The Little Post about Shareholder Activism in Japan - (Part One)

This post is the first part of a series on shareholder activism in Japan.

"Shareholder activism is a way in which shareholders can influence a corporation's behavior by exercising their rights as owners if they deem the board of directors and/ or the management of a company doing a bad or mediocre job. Although shareholders don't run a company, there are ways for them to influence the board of directors and management. These can range from dialogue with management to voice their concerns about a particular issue to formal proposals that are voted on by all shareholders at a company's annual meetings." (Investopedia)

The most extreme outcome of shareholder activism is the attempt to gain control of the company and replace management for one that the activist deems good for himself and/ or for the shareholders in aggregate. "The activist purchases large numbers of a public company's shares and tries to obtain seats on the company's board with the goal of effecting a major change in the company. A company can become a target for activist investors if it is mismanaged, has excessive costs, could be run more profitably (as a public or private company) or has another problem that the activist investor believes it can fix to make the company more valuable." (Investopedia)

The Many Flavors of Shareholder Activism

From the above definition it becomes apparent that activism comes in many flavors. It can be “relationship- / active value-oriented”, “friendly”, “constructive”, "hostile" etc. But the concept of activism has always one common denominator, e.g. the desire to change the status quo through "voice" or change in control of the firm. Thus, the concept of engaging management is central to all of them.

It is a fact that managers in Japan do often feel social responsibilities to the company’s other stakeholders and operate according to these responsibilities. They often prioritize employees, contractors and customers ahead of shareholders. They reward management for longevity rather than corporate performance. A popular belief in Japan is that management act like “stewards”, obligated to protect and preserve their companies for posterity. That means shareholder value is often further down the list of managers’ priorities than in other developed economies.

It might come as a surprise to many, but actually Japan has stronger individual shareholder rights than the U.S. For example, in Japan dividend payments have to be approved at the shareholders' meetings, whereas in the U.S. they are not subject to shareholder ratification. Directors can be dismissed for any reason by shareholders' vote in Japan. Overall, a board's monitoring power is relatively strong in the U.S while shareholder rights are moderate. In Japan it is the other way around. (Hamao et al)

Combine those two aforementioned conditions with extremely compelling valuations of the stock market in general and individual stocks especially, and it should not come as a surprise that such a country is theoretically a fertile hunting ground for shareholder activists.

Shareholder Activism in Japan: A New Phenomenon

Shareholder activism in Japan is a rather new phenomenon. In the second half of the 20th century bank financing dominated external financing. Most Japanese firms had cross-shareholdings with their main bank and other companies with interlocking business relationships known as keirestu. Corporate and bank shareholders supported the management of companies in which they owned shares. Hostile takeovers were virtually non-existent. M&A activities were typically between agreeing parties, with the approval of friendly institutional shareholders. (Hamao et al)

Especially efficient capital allocation and reasonable pay-out to the shareholders wasn't at the top of the agenda in corporate Japan's board rooms. The motto was: You scratch my back and I'll scratch yours. In short, a cozy atmosphere reigned and it was almost impossible for individual shareholders to do anything about it.

After the collapse of the real estate and stock market bubble in 1990 and the ensuing "lost decade" of economic slump, this situation started to change. Banks suffered severe capital shortages and sold much of their equity holdings to raise capital. Individual companies shifted from bank financing to financing their operations on the capital markets. (Hamao et al)

The age of shareholder activism had finally arrived in Japan and corporate Japan got a little shaken. 

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Activist Shareholders in Japan: The Vanguard

Before the 2000s, there was one isolated case of U.S.-style activism in Japan. In April 1989, T. Boone Pickens, the famed U.S. corporate raider, became the largest shareholder of Koito Manufacturing. Koito Manufacturing was an auto parts maker which had close business ties to Toyota Motor. Pickens holdings in the company started at 20% and eventually increased to 26%. He asked for board representation but Koito's shareholders refused. Pickens then claimed that related party transactions within Toyota's keiretsu were priced in favor of Toyota. Additional demands, including a dividend increase, disclosure of details on the pricing of auto parts and representation on the board, were rejected. T. Boone Pickens activist approach was labeled "The Pickens' affair" and was viewed rather negatively by the Japanese media. (Hamao et al)

Despite having taken a 26 percent stake in Koito, Pickens couldn’t even secure a board seat and eventually backed out of his position. It is said that he was disgusted with his experience in Japan. He even wrote an article after his lost battle in the Washington Post labeled: “The Heck with Japanese Business: Why I’m Not Interested in Trying to Compete in a Cartel System.” (Seattletimes)

The Japanese establishment managed to fend- off the first attack of a "corporate raider" or "hostile activist". In the decade after T.Bone Pickens tried to engage with corporate Japan there were no large-scale shareholder activist events.

