Lost In Translation...
Activist investing is something that receives a large amount of coverage and praise in the media - as it rightly should. Shareholders are often handsomely rewarded by activist involvement in a myriad of ways including special cash dividends, spin-off distributions or simply a higher stock price.
Activist investors, depending on the particular individual, are often lionized or vilified and provide ample headlines as readers get swept up in the narrative as it unfolds. Often I have seen the networks and media sing the praises of a lone activist overturning the established order and "rescuing" the fortunes of shareholders. However when I read about Mr. Loeb's attempts to coerce Sony (SNE) to part with some of its assets - I was quite surprised. Not because I don't doubt the presence of significant value (as I have indeed read the balance sheet) but because he was trying to do it at all.
In this article, which I was inspired to write after reading this piece in The Wall Street Journal, I will discuss some of my observations about the Japanese equity market and the potential for activist investing in Japan, particularly by foreign parties. I will also attempt to explain my views about why activism is both met with resistance and the potential benefits of activist efforts regardless of their success or failure.
I have been a student of the Japanese economy for a long time. Learning about both the excess of the bubble years and the vagaries of the real-estate collapse has proved a very useful mental model, in addition to observing the effects of a protracted low rate environment. Some of my favorite companies are Japanese and were able to prosper in the early 2000s despite anemic economic growth.
Within the circle of value investors that look to international equities - one can find many who are extremely interested in the large amount of Net-Net opportunities concentrated in Japan. Though many of these companies are no longer growing at a break-neck pace, they are cash rich - often carry zero debt and trade at very low multiples.
As a result of years of economic stagnation and the hard lessons of the Japanese recession - many businesses are sitting on enormous hordes of yen. In many instances investors are able to purchase the underlying business at an enormous discount to book value or - sometimes - for free. The only problem however, is that many of these assets are locked in the bank and cannot be dislodged from management.
Cultural Barriers To Foreign Involvement: The Zaibatsu
Japanese society is one that has a thoroughly developed sense of national pride, collective identity and culture. The country's corporate landscape is dominated by a handful of large conglomerates, known as Zaibatsu corporations. Though many Americans know names like Toyota, Sony and Mitsubishi; they often fixate on one sector in which they are familiar with (such as electronics or cars) and do not understand the true size of these companies. For example - did you know that Mitsubishi is engaged banking, builds ships and makes paper in addition to its automobiles? What about Sony's life insurance operations? How about Nintendo owning 51% of the Seattle Mariners?
In addition to not accurately assessing the breadth of many of these corporations - foreigners also do not understand the mindset of the workers they employ and its ramifications. In the United States - people often hop from job to job every several years for higher pay or better lifestyle. In Japan, until only very recently, this behavior was unthinkable. One could work their entire life for one company, which would in turn take care of the employee in a reciprocal relationship. Furthermore, it is not uncommon to find multiple generations of a single family in service of a single Zaibatsu. As a result, these companies have become critical parts of modern Japanese society and to have a foreigner attempt to intervene or acquire the company would be met with extreme resistance in all levels of the society.
While not all Japanese companies are organized in this manner, many corporations of sufficient age enjoy both enormous loyalty from their shareholders and strong opposition to foreign intervention.
Management is Extremely Long Term in Orientation
Many large Japanese companies have an extremely long-term philosophy when it comes to development and growth. A quick glance at Canon's (CAJ) website reveals a desire for one hundred or more years of continued viability, innovation and progress.
In addition to long-term thinking, management is often willing to sacrifice years to achieve their objectives. Some Japanese companies are willing to endure long periods of low or zero profitability in order to achieve their long-term goals, which sometimes take years to realize often to the angst of shareholders.
This Ultra-Long term orientation and willingness to sacrifice near- and medium-term shareholder value makes it difficult for investors to rationalize a significant commitment unless the company is enjoying robust growth or has immediate potential catalysts. This aversion also opens up the potential for significant bargains to be had for patient investors, which I argued earlier this year in my article about Nintendo (OTCPK:NTDOY) and Konami (KNM).
Activism Needs to be Approached Gracefully
Japan is a society that emphasizes manners, politeness and respect. Even if there is a problem to be resolved and it is dire, it has to be approached in the correct way. Diplomacy and politeness are critical, lest any party lose face. Given this cultural attribute - many activist shareholders who have enjoyed success in Western markets have the deck stacked against them almost from the get-go as writing and publicizing material indicting the management of the company for failing to maximize shareholder value can be construed as offensive, pugilistic and will provoke both resentment and stern opposition. When viewing recent events through this lens, I believe that it is obvious why Mr. Loeb received a unanimous refusal from the board of Sony.
Despite the fact that the board of Sony refused Mr. Loeb's advances, I would not be surprised to see the company begin to pursue methods to reward shareholders in the future. I also believe that these measures will be internally generated and may not be as lucrative for shareholders.
In addition, though Mr. Loeb has been rebuffed for the time being, I believe that by virtue of his efforts, he has drawn considerable attention to the undervalued situation at Sony - leading to benefits that have been realized by current shareholders in the form of considerable appreciation of Sony shares in recent months.
I believe that there are also many other companies in Japan that could benefit from shareholder activism (in an albeit tactful and subdued manner) or at least from having their substantial under utilized assets exposed to the global investing public. Though many companies are sitting on large reserves of cash and carry no debt, it is critically important for investors to be aware of the very real risk of "dead money" due to management resistance in order to mitigate the chance of a "Value Trap."