Category Archives: Japanese development

Google’s proposed new class of common stock

April 13, 2012 By in Current Market Thoughts, Industry Analysis, internet, Japanese development, Stock ideas, Stock options, Stock Splits Tags: , , , , , , , , , Leave a comment

the C class announcement

Yesterday, in conjunction with its release of 1Q12 earnings, GOOG published a letter to shareholders on its website.  In it, Larry Page and Sergei Brin outline their plans to create a new class of stock–C shares.

On shareholders’ approval, the new C shares will be distributed as a stock dividend, on a one-for-one basis, to all holders of A and B shares.  C shares will be publicly traded on NASDAQ, using a different ticker symbol from the “GOOG” the A shares use.  As will continue to trade, though.

no voting power

The sole difference among the share classes will be in voting power.  Each A share has one vote; each B share, held by corporate insiders, has 10.   C shares will have no votes.

Since holders of B shares–principally Mssrs. Page, Brin and Eric Schmidt–wield over 70% of Google’s voting power, shareholder approval is a mere formality.

Google intends to file full details of the issue with the SEC next week.

why do this?

…to keep voting control of Google in the hands of the current B shareholders.

How could control be lost?

…through a combination of sales by B holders, issuance of new A shares through stock options or acquisitions for stock.

current shares outstanding

According to the company’s 2011 10-K filing, 67.2 million class B shares, representing 672 million votes, were outstanding on December 31st.  258 million As, representing another 258 million votes, were also out.  Employee stock options on just under 10 million new A shares had been granted and remained to be exercised.  (Notably, I think, the stock option count is growing very slowly.  Google only granted options on 718,000 new shares last year.)

Therefore, assuming all stock options grants are exercised, A shares represent 28.5% of the total vote.  Bs represent 71.5%.

implications of the Cs

control structure frozen

The most obvious is that the new class will provide a way for the company to issue potentially large amounts of new shares without altering the current control structure of the company.  Google has already said future employee stock option grants will be for Cs.  Bs continue to rule.

price of the Cs vs. Bs

It’s not clear that the Cs will trade at the same price as the Bs.  Arguably, voting power should be worth something.  But in this case, as the company is currently constituted, the Bs’ votes basically have no value.  So you’d think the two prices should at least be pretty close.

stock options

Stock options don’t seem to me to be a big deal–or any deal at all.  Here’s what I mean:

If we assume all outstanding stock options are exercised, the company currently has a total of 940 million votes.  Bs have 672 million, with 268 million more for the As.

For the moment, let’s ignore the possibility that insiders sell a significant number of Bs to get walking-around money.  Yes, company rules require that Bs be converted into As before being sold, so no outsiders can end up with the super-vote shares.  Bs, therefore, can–and in the past have–disappeared.  And, yes, Mssrs. Page and Brin are halfway through a modest (for them) sell program that goes into 2015.  But put these thoughts to the side.

As things stand now, A shares can only achieve a voting majority if over 672 million are outstanding.  That’s an extra 404 million shares.  At the 2011 stock option issuance rate, the As take over in the year 2575, or 563 years from now.  At the 2010 issuance rate of 1.7 million, the As grab the reins in a mere 238 years, in 2250.

Suppose B holders sell 10% of their stock–because they need a loose $4.4 billion.  That would imply that the Bs outstanding shrink to roughly 6 million and As expand to 275 million.  In this case, the As still need 325 million more shares to take over.  That would happen, at the earliest, toward the end of the next century.

Even for long-term thinkers like Google, dealing with stock options worries can’t be a pressing issue.

stock-based acquisitions

This is the only reason I can see for the C share move.

True, Google has $44 billion+ in cash; operations generated $14 billion+ last year.  But a seller may well prefer stock to cash.  And, of course, a potential acquisition could be very large.  It could also be very large and very sick, needing a big infusion of cash after the purchase.

Yes, the founders’ letter says  “we don’t have an unusually big acquisition planned, in case you were wondering.”  I’m sure that’s true.  But I’d emphasize the word “planned.”  It seems to me that Google may well have decided it needs to make an acquisition of a certain type over the next couple of years and have developed a list of possible candidates. The next step is figuring out how to pay for it–which is what I think Google is doing now.

Who know what such an acquisition might be?  I wouldn’t care to bet on anything.  But I do have a guess, however   …somebody like Sony.  But that company has been such a train wreck for such a long time that I don’t see any percentage in speculating that Google would rescue them.  There are also severe legal obstacles that Tokyo has erected to deter foreign takeovers of its domestic firms.  On the other hand, Sony is a post-WWII upstart, not part of the establishment.  And the company does have TV technology, cellphones, tablets/PCs and the Playstation in tens of millions of homes around the world.