But it turned out that the victory over the activist funds wasn't a final one, but rather a truce. The "real wave" of shareholder activism in Japan was swashing at Japan's coast. It started only in the early 2000s after the Japanese stock market hit rock bottom. Changes in Japan's corporate law acted as a catalyst.

Legal Framework in Japan As The Catalyst for Shareholder Activism

 

In 1997, the holding company framework was legalized, opening the way for a drastic restructuring of corporate groups and widespread consolidation in many industries. In 1999 it became possible to buy other firms using shares. In 2000 it became easier for companies to spin off non-core divisions. Furthermore, “Triangular mergers” became possible. In a "triangular merger" a foreign firm uses its own shares, via a Japanese subsidiary, to buy a Japanese firm. (Economist (1))

Accounting rules were also changed, forcing companies to produce consolidated statements and disclose cash flow figures and making it harder to hide poorly performing subsidiaries. Another rule change required companies to list assets at market value, which makes it easier to work out whether a company's market capitalization is lower than the value of its (liquid) assets. (Economist (1))

“There have been very drastic changes in this area in the past ten years—more drastic than anything seen before,” says Mr Niwa. (Economist (1))

Shareholder Activism in Japan: The Early Hostile Players

 

Yoshiaki Murakami

 

The first hostile takeover bid and proxy fight in modern Japan was done by the well-known Japanese activist Yoshiaki Murakami in 2000. Murakami is a former Ministry of International Trade and Industry (MITI) official. After he ended his career at MITI he founded M&A consulting, usually known as the Murakami fund. The vehicle was funded by leading Japanese business establishments. Murakami was considered the most prominent individual shareholder activist coming from within Japan. It is said that he has been deeply influenced by Robert A.G. Monks, a well-known American shareholder activist who started the LENS fund and Institutional Shareholder Services in the U.S. and helped set up the Hermes fund in the U.K. Murakami is reported to have met Monks in 1999. (Hamao et al)

Murakami's first hostile bid was against Shoei, a former textile company. It was trading on the stock market around liquidation value and therefore was a classic Graham and Dodd net-net stock. His hostile bid for the company did not succeed. But Murakami wasn't discouraged by this failed attempt. In 2001 he launched a campaign against Tokyo Style. Initially acquiring 5.77% of Tokyo Style shares through MAC International Ltd., Murakami initiated another proxy fight and failed again. He did, however, succeed in getting the firm to increase its cash dividends and engaging in share buybacks. In other high-profile cases, Murakami acquired shares of Nippon Broadcasting System, Tokyo Broadcasting System, and Hanshin Electric Railway. (Hamao et al) I think it was Murakami-San Peter Cundill was referring to, when making the following remark about shareholder activism in Japan: " (...) foreign investors have been making suggestions, but the real war has been conducted by Japanese on their own (...) it's Japanese against Japanese, it’s terrific (...) if I was a Japanese manager, I wouldn't be scared about foreigners but rather about young Japanese (...)" (Peter Cundill)

Steel Partners Japan Strategic Fund

Another prominent foreign activist fund that was focusing on Japan during that time was Steel Partners, founded by Warren Lichtenstein. The vehicle to engage into activist approaches was the Steel Partners Japan Strategic Fund, which was a partnership with Liberty Square Asset Management.  Among its first investments was Yushiro Chemical. The first filing showed that Steel Partners assembled a shareholding of roughly 5% and subsequently pressured management to distribute the firm's large cash holdings. The management was extremely slow to respond and Steel launched a takeover bid. Although the takeover bid failed, the management at least agreed to increase the annual dividend. (Hamao et al)

In another case, Steel Partners launched a takeover bid of Myojo Foods. In response, Myojo Foods arranged for a buyout from Nissin Foods. The investment in Myojo Foods provided a good return for Steel Partners. But more importantly it set a precedent; the first "white-knight case" in Japan. (Hamao et al)

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Steel Partners Proxy Fight With Bulldog Sauce

The most prominent case of Steel Partners was its lost hostile takeover battle over Bulldog Sauce, a Japanese condiment maker. The battle had far reaching implications which can be felt up to date. During the battle with Steel Partners, Bulldog Sauce's management decided to introduce anti-takeover steps (a poison pill), which the majority of shareholders supported. The scheme consisted of the issuance of new stock warrants to all shareholders except Steel Partners. That would have diluted Steel Partners 10.52% stake, which had made Steel Partners the company’s biggest shareholder, to less than 3%. (Forbes) Steel Partners took Bull-Dog Sauce to court over the “poison pill” defense scheme. During its legal battle Steel Partners was labelled an “abusive acquirer” and "vulture investor" by the Japanese legal authorities and in the Japanese media. The court ruled against Steel Partners. One could say, that the final outcome of Steel Partners' activities in Japan was a landmark ruling by the Supreme Court supporting the use of "poison pills" in corporate Japan (Hamao et al)

