NO. 77 APRIL/MAY 12

CLOSING RANKS – JAPANESE STYLE

In this my annual opinion piece on Japan I want to update readers on the fascinating developments at Olympus. I also want to give an update on other interesting developments in the broader Japanese investment sphere.

Last November when I wrote about Olympus Michael Woodford had indicated that he was prepared to accept the role of CEO if the shareholders and new board of directors were prepared to appoint him. At that stage Japanese shareholders had not indicated what they were thinking so I concluded the piece with the following:

If Woodford doesn’t succeed it will be an indication that Japan remains stuck in the past. I just cannot wait to see what happens next.

Unfortunately it is now clear that the ruling elite in Japan remain unwilling to change. The main Japanese shareholders led by Sumitomo-Mitsui Bank were not even prepared to meet Michael Woodford and made it quite clear that any attempt to get elected to the board would fail. Woodford and the foreign shareholders that backed his attempt had to grudgingly accept that they were powerless to get their people on the board.
The new Chairman Yasuyuki Kimoto is a former executive of Sumitomo-Mitsui Bank and therefore it appears quite clear to me that "traditional" Japan has closed ranks and put in place a new board that will not break with tradition.
(Ironically when I put the name Yasuyuki Kimoto into Google to see what I could find out about the man I was intrigued to find a picture of him on a visit to Ireland. This picture and some further information is included at the end of this opinion piece)

The Olympus scandal confirms my belief that Japanese companies will continue to do things their own way and this means that employees will remain the top priority and foreign shareholders a very low priority.

In addition to the problems at Olympus there has been another recent example of a leading Japanese company doing something that appears quite strange to foreign shareholders. NTT Docomo (the largest mobile phone network) on January 30th announced that they were trying to buy a company called Radishboya. This is a very small deal but it just seems so unusual because Radishboya is involved in the food business. Here is how they describe the purpose of the acquisition:

DOCOMO, a growing provider of integrated services centered on mobility, regards food as a promising field for new business development, because these products are suited to mobile commerce. At the same time, DOCOMO believes it can help expand Radishbo-ya’s customer base through access to DOCOMO’s approx. 60 million subscribers. DOCOMO expects to increase customer satisfaction for both companies by combining Radishbo-ya’s products, long regarded in Japan as a top brand with high standards of quality, and DOCOMO’s smartphones, tablets and mobile services. DOCOMO will drive innovation by collaborating with Radishbo-ya in areas including food safety, solutions for graying society, and agricultural and environmental issues. DOCOMO, which is evolving into an integrated service company centered on mobility, intends to accelerate its deployment of related commercial businesses through the acquisition.

Here is what one analyst had to say about this transaction:

NTT DoCoMo has been making investments that turned out to have dubious consequences in the absence of an obvious strategic fit at the rate of about one every three or four years. In 2005, it spent roughly ¥12.8bn to acquire a stake in Tower Records and in 2009 some ¥31bn on the TV marketing company Oak Lawn Marketing, giving as its main reason plans to use the companies as vehicles for mobile commerce.

I would guess that if Vodafone announced that they were about to move into the food business and had a poor record of diversification there would be a few questions asked about management.
I really struggle to see the logic of this move but as it is a Japanese company there is no accountability and I have to accept that Japanese shareholders will not do anything about it.

NTT Docomo isn’t the only Japanese company making acquisitions. In other opinion pieces I have written about Asahi Chemical as a prime example of a traditional Japanese conglomerate. They too have been on the acquisition trail. They agreed to spend over $2bn on American company Zoll Medical. Here is what one analyst had to say:

The offer price of $93/share values Zoll Medical at $2.21bn, making it Asahi Kasei’s largest-ever acquisition. The offer works out to a FY2011 PER of 71x and EV/EBITDA of 29x. As Zoll Medical’s business is slightly different to Asahi Kasei’s existing healthcare (pharmaceuticals/medical devices) business, we do not anticipate large synergy benefits near term and from this perspective the acquisition price strikes us as somewhat high. Asahi Kasei believes Zoll Medical’s organic growth will be quite strong, so actual growth rates will have to determine the validity of the acquisition price.
In other words this appears to be an expensive acquisition and given the track record of Japanese companies I would be concerned that an appropriate return will be difficult to achieve.

NTT Docomo and Asahi Chemical are not alone. As the following chart shows Japanese companies are spending more on foreign acquisitions than they ever have.

In the past Japanese companies had a very poor record in terms of foreign acquisitions (the following report from the Economist Intelligence Unit researches this topic)
My instinct tells me that once more Japanese companies will struggle to make these acquisitions work.

With Japanese companies spending more money on acquisitions they have less for dividends or share buybacks. Allocation of capital therefore remains a real problem and depresses me because there are so many really cheap companies (cheap relative to assets) that I would love to buy if I thought that they would be managed in a reasonable way.

In the past I have expressed the hope that the demise of the Liberal Democratic Party (LDP) would lead to a significant change in the political landscape but unfortunately political leadership remains a problem. The DPJ appear to be prone to the same problems as their predecessors. Attempts to increase the sales tax and decisions about the future of nuclear power generation suggest that the political system remains in a state of severe difficulty.

Overall then I struggle to find anything new that is positive to say about potential investment opportunities in the Japanese market. The cheapness of the market is the one big positive but unfortunately I worry that it will remain cheap for many more years to come.
It appears that it will take a crisis to bring about change and my crystal ball struggles to foresee when that might happen.

SIGNIFICANT INVESTMENT AT KERRY TECHNOLOGY PARK BY A MAJOR JAPANESE BANK

In September 2011, JRI America Inc announced its plans to establish a Software Development Operation at Shannon Development’s Kerry Technology Park in Tralee, Co. Kerry. The company has already put in place a core team of 10 people at its new facility which will quickly grow to 25, with the potential to create an estimated 100 highly skilled positions over the next 5 years.

JRI America Inc is a subsidiary of the Japanese IT financial services company, Japan Research Institute Ltd (JRI), which is the specialist IT subsidiary of Sumitomo Mitsui Financial Group (SMFG), owners of Japan’s second-largest bank, Sumitomo Mitsui Banking Corporation. The Tralee operation will support the group’s Western Hemisphere IT operations In North America and Europe.

Mr. Yasuyuki Kimoto, President of the Japanese Research Institute, recently visited Kerry Technology Park to view the new facility and to welcome the new employees to the company. Mr. Kimoto said: “JRI places a strong emphasis on loyalty and teamwork and the company believes it can build a sustainable team in Kerry Technology Park to implement its long term vision.”



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