#toshiba

If we’re so keen to stick to Paris should we feel guilty about nuclear power?

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Australia seems keen to stick to the Paris Accord. Despite knowing whatever we do on saving the planet through following the politics of Paris will result in no palpable change in world temperatures at considerable economic cost to overstretched taxpayers. If we seem so keen to do our bit for tokenism, why not copy so many signatories and build nuclear plants? After all if we don’t want to be censured for abandoning the accord should we feel any sense of guilt if we adopt the very same CO2 limiting measures of others? Safety in numbers – literally.

CM was privy to a meeting with a former US Navy officer who was speaking about how negative PR can create false narratives. Nuclear power was one of them. He argued that the US & Japan were losing the PR war hence technological leadership on civilian nuclear power. The likes of Toshiba-Westinghouse are now shrinking minnows whose dwindling order book looks like the victim of a sunset industry when in reality it has been terrible program management. However why should it?

Nuclear power is set to be 14% of global electricity generation by 2040 from 11% today. Emerging Asia get the practicalities of nuclear power. Affordable and sustainable baseload with virtually no emissions.

Of course the horrible outcomes of poorly managed nuclear plants has come at great financial cost as experienced most recently  with Fukushima but the safety record of nuclear power is astonishingly good. Quantum levels more people die in coal mine accidents every year than the combined deaths from radiation from Chernobyl or Fukushima meltdowns since either occurred.

The misplaced fear of Fukushima was so high at the time that Americans across the Pacific were stocking up on radiation masks and Geiger counters in preparation of impending irradiation. It seemed the further one got away from the reactor the more hysteric people became. Deaths in the US as a result of the Fukushima meltdown? Zero!

As it stands, the US has two nuclear plants under construction at present which are saddled with delays and costly overruns based on incompetent execution. The Chinese have twenty in the build phase. India 7. Korea and the UAE 4 each. Russia 3. Even Bangladesh & Pakistan have two in the pipeline using technologies outside of the US/Japan.

There are about 150 power reactors with a total gross capacity of about 160GWe on order with about 300 more proposed. Where are the former world leaders in power technology? Next to nowhere. Cowering in a corner and allowing themselves to be beaten up senseless over false statistics. Where is the PR reporting reality? It’s as if they’ve given up. Where is the media lambasting China, India and other nations for putting our lives at risk? That’s right – nowhere.

What probably escapes many people is that for all the negative news cycle around nuclear power and the thirst for renewable alternatives, many Americans are already surrounded by active nuclear plants. While they visit a zoo or the beach they are blissfully unaware that at all the naval ports dotted around the mainland (e.g. California, Connecticut, NY, Florida, DC, Texas, South Carolina etc) and islands (e.g. Hawaii, Japan) there are 100s of nuclear reactors sitting safely in close proximity to millions of civilians. Yet where is the outrage? Not a peep.

Shout from the hilltops at the efficiency of renewables all you want. Then explain why those with higher levels of renewables as baseload power end up with the highest incidents of blackouts and steepest prices.

South Australia is the case in point. Australia is home to the cheapest materials (gas, coal and uranium) to make affordable electricity but we have caved to the green madness and saddled ourselves with punitive power prices to meet goals based on unproven and often whistle blown manipulated science. If climate scientists were subject to the same punitive damages that players in the financial industry are then it is likely the “targets” leading to our ecological disaster would be pared back to such a degree we’d just keep calm and carry on. Yet because there is no risk of jail sentences the tax dollars get misappropriated, funding an industry whose survival and growth depends on fear. Talk about a lack of ethics.

Even worse we want to double down on this inefficient renewable technology (where claims are often made on 100% capacity rather than the 20% they truly operate on) despite having empirical evidence of its all too obvious shortcomings. Virtue signaling actions such as blowing up old coal fired power stations has ironically proven the stupidest of moves in that all the while demand hasn’t changed reductions in reliable baseload supply makes us vulnerable.

