More "Livedoor Shock" for American Mutual Fund Investors?

by: Steven Towns

The Tokyo Stock Exchange and Japanese stocks are pretty much over the "Livedoor shock" that shook the world's second largest stock exchange last week sending it down 6.8% in just two days. Former livedoor Co. president Takafumi Horie (Horiemon) and three other executives have already been taken into police custody as the investing world awaits the findings from the Tokyo District Public Prosecutors Office investigation. Horiemon resigned as president on Tuesday and resigned from the company's board today, although he still denies the allegations of securities violations. The point of this post however, is to consider the potential damage yet to be felt by American investors in Japan specific mutual funds.

First, let me explain the reasoning behind this post. The Wall Street Journal published an article by Yuka Hayashi, entitled, "Livedoor's Woes Roil Mutual Funds," print edition: 1/24/06 C11. I had recently checked the holdings of the Japan fund I invest in and remembered seeing a small allocation for livedoor Co. The WSJ article emphasized the particularly large exposure to livedoor by funds run by Fidelity and Nomura. Hayashi quoted a Morningstar Japan analyst that said, "Small-cap managers often have no choice but to go after these liquid issues [making a reference to livedoor Co.]." You will see below the irony that the liquidity that attracted small-cap Japan fund managers quickly evaporated and became mostly illiquid until today.

Now, why am I concerned there will be more "Livedoor shock" for investors in Japan funds? Check this out and pay special attention to the volume:

livedoor Co. (Tokyo Stock Exchange Mothers Index ticker: 4753) Stock Trading 1/13 - 1/25

For a quick re-cap: news of livedoor Co. and Horiemon's alleged securities violations first came out after the market's close on Monday the 16th. On Tuesday, volume was substantially lighter and its shares were halted from trading after dropping the one day limit at that time of 100 yen. Notice its shares didn't even trade on the 18th when the TSE was unable to handle the overwhelming number of sell orders. Volume over the next three days was less than 200,000 each day. Then today's volume is over 420 million. I doubt American and other foreign mutual funds that held livedoor shares were able to exit between the 17th and 24th. Most likely a majority of them were only able to sell from today.

Livedoor has 1.049 billion shares outstanding with 17% of them being held by Horiemon. Fuji Television holds a 12.5% stake and since the scandal it has publicly stated it is considering selling its stake despite a restriction stating it cannot sell to a third-party before September 2007. It is also considering seeking compensation.

The Tokyo Stock Exchange now has limited livedoor's stock trading hours to just 90-minutes per day in order to prevent an overflow of orders as happened last week that forced the exchange to close twenty-minutes early.

My concern should be understandable by now because not only have livedoor Co. exposed funds taken a hit in share price value, they also face the reality that they may not have been able to sell until today or maybe even not yet. The WSJ article states that Fidelity owned 6.88% of Livedoor's outstanding shares as of the end of December through its small-cap funds sold in the U.S. and Japan. That 6.88% equals approximately 72.2 million shares.

I stated in a prior post that I have chosen T. Rowe Price's Japan fund (MUTF:PRJPX) as my investment vehicle of choice when it comes to Japan. As of December 31st it held 520k-plus shares of livedoor Co. valued at $3.25 million. PRJPX had a total investment in securities of $480.4 million or equal to about two-thirds of a percent.