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Asia-PacificApril 25 2022

The rise of activist investors in Japan

Activist investors are reshaping how businesses operate in Japan. The country’s cash-rich but low return companies are proving to be fertile ground for change, according to Kimberley Long. 
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The rise of activist investors in Japan

Japan has a complex relationship with activist investors, who look to buy significant stakes in public companies to influence how they are run. Often based outside of Japan but with Japanese staff, activist investors – including individual investors, hedge funds and private equity firms – assess the prospects of a target business to establish if, through changes in operation or management structure, it could be made more profitable. The investors will then begin to obtain shares in the company, often with the goal of joining the board of directors. 

The country has seen an increase in activist activity. The structure of Japanese companies has come under criticism from international investors, due to cash-heavy balance sheets which make the companies comfortably liquid, but considerably less profitable when benchmarked against similar companies internationally. And the sums held on balance sheets are significant. At the end of the 2020 fiscal year, companies listed on the Tokyo Stock Price Index held a combined Y493tn ($3.9tn) in cash. 

Josh Black, editor-in-chief of news and data provider Activist Insight, says: “Japan is attractive to investors as there is so much cash on balance sheets and the government is pressuring companies to hit higher return on equity targets. There is a clear gap in how these companies are valued relative to their Western counterparts, and some of these companies are already global in nature. There is a belief the government will push for companies to reform so that financial markets can meet the needs of an ageing population.” 

Japan is attractive to investors as there is so much cash on balance sheets and the government is pressuring companies to hit higher return on equity targets

Josh Black

The ageing population is also causing concerns from the ownership perspective. With a large segment entering retirement and with the younger generation disinterested in taking over the family business, small businesses are either being sold on, or simply shut down. 

The situation playing out in Japan has been experienced elsewhere. Paul ffolkes Davis, chairman of Rising Sun Management, and adviser to Nippon Active Value Fund, says: “The state of development of Japan’s markets now is reminiscent of the UK in the 1960s or the US in the 1970s. There were a lot of companies that were cash rich and in need of consolidation. Rightly or wrongly, Western developed markets now are all run on debt. Only Japan is cash positive. It is a legacy of the historical economic environment, as the country has been in a deflationary spiral in one way or another since the late 1980s.” 

The aim of many activist investors is to push target companies towards bigger returns. Aki Matsumoto, executive director at corporate governance research and consulting company Metrical, says: “The goal of activists is financial gain. Since they are investment managers (although they also invest their own funds), their objective is to return profits to the end investor. Their investment approach is to encourage management change in their portfolio companies to increase corporate value and shareholder returns.” 

Stock exchange response 

All of this is combining to instil a sense of urgency among the authorities. Japan’s relationship with activist investors was legitimised when Hiromi Yamaji, CEO of the Tokyo Stock Exchange (TSE), called for companies to work with activist investors rather than trying to block them. The perception was investors were causing disquiet, due to the force they bring to the decision-making process, which could dramatically shake up the status quo. 

Speaking to Nikkei Asia, Mr Yamaji called for “frank, open discussions” between companies and prospective investors, and noted how some have provided a sense of urgency to companies. In his comments, he highlighted the limitations of Japan and how its lack of natural resources meant the country needed to co-operate with the international community. 

The stock exchange is keen for companies to take a more nuanced approach to investors. A spokesperson for TSE says: “We cannot lump all activist investors together, and there is a possibility that companies could get good ideas for enhancing their corporate value through constructive dialogue with activist investors.”

Involving international investors can also make up for a lack of interest at home. The domestic investment market does not embrace Japanese-listed companies, choosing instead to place their funds elsewhere. Figures from the Nikko Research Centre, estimated during 2021, show Japanese retail investors placed $72bn with foreign stock funds, while domestic stock funds saw just $243m, after two years of net outflows. As the companies are generally conservative in their risk appetite, it can mean a consistent level of dividend payment, but not a great option for those looking to reap returns. 

The spokesperson for TSE breaks down the investment ratios: “Currently, about 60% of daily trading value comes from non-Japanese investors and they hold almost 30% of Japanese companies’ stocks.”

Mr Davis says Japanese stock ownership is heavily concentrated. “The two largest holders are the Japanese government, through the Ministry of Finance, and the national pension fund. What the government wanted was to get their investments to perform better and more in line with international equities. They owned too much stock that wasn’t generating adequate returns as the management concentrated on safety and the comfort provided by stockpiles of cash,” he explains. 

Mr Matsumoto adds: “The foreign shareholding ratio was 13% in 2000 and rose to 24.8% in 2020. This was made possible by cross-held shares. The shareholding ratio of business companies and financial institutions was 59.3% in 2000, but fell to 50.4% in 2020.”

Abe’s reforms

Japan is attracting a lot of interest from activist investors, partly due to the reforms made in 2014 by then prime minister Shinzo Abe. These saw government-mandated corporate governance reform, such as encouraging the payments of restricted stock to directors and senior management. 

“The reforms do not direct companies to follow these paths, but suggest best practice and that they ought to,” Mr Davis says. “When activists appear, they push for these management improvements on behalf of all shareholders. Often, the activists become the largest holders on the share register and management is increasingly bound to respond. There is now an acceptance that activism is a real thing; it is growing rapidly and cannot be ignored.”

