Relationship Investing Pays in Japan

In the 1980s, investors such Carl Icahn, Boon Pickens, Sir James Goldsmith, Thomas Mellon Evans, Lord James Hanson were known as “greenmailers, “corporate raiders” or “asset strippers”, while firms like Kohlberg Kravis Roberts [KKR], who introduced the concept of leveraged buy-outs, were described in a book called Barbarians at the Gates. Today, they are known as “relationship investors”, "activists" "buy-out funds", "corporate governance funds" or "restructuring funds".

Regardless of what they are called, these (mainly foreign) investors are having a fundamental influence on the balance of power between management and shareholders in Japan, and along with M&A have become a major force driving restructuring and industry consolidation.

Due to pressure from relationship investors, the mindset of Japanese senior management has undergone a sea change. Concepts such as return on equity [ROE], return on assets [ROA] and return on investment capital [ROIC] are now at the forefront of managers’ minds.

Early last year, the now infamous Murakami Fund ran afoul of Japanese regulators through insider trading, but relationship/corporate governance funds such as Steel Partners, Taiyo Pacific Partners, Dalton Investments and Ichigo Asset Management continue to do a thriving business in Japan.

Is relationship investing profitable in Japan? You bet! As a test, we tracked 16 investments by Steel Partners from the time that a public filing of large holdings (5% or more) was filed to recent closes to determine how much “alpha” (excess return) was generated. We found that the 16 Steel Partners investments we tracked since early 2003 have an average positive alpha of 2.7%. While eight of these investments are showing negative alpha, none are showing absolute losses, and half have generated high two-digit returns.

Moreover, M&A activity and relationship investors seeking companies with high potential for enhancing shareholder returns is also boosting prices of similar companies in the same industries. For example, because of M&A and relationship investor activity in the sector, Nagoya Railway (NARRY.PK), Taiheiyo Cement (THYCY.PK) and Toyo Suisan (TSUKY.PK) are up by 16%~20% year-to-date--even though these stocks would usually not get a second look from foreign or domestic institutional investors.

Comments

[Steven Towns:]

Thanks for sharing this information. An article on Steel Partners is carried in this week's Nikkei Weekly (English). Steel has a >5% stake in 28 companies in Japan, valued at ¥420b (~$3.6b) as of 2/19. Apparently it's doing so well so far using its own capital that it is considering external loan financing using shareholdings as collateral, according to sources (per Nikkei Weekly).

2007 Mar 01 10:09 AM

[Darrel Whitten:]

Steve;

Our data shows Steel investments in 37 Japanese companies, and there is no shortage of potential financiers who would like to ride of Steel's coattails. In addition, considering that hedge funds investing in Japan using traditional (eg, long/short strategies) lost money in 2006, more than a few of such hedge funds are considering becoming "activist" investors, given the obvious success of such strategies so far.

2007 Mar 26 11:47 AM