 

 

 

 

a revealing insider trading ruling in Japan

March 28, 2012 By in insider trading, Japanese development, Trading Tags: , , , , , , , Leave a comment

insider trading in Japan

Yesterday’s Financial Times outlines a judgment made last week in a Japanese insider trading case.  The newspaper misses what I think is the main story, however.

the recent verdict

An institutional portfolio manager at Chuo Mitsui Asset Trust and Banking was found guilty of receiving, and acting on, insider information about an upcoming issue of new stock by a publicly listed company.  The PM made ¥14 million ($170,000) for his clients by trading on the tip.

penalties?

They were:

–the PM’s employer, Chuo Mitsui, was fined ¥50,000 ($600)

–there was no requirement of forfeiture of profits illegally made

–no penalty of any type either for the portfolio manager who received the tip or the broker who gave it.

The article goes on a bit about how, in the mysterious way Japan works, the nominal fine may have sent a powerful symbolic message that therefore the penalties may be more severe than a foreigner might suppose.  I think the nominal penalties do send a message, though not in the way the FT believes.

Oddly enough, the newspaper contrasts this fine with the ¥1.15 billion ($14 million) fine levied against Yoshiaki Murakami for trading on inside information about a half decade ago.  But it doesn’t realize that this contrast is the real story.

the Murakami saga

Mr. Murakami is a naive former civil servant who believed traditional Japanese corporations badly needed restructuring.  He formed an asset management company about ten years ago.  Its purpose was to be a gadfly that could prompt corporate/social change, while making money for clients at the same time.  One of Mr. Murakami’s targets–his last–was Nippon Broadcasting System.

Mr. Murakami bought a very large position in NBS.   He approached the company with suggestions about how to improve very weak corporate results.  He also asked for a board seat.

Management ignored Mr. Murakami.  It called on the “usual suspects”–suppliers, customers, domestic institutional investors–for support by buying NBS stock themselves, or at least by refusing to sell to Mr. Murakami.  Effectively isolated, Mr. Murakami approached a somewhat sketchy internet entrepreneur, Takafumi Horie of Livedoor, for aid.

Livedoor told Mr. Murakami in a private meeting that it intended to build a stake in NBS itself.  The declaration made Mr. Murakami an insider of Livedoor.  Despite this–he later claimed he didn’t understand the implications of his inside knowledge–Mr. Murakami bought more NBS.

Livedoor subsequently launched a hostile bid for the company.  It failed.  During the battle, Mr. Murakami realized that traditional holders of NBS wouldn’t tender their stock, so he sold his for a ¥3 billion ($36 million at today’s exchange rate) profit.

Mr. Murakami was charged with insider trading and found guilty.

penalties for Mr. Murakami?

They were:

–a ¥1.15 billion ($14 million) fine

–forfeiture of all profits from selling NBS, which amounted to ¥3 billion ($36.5 million)

–two years in jail, later commuted to three years of probation.

why the sharp differences in the two cases?

Why should the punishment for insider trading be so startlingly different in these two cases?

Two factors stand out to me:

–the lesser one is that the Murakami case involved much larger amounts of money–although that doesn’t explain why there was no censure of the Chuo Mitsui portfolio manager or of the broker, and no forfeiture of illegal profits.

–the real difference, I think, is that Mr. Murakami was not part of the establishment.  Worse, he was a critic of the traditional social order.  By exposing its failings, he threatened the status quo.  In contrast, both the broker and the Chuo Mitsui portfolio manager were working within the shadow system of favors and obligations that the establishment uses to feather its own nest and keep itself in power.

the real story

That’s the real story here–stubborn defense of the traditional economic order, even after two decades-plus of resulting economic stagnation.

playing the Japanese stock market today is harder than it seems

March 22, 2012 By in Current Market Thoughts, Japanese development, Recent Market Action, Strategy Tags: , , , , , , , Leave a comment

how so?

No, it isn’t the frequent market holidays.

It isn’t the semi-visible, semi-not, zaibatsu/keiretsu business links that tie firms together with amazingly strong (to me, anyway) emotional bonds that foreigners find difficult to assess.

It isn’t the fact that for many Japanese company managements–to say nothing of institutional investors–one foot remains in the samurai world.

