Size Matters but not how you think

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An article from my good mate Leo Lewis at the FT. The study I wrote on Size Matters is here.

Following last month’s UK vote to leave the EU, the president of Daiwa Securities predicted a spurt of Japanese outbound dealmaking, turbocharged by a resurgent yen. But even then, Takashi Hibino warned, the uncertainties swirling through post-referendum UK meant only a “very courageous individual” would look at doing anything there.

Not for the first time, Masayoshi Son, the founder of SoftBank, duly stepped forward. By making a £24bn bid for British chip designer Arm Holdings he has clearly defied establishment wisdom and apparently reprised his role as Japan’s foremost courageous individual.

One day on, the market had not welcomed the deal: SoftBank shares fell by 10 per cent on Tuesday. However, Mr Son seems happy to put himself at the extreme end of Japanese corporate bravery and risk appetite. His deal history, for right or wrong, has not just been bold in scale, it has also been bold in its willingness to change the DNA of SoftBank itself.

Critically, say analysts, Mr Son embraces risk with skin in the game: a 19.2 per cent stake in SoftBank that is both stick and carrot to his bravura dealmaking. By contrast, the rest of corporate Japan — increasingly led by a generation of salaryman chief executives who hold minuscule quantities of stock and have risen to their positions by avoiding risk wherever possible — does not do very much of that.

Some larger, cash-rich Japanese companies, following pressure from shareholders, have started to become more proactive in looking abroad for long-term growth and a higher return on equity. They logged a record ¥10tn of outbound M&A deals in 2015. Even so, it was an improvement rather than an outright transformation. Those outbound deals were fairly conservative, led by the insurance and banking sectors looking for large, bolt-on businesses in dependable, developed parts of the world. The scale of the deals — modest by global standards — demonstrated a reluctance on the part of acquirers fundamentally to reshape themselves.

According to figures from Dealogic, Japan’s unprecedented M&A spree last year only put it at seventh in the world rankings of outbound dealmaking by volume — behind the UK and the Netherlands.

Mr Son’s ability to stand out as Japan’s pre-eminent risk taker also shines a spotlight on a deeper issue restraining swaths of corporate Japan and preventing the key reforms of Abenomics from gaining long-term traction: a corporate unwillingness to hold equity stakes or to use them as incentives. Japan’s 2015 corporate governance code, along with a broad campaign to convince Japanese managements to become more passionate about raising shareholder value, are in effect stymied by the very small stakes that the top executives hold in their companies.

A study of the phenomenon by analysts at Custom Products Research found that taking the five-year performance to the end of March, the average combined stake held by the boards of the Tokyo market’s 50 best performers was 11.2 per cent. For the 50 worst performers, the average was just 1.7 per cent.

Japan’s Financial Services Authority has spent the past few months attempting to convince investors that companies in the First Section of the Tokyo Stock Exchange have grasped the “essence” of the code. Foreign fund managers tend to doubt that and many argue that management focus will only truly shift when it has more skin in the game — not Mr Son’s level of skin, but enough to snap boardrooms out of their salaryman mindsets.

As Michael Newman, the head of corporate advisory services at Custom Products Research points out, the process of restructuring Sharp and then negotiating its sale to the notoriously aggressive Terry Gou of Hon Hai, was never likely to be conducted with any great pro-shareholder vigour by a Sharp CEO who had just $33,000 of stock after working for the company for 36 years.

According to the head of one global fund with large investments in Japan, a majority of big Japanese company managements are still not noticeably aligned with their shareholders.

That means there is little to suggest they are about to get creative in their dealmaking and reshaping their companies’ futures — certainly not in a way that would make the courageous SoftBank president less of an exception.

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