Throw on the desire to electrify the automobile  and we already know that existing base load won’t cope with the increased demands. Take a look at Britain as an example. Apart from the risks of losing massive fuel tax levies (around 5% of total government revenue) the power industry’s current projections of new electricity generation additions can’t meet the expected demand if we all plug our EV in overnight.

So Australia should quit worrying about what others think and act in its own best interests. Maybe Canberra needs a PR agency more than the nuclear industry does. High time to look at real data and sustainability.

 

Trust in Japan? Strangled by sontaku 忖度

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Trust and Japan used to go hand in hand. It was a hard earned reputation.  A mining executive once told me that “when you sign a contract with the Japanese, that is the contract. When you sign a contract with the Chinese that is the beginning of the negotiations.” Hardly a subtle difference. Yet here we are in the last few years where a plethora of scandals from Japanese companies have come to light. Houeshold names too – Olympus, Toshiba, Kobe Steel, Subaru, Toray, Nissan, Mitsubishi Motors, Takata, Mitsubishi Materials, Asahi Kasei, Obayashi, JR Central, Nomura etc etc. It is almost as if there is a coming-out of sorts so the crimes are somewhat diluted in the midst of others. Syndicated scandals? Expect more to come out. Perhaps the worst part about it is the limp wristed approach by the regulators. ‘Sontaku’ (忖度) in Japanese is a word meaning ‘glossing over’ which is exactly what the regulator is doing over scandals involving household names. Hear no evil, see no evil, speak no evil.

In October I was invited to give a lecture to 70 bureaucrats at the Ministry of Finance’s attack dogs – the Financial Services Agency (FSA) and the Securities and Exchange Surveillance Commission (SESC) on foreign perceptions of Japan’s handling of corporate  crime. In the interests of objectivity the first slide pointed to how no corporate governance system is perfect citing the minefield of foreign corporations caught up in bad behaviour – VW, Petrobras, Parmalat, HealthSouth, Lehman Brothers etc etc. I also highlighted the sentencing of executives who commit crimes – many received lengthy jail sentences, personal fines while the corporates faced eye-watering penalties.

Ironically much of the crime committed by corporates here is at a relatively pithy level. Instead of billions being massaged into or from the books, Japanese corporates tend to commit the equivalent of falsely submitting a $20 taxi receipt to your boss as a business related expense. One almost could conjure up a scenario that if Toshiba was ever able to make back the money to cover the accounting fraud they’d have broken into corporate HQ in the dead of night to put it back in the safe.

I touched on Kobe Steel which conveniently broke the news that it had falsified the true contents of its products to customers. While pointing out such behaviour was regrettable a chart which showed a heavy shorting of the stock on the day it announced it to its duped clients displayed the bigger problem. A question was asked directly to the regulator – “do you intend to investigate the heavy short selling of Kobe Steel stock 3 weeks before the company announced this to market?” No answer.  The following slide showed that a person that was able to short the stock 3 weeks before the announcement would have cleaned up a tidy 60% profit. Again no plans to investigate the insider trading. Why bother having the FSA if it is a toothless tiger?

The following slide showed the types of fines dealt to both the broker (Nomura was a regular feature in the leaks) and the investor (at the time Chuo Mitsui Asset). The fines were the equivalent of $500 and no suspension of license was pursued by the regulator, When the following slide that compared it to the types of fines meted out to foreign banks – lengthy jail terms, lifetime suspensions and monster fines in the the millions and billions jaws didn’t so much drop but celebrate the idea “thank God we live in Japan”. Truth be told the FSA did punish one dying asset manager $150mn but that is an exception. That is the problem. It is too conditional where convenient.

Rolling onto the next slide the discussion looked at how ‘sontaku’ was a problem. Whereas the FSA & SESC heavily pushed for license revocation of foreign investment companies that it found to break rules, it let off all the domestic companies that had ‘brand names’ to protect. What message is the regulator sending if local corporations know they can pretty much get away with anything. In what way is that a fair system? If foreigners will be turfed on a whim then why do the locals get special protection?

