#kobesteal

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 Steel 5yr CDS not showing much fear vs history

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Kobe Steel’s 5yr CDS rate showing a 271bps premium above the risk free rate from around 50bps before the scandal broke. During GFC it was around 600bps+.

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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Kobe ‘Steal’ – why this scandal could get much uglier

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Kobe Steel is the next in a growing list of Japanese corporates embroiled in data falsification. Kobe Steel has been supplying lower spec material to customers than advertised. In a sense stealing. Sure VW is no better in lying about its emissions but Kobe Steel has the potential to be more like Takata than Mitsubishi Motors in terms of impact. The issue here has to do with Kobe Steel products being in structures of aircraft, trains (including bullet trains) and cars. While much is being made of ‘little risk’ attached to these slightly lower spec products the reality is that ‘metal fatigue’ is calculated in the resesearch, development, testing and evaluation of such products.

For instance when planes are in the development phase FAA certification depends on making sure products can meet certain tolerances, cycles and stress tests. Once certification is granted, if subsequent production is met by sub-standard intermediate products unbeknownst to the manufacturer of the part then the trail becomes a much more serious matter. It is easy enough to determine which Honda’s had defective airbags as it is a specific part on specific models. Yet Kobe Steel steel products shipped all over the globe may have been used in different parts. Then those discrete parts would need to be traced to the next intermediate stage and then on to the finished part to which may be fixed to an airline on the other side of the world. Boeing is naturally not raising any alarms until they can assess the issue.

JR has already noted 310 sub standard parts in wheel bearings in its bullet trains which will be replaced at the next scheduled service. It is likely that the JR parts are over spec for the extra margin of safety.

None-the-less aircraft could turn into a much bigger problem. There is only one spec that is supposed to be met. Failure to meet it could cause planes to be grounded until parts are replaced. This could be massively costly as planes not in the air earning money cost millions on the ground. Not to mention the risk of the US government fining the company for reckless behaviour.

Kobe Steel has seen revenues track sideways for the better part of a decade. Profits have been all over the shop. Much like Toshiba tried to fiddle the books with one division in the hope that in time it would be able to put the money back and no one would notice. As for Kobe Steel, there was obviously a plan to try to boost profitability by lowering specs and charging prices for superior spec. Even then the contribution has been poor. Hardly surprising when the cash conversion cycle has exploded from 38 days a decade ago to around 82 today. To be faker most of the big steel companies have a similar CCC which hasn’t changed much over the last decade.

What we can be pretty sure of will be the soft touch of the local authorities. Even with such willful deceit, it is unlikely anyone will see inside of a jail cell or pay multi million dollar fines in Japan. However the tail risk here is the likes of Boeing who will extract every pound of flesh with the help of its authorities to rent seek from Kobe Steel if certain parts are found to be ultimately faulty because of negligence. This is not a staged Nissan-Mitsubishi Motors leak to force a cheap entry into the latter. Still, 37,000 employees at Kobe Steel will be seen as a sizable number to protect at a national level hence a limp wristed response to follow.

One final point. Do we honestly think that Kobe Steel can conduct an honest audit of its deceit? Surely flagrant data fiddling will be milled down to more acceptable cheating.  It is a time honored tradition to leak a bit, then a bit more so as to minimize the shame.

Until Japanese listed corporates face far harsher penalties for such malfeasance, it will be hard to shake off the cynicism that the corporate governance code has introduced anything more than mere lip service. That is OK if that is what Japan wants to project to the world that shareholders are not a priority.