#japaninc

Kobe Steel’s White Samurai – who might be forced into national service?

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While we are some way off understanding the extent of damage to Kobe Steel, we shouldn’t rule out the inevitable action which could involve a structured rescue of it, a white samurai if you will. Japan’s largest steel company NSSMC (5401) owns 2.95% of the outstanding shares of Kobe Steel. Will we see a motion in several months time as more facts become known for a consortium like the INCJ to team up with NSSMC to turn it into another Hinomaru sunset business? We saw the dying semiconductor industry in Japan get rolled into Elpida (which went bust) and cell phone screen players get merged into Japan Display (still listed) so why would anyone doubt a Hinomaru Steel consortium which would be a forced sense of national duty. While still way too early to surmise we should not ignore such a scenario should Kobe really find itself hoisted by its own petard. Corporate harakiri is the last thing Nippon Sumitomo Steel holders want from a governance perspective

Kobe ‘Steal’ – will the market referee wave a red card at what looks a lot like insider trading?

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If the referee caught Kobe Steel’s (5406) rugby team up to such foul play it is likely that players would be red carded. While unconfirmed speculation at the moment, it would appear that since September 21st Kobe Steel shares came under heavy selling pressure in what a seasoned market punter might suspect looks like insider trading via aggressive short selling. 7 straight negative candle sticks. Kobe Steel spilled the ball on its data manipulation on October 8th.

This would not be the first time that a broker conspired with a fund to short sell a stock ahead of a negative release on insider information where several weeks later news broke and sent the shares collapsing. This is the current action of Kobe Steel shares.

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So excluding borrowing costs or any leverage, if one had managed to short sell Kobe Steel at 1350 (on Sep 21) and brought back at today’s prices a quick fire 53% return would be gained.

The important question is whether the regulator will investigate any potential foul play when looking at the video replay. I will be asking this question directly to the Financial Services Agency (FSA) as I have been invited the regulator to give a speech on ways to improve Japanese corporate governance in a few weeks time.

This won’t be just a beat up of Japan’s corporate governance as foreign corporates have made countless scandals post the introduction of Sarbanes Oxley in 2002.  However it will aim to be a realistic overview of tolerating what seems to be endless preventable insider trading scams with paltry penalties of $500 and a slap on the wrists with a feather duster.

Until serious punishments for flagrant market manipulation are thrust front and centre in front of bewildered and annoyed (foreign) investors, the cynicism will remain that Japan is not a safe place to invest. Remember insider trading is effectively fraud. Perhaps your pension fund owns Kobe Steel in a global portfolio meaning that some shady investor has stolen your retirement to feather his or her nest.

Perhaps I should thank Kobe Steel for getting dirty in the ruck area to help the final presentation draft.

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59yo COO sues Fujifilm Australia for ageism

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The Australian Financial Review (AFR) reports that one of Fuji Film Australia’s executives, COO David Marshall is suing for ageism. There is a sense of irony in that the Chairman of Fujifilm Japan is 78. The AFR reports,

At a dinner at Melbourne’s Rococo restaurant in 2015, former Fujifilm CEO Kevin Masuda allegedly stood up and pointed at Mr Marshall, laughingly saying “Dave is too old” in front of senior clients…During 2017, Mr Koshimizu repeatedly referred to himself in front of Mr Marshall as “old, like past 60, retirement age” and allegedly told him Fujifilm “wants you to find the next Mr Marshall” and it was looking for a “young, strong” team.’We need a younger person’

On May 18, during a dinner at Palace Hotel in Tokyo, the chairman Mr Koshimizu told Mr Marshall “Dave, you and I are old too. We need a younger person to make strong as a general manager.”

Retirement is a hot issue in Japan. Corporates are retiring expensive workers (who are often paid based on seniority) and reemploying them as ‘advisors’ (pp.15-24) on relatively paltry sums of $1,000/mth. While it is not unusual here, it would be rather strange if Fujifilm in Australia were to make such a rookie mistake in trying to flip a worker approaching 60. In 1984 85% of male employees were full time vs 62% odd today. It isn’t surprising to see the most active demographic seeking work aren’t young uni grads but the elderly struggling to make ends meet.