When looking at agency funding, the FSA was put up against the US SEC and Australia’s ASIC equivalents. The US was there for illustrative purposes. Yet Australia was the market that made the point clearest. Despite having a total market cap 5x the size of Australia and 30% more listed companies, Japan spends 20% less than the antoipodeans. Even worse it had fewer numbers of staff and its budget was shrinking.

When analyzing market surveillance, in 2014 the Aussie market issued 36,000 speeding tickets (alerts to potentially suspicious trading). The sophisticated systems are designed to catch any wrong doing. The Japanese issued around 180 speeding tickets. I suggested the FSA go cap in hand to ASIC and the ASX and ask if they can buy the software off the shelf. Safe markets attract capital because all actors feel adequate protections are in place to prevent crime. Higher liquidity attracts more liquidity. It is a win win.

Several years ago the fanfare of the Corporate Governance Code was thrust into the faces of the intenational investment community that Japan Inc was changing. After visiting multiple staff inside the FSA and the TSE there is absolutely no pulse of proactively to be seen anywhere. Even my slight nudge to get the FSA to tap the shoulder of the TSE to suggest listed corporates provide English language materials to encourage more transparency for foreign investment met with the response, “it might help if you spoke directly to the Deputy PM & Minister of Finance Taro Aso.”Not a word of a lie.

How can the Japanese authorities look to appropriately handle a slew of corporate scandals if the encouragement of English language documents requires someone (a gaijin no less) outside the agency to ask the Deputy PM to suggest it back down to them. It is an embarrassment.

In closing perhaps we can look to these corporate scandals breaking out as endemic of a greater underlying problem. While the knowledge that the regulator is likely to do next to nothing provides mild comfort, the reality is that Japanese companies have been strangling themselves for decades. The corporate fabric is fraying. The world is far more competitive than it was. For Japan to assert its ‘quality and/or engineering gap’ dominance now means profits likely suffer. In order to  get around that hurdle it seems that to maintain profit margins, corporates now lie about specifications hoping a history of ‘trust’ and ‘time honoured’ traditions can keep the bluff going. As mentioned earlier the scale of the ‘cheating’ is pitiful yet the shame it brings is multiples larger.

Japan’s cultural rigidities are on full display. Unfortunately they couldn’t arrive at a worse time. Clumps of companies confessing crimes to soften the collective blow is only the start of many more. I suggested in my speech that the authorities introduce a 3 month amnesty period for companies to fess up to any wrong doing. That way they can clear the decks and make it clear that any wrong doing after that date will be met with harsh repercussions. Of course it won’t happen but expect the list of companies above to have many join them at the table of shame.

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.

Hinomaru Hard Drive proves Japan Inc’s memory is too short

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It seems the Japanese government is trying in earnest to launch a local based consortium to fend off foreign attempts to buy Toshiba’s memory business. Taiwan’s Hon Hai, which recently acquired Sharp, is in the running to buy it. It begs the question that if the technology that resides inside Toshiba’s memory division is so state of the art (Hon Hai seems to think so), why aren’t Japanese corporations lining up to buy it? Affordability may be one argument but why isn’t there a Softbank Masayoshi Son styled mega-scale leveraged buy out? Where is the risk taking corproation that can see the future value? Why does the government require an orchestrated syndicate to launch a group bid? We only need to look at the long history of failure of this type of consortium formation.

Exhibit #1. Elpida Memory. Originally the love child of the failed DRAM businesses of Hitachi & NEC in 1999, it adopted Mitsubishi Electric’s struggling DRAM operation in 2003. It listed in 2004 and went bankrupt in 2012. Put simply Japan’s DRAM business, already buried by foreign manufacturers with lower costs, required regular capital raisings which dfailed to deliver the rosy future painted by the charismatic CEO Sakamoto. Hinomaru DRAM died.

Exhibit #2: Japan Display (JDI) which is the listed LCD JV of Sony, Hitachi & Toshiba is yet another mish mash of companies that is trying to keep an uncompetitive product on life support. While it might have Apple as a customer it has margins which scream lap dog. JDI’s market capitalization is 1/3rd of its listing value. Once again Hinomaru Display shows signs of remaining an uncompetitive sloth. Yes, tech analysts will tell me it has best in class technologies. Sad thing is they aren’t getting paid a fair rent for it.