"(...) Over 400 companies have introduced AWS poison pills, denying a shareholder’s right to sell shares during a tender offer. Others have resurrected the practice of cross shareholdings to build a management friendly shareholder base under the guise of strategic partnerships. Some have done both. Management has made it clear that maximizing shareholder value is not a principal concern. (...) Clearly we are witnessing a fundamental disconnect between the steward and the shareholder. As we were told by one such steward last year in the course of a tender offer, “[stock] price does not matter”. (SP Japan; March 2008) He further noted that the defense scheme: " (...) would be detrimental to the legal framework of corporate Japan' and will not only deter investment in Japanese companies but also undermine Japan's efforts to become a global financial center.'' (Bloomberg) 

The failed takeover and ruling by the Supreme Court was extensively covered and commented in the (western) financial media.

"The ruling (...) reflects the prevailing distaste in corporate Japan for foreign invaders like Steel Partners that threaten the long-cherished coziness of its management ranks." (Forbes)

"Japan's star on the global investable universe continues to fall,'' said Kirby Daley, a strategist at Societe Generale Group's Fimat unit in Hong Kong. ``The impetus for foreign investors to highlight the country as an investment destination wanes with it.''  (Bloomberg)

The denouement marked a victory for Bull-Dog Sauce. But does it signal Japan Inc.'s backsliding on boardroom reforms? John Ho, Asia director for The Children's Investment Fund, thinks so. (Businessweek)

"I fear, as do many other observers, that once companies are protected in this way, they will have less of an incentive to focus on the needs and interests of shareholders," said Marc Goldstein, representative director of proxy advisory firm ISS Japan. "(They may) revert to their former patterns of behavior, in which the interests of lenders and business partners often took priority. “ (Reuters)

"Recent battles by activist investment funds for tighter control of Japanese companies have led to serious questions about Japan’s investment environment, both for activist shareholders and strategic investors" (Economist)

Aderans: Steel Partners' Only Successfull Battle in Japan

Although Steel's hostile takeover bids for Bulldog sauce and other Japanese companies failed, he was partially successful at one company.  Aderans, a loss-making Japanese wigmaker, had a too hard time shrugging off the advances of Steel Partners. At an annual general shareholders' meeting held by Aderans in 2008 proposed director appointments were rejected by a majority.

Many Aderans shareholders were unhappy with the persistent and significant underperformance of the company's share price. A large number of them sided with Steel Partners, the biggest shareholder with a 29% stake, in its opposition to the reappointment of directors. The outcome was a substantial change in management.  Five directors, including the president and representative director, were removed from the board. Furthermore, two new outside directors, recommended by Steel Partners, were appointed. (Iwatani et al) 

Steel Partner's success at Aderans’s shareholder meeting marked the first time a foreign fund had ousted a board at a publicly traded Japanese company.

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The Outcome of The Activist Campaigns in Japan 

All in all Steel Partners targeted 41 companies between 2002-2008. (Hamao et al)  Steel partners withdrew from most of its Japan holdings when faced with huge redemptions by his partners following the financial crisis of 2008/2009.

Yoshiaki Murakami got a two year jail sentence and was fined 1,2 bln. Yen for insider trading. "Prosecutors said Murakami had traded shares with prior knowledge of a February 2005 takeover bid by the Internet firm Livedoor for Nippon Broadcasting System, or NBS, a radio operator. Murakami denied any wrongdoing." (NY Times)

Steel partners and Murakami were the most prominent activists operating in Japan. Mainly because of the perceived hostility towards the Japanese management and the ensuing coverage in the press. But many other, more subtle activist approaches took place during that time.