 

And we wonder why the youth are abandoning Japan’s regions

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While Aussies whine and moan about cuts to penalty rates spare a thought for the poor blighters in regional Japan who have to suck up ¥800/hr (US$7.50) salaries (in this case Gunma Pref) versus around ¥950/hr in Tokyo. Sure the cost of living might be cheaper in the sticks but such disparity for someone thinking future prospects and sustainable employment. For more details on those fleeing the big smoke in Japan here.

Corporate Governance in Japan & our talks with the FSA & JPX on changes for 2017

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2017 Report

In our report of August 2015 it was made clear that “NO corporate governance code is perfect.” However, the emphasis was that corporates needed to focus on the quality of independent directors rather than submit to a quantitative box ticking exercise when it came to complying with the new corporate governance code (The Code). While the Tokyo Stock Exchange (JPX) can be rightfully pleased with the progress of compliance by listed entities, when looking through the data, there appears a concerted effort by corporates to employ independent directors with a bent on not upsetting the status quo. That would appear at odds with the spirit of The Code.

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We made clear that the introduction of the Sarbanes Oxley Act (SOX) and other corporate governance codes – which pushed for more independence on boards to ensure fiduciary duty to shareholders – did not prevent investor losses hitting all-time records. Good corporate governance is about building a culture of trust (both inside and outside the boardroom). We have been fortunate to spend ample time with the Financial Services Agency (FSA) and JPX discussing the potential revisions to The Code. We have put forward three suggestions to increase transparency and achieve the slated goals of the document:

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One, we have always suggested that the quality of independent directors is imperative. Forget SOX as a prerequisite. A well-managed company should never feel threatened by the number of independent directors challenging consensus in the boardroom. Good governance is being open to constructive criticism. If a company has lacked strategic direction for years, a fresh perspective from independent minds is invaluable. Our greatest criticism gleaned from the published data is the high concentration of the three A’s (attorneys, accountants and academics) as independent directors which is more acute the smaller the company. Diversity (of opinion) on boards is imperative but the figures suggest a group think mentality (Kintaro-ame) approach skewed to such a narrow field of professions limits innovation as no two companies are alike. How do authorities change it?

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Simply, secondly, and more importantly we think that companies need to introduce proper incentive structures for executives. Our studies show that companies tend to perform better when board members (insiders) have a higher proportion of their remuneration linked to stock performance. Stock incentives, especially in larger corporations, are often a minuscule part of total compensation for leaders. So much so that there is little incentive to focus on chasing real returns through more aggressive strategy. Fix this and independent director selection will be more serious.

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Third and finally, we think that the authorities should encourage corporates to adopt English language financial materials. A growing number are but the pace is slow. By doing so would invite more eyes from investors in markets where shareholder returns are prioritised. This would create an environment that would encourage Japanese corporates to unlock shareholder value. The JPX would accrue large upside. Not only would it gain more status as a proper global exchange, it would invite higher activity which would improve liquidity which is a virtuous circle for a financial exchange.

In short, Japan remains by and large a masterclass in risk avoidance. Until company executives have performance linked remuneration structures we believe independent directors will do little to help drive shareholder returns. Kintaro-ame independent director selection is not the way forward. By prioritising the linkage of remuneration, driven by higher disclosure via English language we think the ultimate aims of The Code can be achieved and the soft corporate governance approaches we have seen to date with the failures of Toshiba, Sharp and Olympus can be consigned to history.