Exhibit #3: Renesas Electronics was formed as the rejected love-child of NEC Electronics which was bought by Mitsubishi Electric and Hitachi. The lack of profitability saw the government’s Incubation Network Corporation of Japan take a c.70% stake in the group to help revitalize it. The shares have performed well in the last 12 months but remain 90% below the peak when it was conceived. Much of the performance is weighing on the expectation of automotive electronic systems requiring more of their chips.

Minister of Economy Trade and Industry (METI) Hiroshige Seko said recently that Toshiba’s memory chip technology could be used to wage destructive cyberattacks if installed in corporate data centers. National security issues should always be entertained as they are in many countries but corporate data centre vulnerability is a much broader problem. Protecting memory chips won’t necessarily stop hackers – in individual, underworld and state sponsored forms – from carrying out cyber attacks.

What we are dealing with here is yet another last ditched attempt to save face in an industry which has lost its competitive edge. Instead of being an IP owner that outsources production it insists on keeping the entire model in a state that can’t compete. Ultimately market economics is a tough judge and jury. Putting together such Hinomaru structures only leads to inefficient capital allocation that hopes to survive as two drowning men trying to make one swimmer. It misses all of the points of making it competitive. Instead of taking hard decisions, it wants the board of Toshiba to accept a lower bid from national interests as preferable to a better bid from a foreigner. How that plays into Japan’s wish to foster best in class corporate governance one will never know? Like Daiko Henjo, such rearguard actions only support the idea that running businesses inefficiently is OK because eventually government backed bailouts are there to save them.

That doesn’t foster risk taking so desperately needed to turn the tech industry’s in Japan around. Is it any wonder that Intel made 50% more net income over the last 25 years than all of Japan’s largest 20 tech companies combined?…

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, NEC, Panasonic & Sharp lost a combined ¥1.9tn over the last 25 years

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I am putting together a piece on corporate governance in Japan and stumbled over some interesting charts. The one above shows the aggregate net income of Intel and 20 of Japan’s tech juggernauts over 25 years. Sadly, Intel on its own made 41% more net income (currency adjusted) than all of the Japanese 20 combined. Toshiba, NEC, Panasonic & Sharp lost a combined ¥1.9tn ($18bn) over the last 25 years.

I’ve been speaking to the Financial Services Agency (FSA) about how to improve corporate governance as they look to tweak the code.

Is it any surprise that companies tend to perform better when board members (insiders) have a higher proportion of their remuneration linked to stock performance? Shareholders have traditionally been well down the list of priorities of Japanese companies, much to the chagrin of foreign investors. 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. Many leaders in Japan would prefer to see out their tenure as CEO without blemish or scandal to avoid the risk of failure and the shame it would inevitably bring.

In hindsight looking at Sharp’s (6753) desperate long term need for crisis management could we have honestly expected any substantial restructuring when the CEO had $33,000 in stock despite being at the company 36 years? Had Sharp’s board held more skin in the game they might have defended shareholders much better against Terry Gou’s constant renegotiations. Perhaps if Sharp had learnt from Carlos Ghosn style performance based compensation structures, they might have been able to defend their turf from Gou. As it stands now Sharp were mere whipping boys of Hon Hai.

When I looked at insider (executive) ownership of Japanese corporations over 10yrs mapped against total returns, surprise surprise, there was strong correlation.

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More to follow but there is actually a lot of longer term hope here. Japan licks the world in most areas of technology. If they managed to connect those dots to shareholder returns then this market would re-rate substantially. Looks as though a growing number of corporations are working more performance linked pay.

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I think that the authorities should encourage corporates to adopt English language financial materials. 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 more 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.  This is the number of Japanese corporates where CEO/Chairman engagement with foreign shareholders -a little over  10% of listed entities.

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So some interesting trends and maybe something to look forward to if Japan accelerates the pace of corporate governance application. They can start by hiring fewer lawyers, accountants and academics as independent directors too!

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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.