Shareholder activism in Japan on the rise, but change will be difficult

Raid in Japan

02 November 2007 14:54  [Source: ICB]

Shareholder activism - the words strike fear in the hearts of company boards and management. What was once mainly a US phenomenon is spreading across the globe and the crowds are at the gate

Joseph Chang/New York

IN THE land of the rising sun, a new dawn has broken - the emergence of the activist shareholder.

Led by firms such as Steel Partners and Dalton Investments, this development could change the face of corporate Japan, but not without a fight.

Why Japan? The corporate culture fosters the accumulation of cash reserves at the expense of dividends or reinvestment, a reluctance to reduce the workforce, and layered, inefficient management structures. According to many observers, shareholder rights often come last.

"Japanese management does not consider shareholders seriously yet," says Junichiro Sano, CEO of Dalton Investments in Japan. "They believe the company is run for management, employees, related domestic financial institutional investors, suppliers and customers. Lastly, come shareholders. They say that this goes back over 100 years in the history of Japan."

"For more than 100 years, the structure of Japanese public companies has been very unique," says Peter Young, president of New York-based investment bank Young & Partners. "All the major industrial groups like Mitsubishi and Mitsui had related companies in areas such as banking that were all working together as Kiretsus [conglomerates]."

The structure of having cross-ownership of shares between the related companies would make a takeover next to impossible. This structure also insulated management from external influence.

"Companies would be resistant to not only takeovers, but any kind of pressure from the outside," says Young. "The idea of fiduciary duty was convoluted, because these companies were all owned by each other. Over time, the change to broader ownership has been very slow."

Sano notes that Japanese corporations also perpetuate the myth that having no debt is beneficial. "Many public companies still believe that no debt is the best. They treat their financial statements like their own household book," he says. "They don't care about return on equity and return on assets as much."

Because of these inefficiencies, activist shareholders see great opportunity to get management to boost shareholder returns, especially in small to medium-sized companies, where stock ownership is spread out to the general public.

UNDER SIEGE

Last April, Los Angeles, California-based Dalton Investments met with the managements of Nippon Fine Chemical and Fujitec to propose friendly management and employee buyouts (MEBOs) of the companies.

For Nippon Fine Chemical, Dalton offered to buy out all outstanding shares for yen (Y) 900 ($7.67), or Y24bn, representing a 12% premium to its previous stock price. The Y900/share offer for Fujitec, or Y84bn, represented a premium of 11% to its prior share price.

Dalton holds a 15.3% stake in Fujitec and 14% of Nippon Fine Chemical.

Dalton, which has about $1.3bn (€900m) in assets under management, said the offers gave the opportunity for both companies to significantly restructure their operations, without the pressures of being public companies.

"Nippon Fine Chemical has a real estate development business which is irrelevant to their core chemical business," says Sano. "We have been advising management to sell out and concentrate on their main business."

That's been a common demand from many activist shareholders.

In August, activist shareholder Ichigo Asset Management, which is led by CEO Scott Callon, reported a 7.08% stake in Patlite, a producer of lights, LCD devices, voice synthesizers and micromotors, among other products.

One of its demands was that Patlite "stop noncore real estate investments and unsuccessful product sales that have wasted Patlite's hard-earned profits."

While Dalton has not been able to engineer buyouts of Nippon Fine Chemical and Fujitec, it has made progress on a ­number of fronts.

"We have been holding Nippon Fine Chemical for three years and management has finally started listening to us in the last 18 months," says Sano. "They adopted our ideas of raising dividends every year by 35%, giving $26 worth of detergent to shareholders at the end of the fiscal year lowering the minimum trading unit to improve liquidity and having a more open shareholders' meeting, with a presentation of their business model."

Nippon Fine Chemical's ARBOS brand detergent, with a retail value of $26, was delivered to shareholders for the first time in March 2007.

"The company wanted to send the message that it is more aware of shareholders' existence, and also wanted to draw the attention of individual investors," says Sano.

Dalton is not the only foreign fund seeking to make changes in Japan through shareholder activism.

"EDUCATE AND ENLIGHTEN"

In June, Warren Lichtenstein, chairman of New York-based Steel Partners, made his first public appearance in Japan.

"I enjoy my privacy, but I feel that at this point in time, we need to educate the management of Japanese companies that we invest in," he said at a news conference in Tokyo. "The first thing we need to enlighten them on is that we are here to help. Japan is a world-class country with the world's second-largest economy. It should have world-class financial systems and corporate governance systems as well."

Lichtenstein's attempts to "educate" and "enlighten" corporate management in Japan have not been well received, to say the least. His company is well known for launching a series of hostile buyout bids.

Lichtenstein characterized Steel Partners, with $7bn under management, not as an activist, but as an "active value investor" that makes "unsolicited," rather than hostile, offers for companies.

Steel Partners has holdings in a wide range of Japanese companies, from wigmaker Aderans to brewer Sapporo to circular saw firm Tenryu Saw Manufacturing to food maker Nissin Foods and condiment company Bull-Dog Sauce.

Also in June, the benign-sounding, London-based The Children's Investment Fund Management, known as TCI, attempted to wring out higher dividend payouts from Japan's Electric Power Development (J-Power) but had the proposal rejected, coming up short with 30% of the vote. TCI owned 9.9% of J-Power.

TCI, which donates a portion of its profits to charities helping orphans, is now seeking to make itself more accepted in Japan.

Foreign activist funds have targeted Japan, but are they making inroads? Not if you're looking at the tally from shareholder votes.

POISON PILL HARD TO SWALLOW

Shareholders have overwhelmingly turned down activists' proposals and even sided with management in adopting poison pill takeover defense mechanisms.

In July, Bull-Dog Sauce effectively blocked Steel Partners' takeover bid by instituting a highly unusual poison pill that diluted Steel Partners' 10% stake in the company to a less threatening 3%.

A Tokyo court labeled Steel Partners a "hostile acquirer" and upheld the poison pill Steel Partners had challenged as discriminatory and in violation of Japanese law.

Public perception of these activist funds has also declined with the proxy fight and court ruling.

"The characterization of Steel Partners as an "abusive investor" by the Tokyo higher court was a disappointing setback in shareholder activism in Japan," says Sano. "As a result of the court decision, the public perception of these Gaijin [foreign] funds has been that they are abusive and evil to the Japanese business community. Unfortunately, the Japanese media accelerated the propaganda."

Almost 400 Japanese companies have proposed or implemented poison pills to keep activists at bay.

"It is very unlikely we'll see a takeover of a large Japanese company by a foreign fund," notes Young. "In the lower tier, it may happen one day, but it is still very ­difficult. For private equity or venture funds to go in and do traditional deals is very challenging. Even for Japanese private equity firms, it's difficult."

But how long will management be able to keep the crowds at the gate? Foreign investors already own 28% of Japanese equities and are aiming to spread their values to Japanese shareholders.

"The level of Japanese individual investors' awareness is increasing to the level of the Gaijin," says Sano.

"Many are now becoming aware of the concept of 'shareholder democracy.' When both Japanese individual shareholders and the Gaijin activist funds march hand in hand in the name of shareholder democracy, they will walk the path to prosperity."

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