As Elliott management was duking it out with the Toyota Group over its underpriced friendly take-private deal for Toyota Industries, the Ministry of Economy, Trade, and Industry (METI) announced it will publish clarifications to its takeover guidelines, making it clear that company directors should not feel an obligation to accept the highest bid in a takeover deal if that would not deliver the best outcome for overall “corporate value”.
METI’s 2023 takeover guidelines were and are a key catalyst for the explosion in take-private deal activity. The focus on “corporate value”, defined simply as the present value of future cash flows of the company, shifted the paradigm from the ambiguity of stakeholder capitalism to a more commercial footing.
However, “corporate value” as a concept has always been a halfway house between US-style shareholder capitalism and the more socially conscious traditional Japanese approach to business. Note that METI did not mention future cash flow per share, but rather cash flow in the aggregate. The benefits of such cash flow impliedly accrue to society more generally, rather than to shareholders specifically, hence the distinction.
METI’s clarification here likely comes at the behest of establishment business lobby Keidanren. It is unlikely a coincidence that reports surfaced around the same time that Elliott Management representatives will meet with Keidanren representatives to discuss views on corporate governance. It appears Elliott’s efforts, in particular the involvement with Toyota (Toyota’s former CEO and current Chief Industry Officer is the Vice-Chair of Keidanren), has awoken the establishment beast.
As yet, the reaction seems unlikely to have a large impact on the reform process. METI is just clarifying what was already understood to be the case by most. What matters in a takeover or activist situation, as always, is the composition of the shareholder register, and which shareholders will side with which in a vote.
The rise of the Defence Funds
A potentially more concerning development is the recent activity in the “defence fund” space. Often branded as private investments in public equity (“PIPEs”), but sometimes structured as exposure via warrants/options or convertible bonds, these funds operate in a murky area insofar as governance and shareholder capitalism are concerned.
There is not a consistent playbook, but an investment from one of these funds may involve:
- purchasing a large stake via a secondary sale of cross-shareholders’ holdings.
- Investing via a large private placement of new equity, without requiring shareholder approval
- Purchasing a convertible bond or being awarded options or warrants over a significant minority (often 20-30%) of the company’s market value
Particularly egregious is where #2 is then coupled with a friendly take private transaction agreed with the fund at a highly advantageous price, shortly after the PIPE transaction, and free from the potential for activist disruption thanks to the combined controlling shareholdings of the defence fund and the management-aligned shareholders.
This was the case in the recent agreed deal by Taiyo Pacific (also the former employer of Senjin Capital co-founder Umezaki Tsubasa), now owned by the family office of Nintendo’s founding family, to take Star Micronics private shortly after Taiyo invested via a large placement of new stock at a 10% discount to the market price(!). The new equity was issued to Taiyo despite substantial net cash reserves, amounting to around 1/3 of the company’s market value. The obvious reason for the placement was to ensure a friendly deal could go through without any shareholder opposition. This is about as cynical an approach as is possible from a firm formerly known for prognosticating on the benefits of good corporate governance and protecting minority shareholders.
Potentially less egregious is where a PE fund buys a stake off a founder or other major holder in a PIPE transaction, but keeps the company public. NSSK recently completed such a deal, buying 25% of Fujita Kanko. The fund can work with the company to improve capital allocation and business operations, and generate a return for its investors in the process.
The convertible bond / options / warrants model followed by players such as Advantage Partners (partially owned, and distributed in Australia by the publicly listed Pinnacle Investments) may be somewhere in the middle. Our concerns over this model were initially less pronounced, with the main issue being dilution of existing shareholders at an unfavourable price. Our view has since soured somewhat following learning that another well-known activist-defense advisory firm is launching a fund to follow a similar strategy.
Repackaging the Cross-Shareholding problem
Then we have the purchase of shares from cross-shareholders. Japan Activation Capital was set up by the former head of Carlyle in Japan. It is funded by the banks and insurers essentially so that it can, wait for it, buy the cross-shareholdings of the banks and insurers that the banks and insurers are under pressure to sell. We have seen this a few times, most recently in the case of Meiji Holdings, but also with Omron and Lion.
Notionally JAC buys these cross-shareholdings on the understanding that JAC will bring its private equity expertise to bear to help management improve the company’s operations and capital allocation. There is little evidence of this so far, other than Lion announcing the disposal of a non-core business, and it seems to be more the case that JAC earns a nice management fee for the purpose of providing a layer between the cross-holder and the cross-holdee. This may be proven to be too cynical a view, but then again, we may be assessing things correctly.
Put all together, do recent events mean the corporate governance reform is being waylaid by the establishment and other reactionaries?
Far from it. These are relatively isolated examples of pushback. The widespread nature of activist involvement in today’s Japan, and the growing public acceptance that activists should try to change backward businesses, indicate that Japan continues its forward progress.
The recent defence fund actions are not a positive, but it is a large market, and their impact is still very small in relative terms.
