IN-DEPTH: The lure of Japan

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While shareholder activism is in slight retreat in some key areas in the world, in Japan it kept pace with last year, allowing that country to become the second-busiest market after the U.S. in the first half of 2019, according to Activist Insight Online.

American activists have increasingly been attracted by Japan due to shareholder-friendly government reforms, undervalued cash-rich companies and a diminishing set of opportunities at home. Eight Japanese companies have already been subjected to activist demands this year through July 29, already beating the six-year high set last year, when seven companies were targeted, according to data compiled by Activist Insight Online.

Overall, 49 Japanese companies were publicly subjected to activist demands this year through July 29, compared with 44 during the same period last year. At the same time, Australia, which finished second last year, saw a slight drop in activity. Canada, the third-busiest market in the whole of 2018, recorded a substantial decline, from 61 companies publicly subjected to activist demands to 38, as stock prices in the basic materials sector – which largely dictates the amount of activity in the country – recovered, providing for fewer opportunities.

Valuable enterprise

Comparing Japanese with American balance sheets makes clear what activists see in the country. According to research firm Pavilion Global Markets, the Japanese stock market trades at an enterprise value-to-EBITDA ratio of 6.8 compared with 9.5 and 12.7 for Europe and the U.S., respectively. Japanese companies are famously cash-rich as they are debt-free, allowing for strategic flexibility.

“The valuation gap between the U.S. market and the Japanese market on an unlevered basis is very, very large, and it has never been this big – at least since the early 1980s,” Aaron Stern, partner and managing director at Fir Tree Partners, told Activist Insight Online in an interview.

Fir Tree, which typically launches activist campaigns in the U.S. energy sector, this year targeted Japanese railway firm JR Kyushu. The fact that its proposals for corporate governance changes and share buybacks were marginally rejected by shareholders – support was between 34% and 40% at the annual meeting in June – encouraged Stern in his belief that Japan is a “much friendlier environment” than is generally believed.

The relative undervaluation of Sony prompted Third Point Partners to reignite a campaign from six years ago. Third Point said Sony’s complicated conglomerate structure gives investors “the opportunity to buy Sony at a ~50% discount” to its estimate of intrinsic value. Both the tone and specifics of the thesis had been significantly updated but the activist again proposed spinning off noncore assets and focusing on entertainment to plug the discount.

The Japanese government’s continued backing is also key. While the regulatory framework in most jurisdictions remains neutral on shareholder activism, and in others – such as France and the Netherlands – is becoming harsher, Japan is stepping up its efforts to stimulate shareholder engagement. “The government’s support for corporate governance reforms – even those that strike at the heart of some of the business practices that define Japanese social norms – is forceful and unwavering,” Alicia Ogawa, an expert on Japanese corporate governance, told Activist Insight Online.

Behavioral shift

Tsuyoshi Maruki, whose Strategic Capital targeted four Japanese companies this year, said the behavior of Japanese institutional investors has been changing. Many institutions no longer shy away from supporting activists, particularly since those that comply with the Stewardship Code need to disclose how they voted.

“Institutional shareholders are taking a much more progressive view towards engaging with companies in Japan and are happy to let their voices be heard with votes,” Stern added.

It remains to be seen if Japan maintains its position through the end of 2019. A peculiarity of the Japanese market is that most campaigns are launched in the first part of the year with the activity slowing down after the end of the proxy season in mid-summer.

Just nine additional companies were targeted in the second part of 2018 versus 33 in Australia, where there is no clearly defined proxy season given that activists can easily call special meetings. Another potential contender to retain the second spot by the end of the year is United Kingdom, which saw a 27% rise in companies targeted in the first half of 2019 to 38, compared to the first half of 2018, despite Brexit headwinds.

Low on deals

While activist demands have followed broadly similar themes, a notable exception has been M&A activism, which continued to drop as a proportion of all demands. According to Activist Insight Online, around 3% of total activist demands in Japan involved M&A in the first half of 2019, versus 5.7% and 6.4% in 2018 and 2017 respectively.

One possible explanation is activists’ poor track record in stopping deals and bumpitrage campaigns, which this year was harder even in more established markets such as the U.S. Strategic believes Tosho Printing’s sale to parent Toppan earlier this year was made at an unfair price but decided not to oppose it. Oasis Management failed to block the takeover of Alps by its parent Alpine Electronics in 2018, as well as Panasonic’s takeover of PanaHome, although in the latter case it secured a small bump in the exchange ratio.

Newly-adopted M&A guidelines by Japan’s Ministry of Economy, Trade and Industry (METI) might improve the treatment of minority shareholders in parent-subsidiary deals. The rules recommend target companies set up committees of independent directors to safeguard minority interests. While some criticized the new rules for being non-binding, others pointed out that the Stewardship Code has had a notable influence despite sharing the same characteristics.

Outbound M&A

With high levels of cash and fewer opportunities for its deployment at home, larger Japanese companies have been hunting for deals overseas, yet few have seen opposition from shareholders. Takeda’s acquisition of Shire last year faced some resistance from a group of retail investors, but the deal eventually went through.

The next frontier for activists may be to question whether overseas acquisitions are the best way to deploy capital given the mixed track record, although stopping deals is not easy and Japan still presents low-hanging fruit for activists. Stern sees a change in perceptions. “I think companies are starting to be more progressive in the way they evaluate the returns of buybacks versus the returns of M&A,” he said. “Now, a lot of Japanese managers understand that buybacks are an effective tool to boost the return on equity over the long term.”