2017 Full report

Toshiba reveals yet again the depths of its lack of imagination and innovation

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If we needed any more proof of how starved Toshiba’s board is of innovative thinking (by the way Toshiba’s logo is “Leading Innovation”) the actions to cut wages, salaries, costs and travel highlight it in spades. Simply put, to exact more self inflicted pain across the entire group that is struggling to recover is corporate suicide. Toshiba should be picking its battles and investing in its portfolio of relative winners to climb out of the hole of its own making. Wages are not going to be the swing factor here. While it might help the P&L for a few months, the actions are likely to further demotivate an already demoralized labour force leading to further revenue declines. Instead of asking those at the coal face what process improvements and efficiencies have been overlooked that may save them a fortune they can’t think beyond cutting free biscuits in the tea room. Clients also notice when companies start to scrooge. No client sees value in forging relationships with companies that look increasingly likely to go out of business. Scans in America is considering canceling two nuke plants for this reason. When we tally the cost savings of cutting salaries, we can be guaranteed that Toshiba will meet its maker. Time to let it fall under the weight of its own incompetence and let sensible buyers of its business divisions rediscover latent asset value. For a company that has been in deep crisis for years, I don’t buy that they’ve realized they have a problem only recently. Toshiba has dropped another $1bn in market cap since yesterday. At that rate (limit down rules excluded) is technically worth nothing at that rate in a little over 7 more days.

Toshiba should be left to rot as a warning to others like Captain Kidd. Sadly Japan Inc is Captain Kidding

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In the olden days, pirates and criminals were left to rot and die as a gruesome warning to others. Japan should adopt the same policy for corporates which no longer reserve the right to function. I once conducted a study that showed that Intel by itself made more net profit over 25 years in aggregate than the largest 20 Japanese technology firms combined over the same period. Yes, that is right Intel made 40% more net profit than Sony, Panasonic, Toshiba, Mitsubishi Electric, Nidec, Canon, NEC, TDK, Hoya, Nikon, Kyocera, Ricoh, Olympus, Konica Minolta, Sharp, Tokyo Electron, Advantest, Fuji Film, Ibiden, Fujitsu and Brother combined.

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Fuji Film once boasted that it was a better company than Kodak on the announcement of its bankruptcy. The reality is that as a shareholder the decade preceding Kodak’s bankruptcy had higher total returns (dividends, buybacks) than one who held Fuji Film. Not exactly a proud boast to say you’re superior only in terms of survival. That is the problem many corporates face. They do not properly understand the importance of shareholders.

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I have lived in Japan for too long to know that foreign investors remain right to hold such a negative outlook on corporate governance here despite the introduction of the Corporate Governance Code I wrote about in 2015. Toshiba is without a doubt a poorly run company that has become an uncompetitive mess of its own doing. It is decades of poor business decisions that has led to its demise. Not bad luck . The way the government is trying to protect Toshiba and its 200,000 employees is exactly why foreigners will stay away. All such rearguard actions do is send a strong message to all other large Japanese corporates that there is a safety net if they screw up.

Toshiba tried to appeal to investors after the initial accounting scandal that a majority of independent directors would prevent it happening again. Reality is that they were completely ineffective. To that point the Japanese stock exchange (JPX) asked me to fill in a survey on what I thought of corporate governance and whether it should be made mandatory instead of ‘comply or explain’. 98% of listed corporates have volunteered to hire two independent directors so I asked why would you make law what almost all are already in step with? Talk about not understanding what the point of shareholder needs are from the exchange itself. It is embarrassing. I made the point that the “quality” of independent directors was most important. I wrote in the corporate governance report the following,

“Companies must focus on qualitative aspects when hiring independent directors over quantitative parameters. Soft options to meet minimum regulatory requirements to protect the status quo is a recipe for failure. Independent directors should not be viewed as an ‘unavoidable cost’ but as a ‘wise investment’ for firms. Which company would rationally choose inferior staff for its operations? Would an airline actively seek unqualified pilots to fly its passengers? That is not the way of sustaining good reputation in the long run.”

Toshiba is to all intents and purposes insolvent. It bit off way more than it could chew in nuclear. Westinghouse looked a huge boon at the time and many analysts fawned over the Japanese giant becoming a monster player in nuke power. Now the massive costs of building plants, the delays, the requirement for trained personnel to build them etc has become too much to bear,. Yet the government sees the banks propping it up through syndicated convoy support is the way forward.

I wrote in Jan 2016 about Toshiba as its market cap slipped below Y1 trillion.