For example in 2007 Sparx Group, the largest shareholder in Pentax, and the president of the company were in favor of a takeover by Hoya, the world's biggest producer of optical glass. But suddenly the majority of Pentax's officers and board members changed their mind and surprisingly displaced the company's president who had drafted the deal. Sparx, along with other investors, felt that a takeover by Hoya would be the single best option for Pentax as well as for its shareholders. They got the ousted president reinstated, prompting the Pentax board to resign. The deal went ahead on improved terms. By handling the situation delicately Sparx came out on top. (Economist (1)) “That's their style—not to put up a loudspeaker,” says David Marra of A.T. Kearney. (Economist (1))

Also in 2007 another Japanese investment fund, Ichigo Asset Management, successfully persuaded shareholders in Tokyo Kohtetsu, a steel company, to reject a merger with Osaka Steel. The rejection by Tokyo Kohetsu of Osaka Steel's merger proposal showed that it was possible for shareholders to block a merger already agreed upon by the management of both sides. In this particular case, Ichigo Asset Management (led by former Morgan Stanley executive Scott Callon), by than a major shareholder with roughly a 10% stake, launched a proxy battle based on its objections to what he deemed an unfair share exchange ratio for the merger. Ichigo Asset Management's success in obtaining the one-third of votes needed to overturn the special resolution at an extraordinary general meeting was helped by many individual shareholders. It made clear to the Japanese business elite the potential impact from individual shareholders exercising their voting rights. (Iwatani et al)

Some foreign activist investors were also taking a more subtle approach. The Children's Investment fund (TCI), for instance, which had a 10% stake in J-Power, an electrical utility, pressed the company to raise the year-end dividend significantly. TCI's boss, Christopher Hohn, wrote a letter to the management and the shareholders explaining his reasoning for an increased payout. He astutely began his letter by apologizing for writing to them out of the blue. Then carefully he explained why he thought that J-Power needed to do more for its shareholders. The company responded with a letter of its own, and TCI's resolution was defeated. “TCI trod carefully and decided to lose round one gracefully,” says Mr Marra approvingly. "Investors who recognize that Japan is still getting used to a more activist approach (rather than treating Japanese firms in the same way they would treat American ones) will reap benefits in the long term". (Economist (1)) In the end TCI reaped its benefit. Its stake was repurchased by the company at favorable terms.

Other cases of shareholder activism in Japan worth mentioning (but by far not all) are:

• The takeover of Nikko Cordial by Citigroup, which was the first triangular deal in Japan.(Economist (1))

•  Oji Paper's (Japan's biggest paper firm) hostile bid to take over Hokuetsu Paper, a smaller rival, in 2006. It was the first hostile bid by one blue-chip firm for another in Japan. " (...) The bid made commercial sense. The paper industry was plagued by overcapacity and it seemed a better idea to buy Hokuetsu, which had just invested huge sums in new equipment, than to splash out on updated equipment itself. But Oji's move was widely criticized, and the bid was blocked when Nippon Paper, the industry's number two, bought a stake in Hokuetsu. (...)" (Economist (1))

• " (...) Perry Capital, another American fund, pressuring NEC Electronics, a semiconductor firm in which it held a 6% stake, to disclose the margins on its mobile-phone chip business. Perry suspected that the company was selling chips to its parent at a preferentially low price, to the detriment of minority shareholders."  (Economist (2))

• "(...)The scuttled CFS / Ain merger. Aeon Corp., the leading shareholder in CFS with a 15% stake, waged a proxy contest to prevent the merger from going ahead, securing support from stakeholders with 42.8% of the total voting rights (far above the minimum 33.3% needed). Aeon argued that the merger terms were unfair to CFS shareholders."(SP Japan; March 2008)

This short overview on activist approaches in Japan during the first decade of the year 2000 makes one sense how diverse the applied techniques were. Not all approaches to corporate Japan by activists were crowned with success. And some approaches even appear to have been outright counterproductive to the greater cause of shareholder activism.


Shareholder Activism in Japan  (Part Two)

Shareholder Activism in Japan  (Part Three)


Source:

Sharholder Activist - (Investopedia)

Activist Investor - (Investopedia) 

U.S.-Style Investor Activism in Japan: The First Ten Years;Yasushi Hamao, University of Southern California; Kenji Kutsuna, Kobe University; Pedro Matos, University of Southern California; October 21, 2010

T. Boone Pickens:  The Heck With Japanese Business - (The Seattly Times)

Message in a bottle of sauce (Economist (1))

Activist investors in Japan: Samurai v shareholders (Economist (2))

Peter Cundill (Video) 

Japan High Court Keeps Bull-Dog Sauce From Steel Partners' Jaws - (Forbes)
 
Steel Partners Japan (SP Japan); Letters to Shareholders; March 2008

Steel Partners Bid for Japan's Bull-Dog Sauce Fails (Bloomberg)

Steel Partners Off the Sauce in Japan (Business Week)

Bull-Dog wins court case vs Steel Partners (Reuters)

Evolution of General Shareholders' Meetings in Japan; Masanobu Iwatani; Toshio Taki; Nomura Institute of Capital Market Research 2009

Murakami gets two years in jail  in Livedoor scandal  (NY Times)

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