There is now an acceptance that activism is a real thing; it is growing rapidly and cannot be ignored

Paul ffolkes Davis

“The Japanese government has tried to encourage activism and engagement with shareholders to bring higher return on equity targets, more pay-outs and the breakups of cross-ownership structures,” Mr Black says. “Due to this, a lot of foreign activists have gravitated towards Japan.” 

The levels of activity have remained high throughout the pandemic, with the possibility of tax rule changes that would likely bring about more mergers and acquisitions and spin-offs attracting attention. The changes mean that, if certain criteria is met, the spin-off transactions could be tax free. The TSE is also revising its listing standards through restructuring into three market segments, namely the prime market, standard market and growth market. 

The composition of Japanese companies is also a significant reason for activist interest. This may mean picking out companies that are not considered traditional investment opportunities. 

“We look out for companies that are small but productive in their sphere,” explains Mr Davis. “They may not be market leaders or be particularly well-managed, but they tend to have strong liquidity and carry excess capital on their balance sheets. They are run by ‘salary men’ for safety, with lower dividends and share buybacks than they are capable of, and are slow to respond to change. We believe they can be run much more aggressively and efficiently, with better capital allocation and their economic interests more closely aligned with those of shareholders.” 

After identifying these companies, which are often small and not followed by third party analysts, the investors will talk with the businesses about improving their capital allocation and the prospect of expansion or consolidation. 

The gamut of companies suitable for activist investor involvement is wide in Japan. “There are many small cap companies which are ripe for consolidation,” says Mr Davis. “At the other end of the size spectrum, there are companies like Toshiba, where pressure is building to break them up. At both ends of the market, it is activism that is waking up sleepy corporate Japan.”

Large scale activism 

Toshiba has had a long process with activist investors, including Singapore-based Effissimo Capital Management and 3D Investment Partners, as well as US-based Farallon Capital Management. Toshiba CEO Satoshi Tsunakawa stood down at the beginning of March 2022, after having joined the company in 1979. He was replaced by chief digital officer Taro Shimada, who pledged to work with shareholders and activist investors at a press conference. “The important thing is being able to look at things from shareholders’ point of view … I will make sure that the company and the shareholders will achieve the same understanding,” he said.

The company has further progressed, and saw its shares rise after it announced at the beginning of April 2022 that it was to appoint a special committee to assess bids from investors, which is seen as a move towards taking the company private. The news saw its shares climb by 4%, before closing up 1.9% higher. The move has been pushed by the divisions in the company, caused by ongoing confrontation with the activist shareholders. 

Mio Kato, founder at LightStream Research, believes the Toshiba situation still has to fully play out. “Toshiba is a key focus, as it would be a big scalp to rally around,” he says. “Most activist efforts against larger corporates have been rather soundly beaten back historically and Toshiba has been a much more drawn-out affair. It is still unclear how the situation will be resolved though.” 

The approach seen at Toshiba is indicative of how activist investors view the Japanese market, as Travis Lundy, an analyst at Quiddity Advisors who publishes on research platform Smartkarma, says there is little “short-term activism”.

“Different types of activists have different sub-styles,” he says. “The principal aims of investors like ValueAct are to be friendly but engaging, and to see large cap companies trade at higher multiples. Some activists seek to encourage companies which should be constructed differently to make significant changes to their capital allocation policy. Some seek profits by encouraging companies to consolidate or be consolidated within an industry which needs it.”

The way in which management approaches working with activist investors is now generally more responsive and professional than they were a decade ago, Mr Lundy adds. 

Asia focus 

With so much focus shifting to Japan, the thought emerges that there will soon not be enough companies to target. Mr Davis disagrees: “The good news for our investors is that we will be busy for a long time. There are not just hundreds, but thousands of companies of the sort we evaluate. We currently have around 170 companies under consideration in our universe of possible investments.”  

Even so, other countries in the region are starting to attract interest. “Australia already has some activists and the market is structured well to see more activism,” Mr Lundy says. “Singapore has some and is probably structurally better suited to activism than is Hong Kong, though Hong Kong could really use more of it.” 

One country in the region that could prove most interesting is South Korea. “South Korea has seen some movement from activist investors, in particular the big family-run companies,” Mr Black says. “When there is a big inheritance​, this can trigger tax issues, which impacts across the holding structures.” 

These family-run companies, known as chaebol, comprise some of the biggest companies in South Korea, including Samsung, LG, SK Group and Hyundai. Similar to the Japanese companies, chaebols have been criticised for their low dividend payments and for favouring the interests of the controlling shareholders over those of ordinary investors. 

There has been some movement from activist investors. One such high-profile case has been seen with the involvement of Korea Corporate Governance Improvement with Korean Air. The family-run Hanjin Group owns the airline, with Walter Cho as chairman. His sister Heather Cho attempted to enlist the support of activist groups in removing him as the head of the company in March 2020.   

In order to see the most market improvement across the region, Mr Kato believes the actions of investors are secondary. “Valuations in many Asian markets could rise if governance improves in my view but whether that could be driven solely or mostly by activism is a question mark,” he says. 

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Kimberley Long is the Asia editor at The Banker. She joined from Euromoney, where she spent four years as transaction services editor. She has a BA in English Language and Literature from the University of Liverpool, and an MA in Print Journalism from the University of Sheffield. Between degrees she spent a year teaching English in Japan as part of the JET Programme.
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