The top five Japan-focused activist funds by size now reportedly each manage US$5bn to US$15bn. Gone are the days when they could buy a meaningful stake in a $200m market cap company with a negative enterprise value due to cash holdings, push for more dividends and buybacks, and exit with a quick double.
The game changes with size. Allowing for 15 equal sized positions, an activist managing $10bn needs to deploy $667m in each position. In reality, the skew is more likely 5 large positions and 10-20 smaller ones. Let’s assume five positions are 50% of the portfolio, then each position needs to be $1bn in size. Let’s use $850m, a number somewhere between those two figures, as a reasonable proxy for a large position.
Investing that much money, the activist needs a relatively liquid stock, and likely a $5bn-$20bn market capitalisation – depending on how much of the register they are willing to own. A larger stake provides more influence over achieving an outcome, but increases the exit liquidity risk.
One needs to be very sure of the underlying value and of the exit plan before taking a 20% position. The reality is, $5bn+ market cap companies are much better covered than their <$500m peers. Not only do they have sell-side research, but they are regularly picked over by major buy-side fund managers.
This does not mean that there are not many opportunities in these companies. There are – especially in Japan. It just means the opportunities are not as obvious, the margins are thinner than at the small end, and the opportunities generally require a lot more work to A) identify, and B) execute on. This type of activism is more like what we see in the US, just with much fatter margins for the activist.
Now, the big activists obviously have the luxury of almost endless resources to help them identify and execute on these situations, but there is no denying that it is much harder work, with a greater uncertainty in the quantum of the payoff, and the timeline to exit.
The other thing that changes apart from the scale of the targets and the margins available to the activist, is the tactics used by the activist. Often the targeted companies may not have huge excess cash balances, or may even be net-debt. They may not have large excess real estate holdings. The ultra-low-hanging-fruit of “increase the dividend and buy back stock” measures which are also simplest for management to implement, and/or “sell off the cross-shareholdings and non-core real estate”, may not be available as a remedy to the situation.
This requires a move away from the relatively easy “fix the balance sheet” to the relatively difficult “fix the business”. At Senjin Capital we engage on both balance sheet AND business operational issues, but the downside protection and much of the potential upside comes from the balance sheet, while fixing the business is the icing on the cake.
The difference in approach required as you get bigger is well illustrated by reference to the current situation in Oasis v Kao.
Kao is generally known as the P&G of Japan with household/personal care, and beauty businesses. Kao is a perennial underperformer:
Oasis now owns a US$2bn position in Kao. This is Oasis’ largest public position ever.
Oasis’ campaign against Kao originally focused on its dramatic underperformance vs global peers, driven by a lack of strategic leadership & global marketing expertise leading to an over-reliance on a shrinking domestic market. A lack of female representation at the board and executive level for a company that predominantly markets to women, and a non-existent brand portfolio strategy with too many brands and SKUs within each brand, were other key issues identified.
These are all very credible points on which to engage, and are exactly the type of issues the government is trying to fix with its corporate governance reform. They should form a solid basis for an operational turnaround.
But, notice what Oasis is not asking for. Nothing related to the balance sheet, nor even selling off non-core divisions. The closest comparable ask is brand & SKU rationalisation. This is a lot more operationally intensive than simply selling a loss-making business.
Oasis put forward a slate of highly credible, talented, and experienced independent director candidates, with a broad range of much-needed skills, for election at the 2025 AGM. Sadly, none of them were elected.
This proved yet again the maxim established with Value Act’s attempt to do the same with Seven & I back in 2023 – in Japan, poor performance is not enough to get you fired.
Contrast this with Oasis’ success replacing the board of Fujitec, where Oasis uncovered a smoking gun – malfeasance by the Chairman; or the Murakamis and Dalton at Fuji Media, where director resignations occurred after activist pressure following a sexual assault scandal.
The other elephants in the room missing from Oasis’ public slide decks are how 1. How difficult it is to turn around beauty businesses, and 2. How the hurdles implicit in Japan’s intermediated distribution system can be overcome, with powerful distributors sitting between FMCG manufacturers and the retailers that are nigh on impossible to bypass.
In relation to point 1. Shiseido has been trying much of what Oasis is recommending for Kao almost a decade. The board and marketing strategy were refreshed, portfolio pruned, much of the team became international. The stock price has gone nowhere. Look at Estee Lauder – once a market darling in prestige beauty, the stock is down ~80% from its peak four years ago. The situations are obviously not identical, but the key point remains – this stuff is not easy.
Regarding point 2, there are many reasons Japan’s FMCG stocks earn much lower margins than elsewhere in the world. It is not all due to incompetent management.
Following this defeat, Oasis has changed tack, calling an extraordinary general meeting to appoint independent investigators to examine whistleblower claims, supported by a (no-doubt expensive) third party report Oasis commissioned, of exposure to suppliers with links to deforestation, human rights violations, and land seizures. To our knowledge, this is the first time this has ever been attempted in Japan (the EGM + special investigation), but it echoes the environmental activism that has begun to appear elsewhere, and various environmental-type proposals in other cases – such as Oasis proposed around carbon goals at packaging manufacturer Toyo Seikan.
The tactic is ingenious, as it ticks all the boxes for the proxy advisors and institutional investors who tend toward rules-based voting – generally because it is too time consuming to do a full deep dive on every shareholder meeting proposal to get to the underlying economics.
Oasis has already announced that it has ISS’s support (particularly influential in Japan) for its proposals, and Glass-Lewis just hosted an Oasis video conference on the EGM. This does not, however, guarantee a win – as Oasis knows all too well after its candidates for Ain Holdings’ board were not elected despite receiving stamps of approval from the proxy advisors.
The tactic also highlights potential hypocrisy from management, as the President’s LTI scheme is 40% based on ESG KPIs. This sets up a scandal which could lead to resignations, board renewal, and potentially, even a sale of the company, if the management team that touts its CSR credentials and is paid for them, turns out to be somewhat less-than-responsible.
A change in management could provide a solid return on Oasis’ position. A sale of the company, which would be a huge, but not insurmountably so, deal for cashed up private equity funds, would provide further upside. It is questionable whether a strategic acquiror would be interested in Kao given the exposure to Japan’s difficult market, and the difficult nature of the beauty market in recent years.
Even in the best scenario, the upside here is unlikely multiples of the current stock price. When Kao earned an operating margin 50% higher than current and traded on a multiple similar to P&G’s before the recent sell-off in consumer staples, the price was only ~50% higher than current levels. Oasis’ average cost is slightly above the current market price, per Factset data, and the position was started two years ago.
Could PE pay a larger premium? Maybe, but the likelihood of achieving a deal is not high, the potential premium uncertain – at least to us outside observers, and the timeframe could be significant.
Oasis can also hold long term as a turnaround progresses, getting topline growth and margin expansion, but at some point, the investment ceases to be an activist position if the activist’s asks are being fulfilled!
Oasis’ historical returns have been exceptional. Reportedly >30%pa compound over an extended period. But Oasis’ AUM was a lot smaller historically. Its funds have been closed to new money in recent times – a measure typically taken due to the difficulty in deploying additional capital at high rates of return.
With any successful exit in Oasis’ largest-ever activist position probably at least a year away, it seems unlikely that the historical return threshold will be met.
It will be interesting to watch the outcome of the vote and follow the proceedings from this point, as this is a novel approach, and involves one of the largest Japan activists taking on one of Japan’s leading household-name companies.
One cannot escape the feeling, however, that we are playing a much easier, higher-returning game, in buying small cap stocks rich with cash and real estate.
