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Funds bullish as Japan hums with activism

Corporate governance

Funds bullish as Japan hums with activism

Foreign investors emboldened as companies feel the pressure for better stewardship

Some observers think an activist golden age is on the way, but others say a big win is needed or momentum could be lost © AFP

With activist skirmishes breaking out almost weekly across corporate Japan, it did not take long before Sony sensed the return of an old adversary. Six years earlier, the Japanese tech giant had done battle with US firm Third Point. Now it seemed that its founder, Daniel Loeb, was back.

But the environment in which round two of Sony-Loeb will unfold — if it even comes to an open fight — has fundamentally shifted since 2013. Foreign investors are emboldened, domestic institutions are under pressure to commit to better stewardship and companies are losing their long-cherished ability to ignore it all.

With activism currently embroiling at least six of Japan’s biggest corporate names, including Toshiba, Lixil and Japan Railways, some believe the market stands on the brink of an activist “golden age”. Although there are plenty who suspect this overstates the picture, Japan, through a mix of government policy and natural evolution, is losing its instinctive antipathy towards activism.

“Activism and engagement has accelerated dramatically in Japan in the last few years, because I think companies feel they have less of a choice,” said Seth Fischer, the head of Oasis Management and a veteran of some of Japan’s most famous activist campaigns, “at least now they are going to meet you some part of the way.”

There is already practical evidence of the shift, argue analysts at the brokerage CLSA who attribute an unprecedented surge in share buybacks to the activists. Buybacks announced in the first four months of the year are up 125 per cent from a year ago. Those in the first 15 days of May are already up 65 per cent on all of May last year.

“Overwhelmingly, this appears to be due to pressure from activist funds,” said CLSA’s Nicholas Smith.

But others see a rapidly closing window: theoretically favourable conditions for a sustained activism boom abound, but unless a major symbolic victory is scored very soon, momentum will be lost.

The behaviour of the main players is clearly changing. Mr Loeb, say people familiar with the situation, will probably deploy much lower-profile tactics than he did six years ago to get what he wants. Sony, which has learnt along with the rest of corporate Japan to take such challenges seriously, has brought in the firepower of Goldman Sachs as an adviser and has already announced its second major share buyback in three months. The downfall of Carlos Ghosn at Nissan, said one large shareholder of Sony, has spectacularly framed the perils of bad governance and sharpened companies’ desire to be seen as improving their own.

Activists, meanwhile, are not crudely targeting what they see as corporate Japan’s excessive piles of spare cash, but focusing on companies that seem open to persuasion. A decade ago, wrote SMBC Nikko chief strategist Masashi Akutsu, the activist mainstay was a simple strategy of taking stakes in companies with low price-to-book ratios or dividend payout ratios and demanding major enhancement of returns.

“Now though, proposals often reach deeper into issues of business strategy and the business portfolio,” noted Mr Akutsu.

Analysts differ widely on what is driving the underlying change in approach, but there is agreement on the key turning-points. Most recently, says Jefferies analyst Zuhair Khan, has been the situation at Olympus.

Shares in Olympus have risen more than 40 per cent since January after US activist hedge fund ValueAct successfully persuaded the medical equipment maker to appoint three foreign board directors for the first time since the 2011 ousting of Michael Woodford. The fund’s campaign was focused on longer-term strategies to improve the company’s profitability and business model. What drove change inside Olympus management were genuine fears that ValueAct would call an extraordinary shareholder meeting if its concerns were not seriously addressed.

If activists are abandoning cruder playbooks, there are also several forces making it harder for even conservative companies to dismiss activists.

The first is the clear recognition by Japanese companies that there is a consequence to having a high ratio of foreign holders on their shareholder register. In response to demands from international investors which hold 72 per cent of its stock, Toshiba this week disclosed a new board line-up that had more non-executive independent directors, including four non-Japanese - its first multicultural board in nearly 80 years.

“We had serious and active discussions with our shareholders and we came up with this selection from a vast number of candidates,” said Nobuaki Kurumatani, who was appointed CEO following a financial crisis at the Japanese industrial group.

The second, highlighted by the Olympus case, is the spectre of the EGM. The power of that threat has emerged at Lixil, where a group of long-term, not previously activist shareholders in the building materials giant used the strategy to expedite the removal of the CEO.

The scheme, which has now set up an unprecedented competition between two proposals for the new board, preyed upon Lixil’s fear that the EGM could actually succeed. In the past, sub-par managements relied upon the docility of their large institutional domestic shareholders to ensure survival. But according to people directly involved, when Lixil sought soundings on the likely outcome of the vote, it was stunned to discover that many of its major Japanese investors were ready to vote against the CEO.

Closely linked to that, said Mr Khan of Jefferies, is the still limited but growing impact of efforts to reduce the practice of companies holding shares in one another and maintaining protective wedges of “allegiant” shareholders.

Companies are probably more vulnerable to activism, he says, when the proportion of allegiant shareholders is low. If such companies are targeted, they must now give a detailed response to activist demands. “They can no longer get away with a meaningless response,” said Mr Khan.

A prime example has been US-based Fir Tree’s demand of railway company JR Kyushu that it buyback shares and introduce structural changes. For many veteran observers of Japan, Fir Tree’s choice of target seemed unwise - Japanese utilities, railways and media companies have proved sternly resistant to activism. Not surprisingly, the railway company opposed all of Fir Tree’s proposals. But against expectations it responded with a 21-page statement laying out its reasons for its opposition. JR Kyushu’s relatively low ratio of allegiant shareholders, said Mr Khan, helps explain why it may have felt it had to respond.

The phenomenon of more active domestic institutions, said Masanaga Kono, the Japan research representative for Marathon Asset Management and one of the instigators of the EGM threat at Lixil, is also central to this latest wave of activism.

The 2015 governance code, which set out desirable minimum governance standards for the first time in Japan, has had some affect on Japanese companies, but has exerted far greater pressure on the country’s investors to push for better stewardship. A major source of that pressure, said Mr Kono, is because Japan’s government pension fund (GPIF) is demanding that the asset managers it employs not only reveal, but explain in detail how they vote at annual general shareholder meetings.

“The effect has been very noticeable,” said Mr Kono, “once asset managers are committed they have been more energetic than expected about applying the rules and shifting their attention to the governance of the companies they hold.”

While activist investors have scored some small victories, Mr Smith of CLSA cautions that it is remains premature to hail this as the start of a golden age for achieving change across corporate Japan.“There is nothing yet that quite crystallises it all,” he said. “We need one big win.”

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