“I once joked soon after Lehman shock that Apple’s overnight move of 5% was the equivalent of the vanquished Toshiba market cap. Now Apple only needs to move 1.29% to increase / decrease the equivalent amount of Toshiba’s mkt-cap. It shows just how far the Japanese tech giant (?) has slipped. When we look at reality, the accounting scandal, the appointment of 50%+ independent directors on the board and the likelihood of having to write down goodwill, the former tech giant faces further woes. Toshiba is in dire need of a ‘crisis’ manager to restore lost fortunes.”

I also argued in the same note:

“Toshiba may be trimming 16,000 odd staff into next fiscal year. Interestingly the decision to cut 6,800 employees from their overseas businesses highlights once again that domestic social harmony takes a front seat to shareholders. We’re not saying the action is not well intentioned but in a sense it is hardly the thing which will help get the supertanker turned around in the required time. Interestingly Nidec’s Nagamori has offered to hire software, communications and robotics engineers from Sharp and Toshiba to ‘help’. So the best engineers from Toshiba and Sharp will sign up for voluntary redundancy (aka tax effective bonus) and land a job with arguably one of the most profit focused Japanese tech companies, further gutting the ‘best assets’ from the ailing companies.”

Yet look at what Toshiba tried to do with fixing its ailing PC business. It’s independent directors voted to copy what abysmally failed in mobile phones, even worse teaming with an old partner. As I also wrote,

“One would have hoped that the independence of the majority of the board would lead to a heightened sense of urgency and crisis management. The recent news is that Toshiba is in talks with Fujitsu again to merge their loss making PC units where the two share 6% of the global market…There is a lot of precedent suggesting that this is a fruitless exercise. As one of my colleagues put it best, “two drowning men together don’t make a swimmer”. One would hope that Toshiba’s revived sense of corporate governance would see its board seek more severe action…

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“Japanese mobile handset makers have consolidated. Toshiba teamed with Fujitsu (surely a lesson in what a poor decision that has been), NEC with Casio and Hitachi, while Sony (albeit teamed with Ericsson until they merged) has had a rear guard action. Sanyo sold its handset business to Kyocera. Mitsubishi Electric just quit altogether in 2008. I remember a time when Japanese clam-shell phones were amazing. Friends from foreign lands would marvel at the designs, light weight and features versus the clunky Nokia and Motorola offerings of the time. They also were stumped at how these devices could get so much battery life. Alas, Japan kept them largely from overseas markets leaving them without the little scale efficiency from expansion abroad.”

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“As smartphones have caught on, Japanese handset makers have been left further in the dust. Sony has the highest global share among Japanese brands at 1.7% (Q1 2015), however even in the domestic market, Apple and Samsung command the leading shares. Japan’s market share in mobile phones globally has slid from 15% a decade ago to less than 4% in 2012. Japanese maker’s global share of flat screen TVs slump from 45% to around 20% over the same period. What magic can a Toshiba-Fujitsu PC alliance make?”

Alas Toshiba dithered and eventually knew that the government would throw out the emergency airbag to cushion its fall. How does throwing hands in the air and not taking more drastic action (selling cross shareholdings etc) sit with best in practice corporate governance and protecting shareholders’ best interests? Not a chance.

What Japan Inc should do is allow it to fail. Let the free market decide what assets they want. If Westinghouse is worth something to Hitachi or some other maker then so be it. Sharp was sold to a Taiwanese maker.  If Toshiba’s NAND flash business is only worth X to a foreigner or Y to a Japanese then that is reality. The market is there to match buyers and sellers. Somehow I fear that there is a ‘Hinomaru’ type structure that will form to absorb the chip businesses of several Japanese companies to form a burdensome partnership to appeal to social goals.

The government must understand that listed corporates are not there for national service. If that is the wish of the state then it should nationalise Toshiba. I’m sure the BoJ will be glad to add more toxic waste to its massive balance sheet which even dwarfs America. There is no way that foreign investors can glean any hope for true reform if protecting zombified atrophied elephants continues.

Japan is a shame culture. How is it that it doesn’t see that protecting Toshiba is in fact seen as so shameful to foreign investors and increasingly Japanese taxpayers.

Toshiba has till March 14th to find a solution before it gets put on the scheduled for delisting board. That I’d argue is even more embarrassing.