None of this helps a foreign investor.  But learning a market’s quirks is arguably part of the price of entry a newbie pays everywhere he goes.

the market structure…

No, the biggest problem for a foreigner today is the structure of the market–the selection of stocks available on the Tokyo Exchange.  Despite the fact that Japan is a wealthy nation and the second-largest advanced economy in the world, its market is dominated by the export-oriented manufacturers, plus the suppliers and distributors that support them, whose heyday (ex the autos) was thirty years ago.

…makes Japan look like an emerging country

The market structure is more like what you’d expect from China or India.  It’s also a little like the US circa 1980.  In the US since then, however, junk bond and private equity barons have taken many older, low growth firms private.  Conglomerates have broken up, or spun off their more glamorous parts, in strategies calculated to maximize their value.  Venture capital has brought a host of new firms into the public arena.  Not so Japan.  There are counterculture exceptions:  Uniqlo and the social networking firms come to mind.  But still…

None of this is exactly news.  But it’s the genesis of the dilemma foreigners now face in the Japanese stock market.

today’s problem:  a weakening yen

Newly initiated quantitative easing in Japan is weakening the yen.  That’s making life more difficult for domestic firms that use imported materials.  And it’s also a lifeline for exporters, who use yen-denominated inputs and sell their products abroad.  So Japanese institutions have been selling the former to buy the latter.  Again, no surprise.  It’s what they always do.

The issue for a foreigner is this:

Ex the autos, the exporters are not a particularly attractive picture.  Historically, they’re a pretty sorry lot in terms of making money.  They face intensifying competition from lower-cost rivals in emerging economies.  By and large, managements are hide-bound and unable to commercialize higher tech products they have.  Law and custom defend dysfunctional incumbents against any shareholder attempts at change .  (Think:  Olympus …or Sharp  …or Pioneer  …or Sanyo   …or Casio   …or Sony).

In addition, for a dollar-oriented investor, at least a part–and probably most–of any yen-denominated gains will be offset by currency losses.  Although my general rule is not to get involved in forex hedging, this is an exception.  Whether you like or not, you probably won’t make much money on your Japanese stocks unless you sell the yen.

…which brings up another potential worry.  Exporters usually run substantial currency hedging operations.  In my experience, they’re pretty good at it.  Nevertheless, it’s always possible that exporters have zigged when they should have zagged.

my bottom line

For a long time, I’ve regarded Japan as a special situations market.  Find an outstanding company; buy and hold.  Enduring the current flight from quality is just a cost of doing business.  I have no desire to chase export-oriented names, although while the yen is softening I think exporters will continue to be market stars.  If I were managing dedicated Japanese money, however, I’m sure I’d find myself under performance pressure to do just that.

quantitative easing in Japan: implications

February 23, 2012 By in Asian economic development, economics, Japanese development, Recent Market Action, Shaping a portfolio for 2012, Strategy Tags: , , , , , , , , , , Leave a comment

quantitative easing in Japan

With all eyes on Greece, one of the less noticed developments in global securities markets is the recent decline of the ¥ versus the US$.  As I’m writing this on Thursday morning, the ¥ has weakened from a high of ¥76 = US$1 reached on February 2nd to the current ¥80 = US$1.

This is not just the result of one of Japan’s periodic, ultimately fruitless, attempts to intervene in currency markets to temporarily weaken the ¥.  Instead, it’s the currency markets reaction to what appears to me to be a substantial shift toward monetary easing by the Bank of Japan.

Why do so?

After over two decades of minimal economic growth and mild deflation, citizens’ tolerance for political and bureaucratic bungling of Japan’s economic policy seems to me to have finally been exhausted.  Voters are deeply unhappy with the administration of the recently installed Democratic Party of Japan.  But no one wants the Liberal Democrats back either.  There’s serious discussion about forming a third political party–really radical thinking in a country where politics has been dominated by a single party, the LDP, for a half century.

There’s also been talk in the Diet of legislation that would take away from the Bank of Japan its Federal Reserve-like role in setting monetary policy.  This threat appears to be what’s prompted the central bank to launch the new program of quantitative easing.  The BoJ is basically saying that it will continue to inject money into the system in large amounts until inflation reappears.  In other words, the new stance is the Fed’s approach, but on steroids.

implications

In the near term, this policy will likely continue to weaken the ¥, removing one source of pressure on the profits of Japanese export-oriented companies.  It’s already prompting investors in the Tokyo stock market to re-orient their portfolios toward export-oriented stocks.  I don’t think this policy move, by itself, has the slightest chance of removing Japan from the morass in which it has been trapped for many years, however.  And substantial negative consequences may lie down the road.

As anyone who has read me on Japan before knows, I think the fundamental issue for that economy is the ground-level social decision made twenty years ago not to adapt to a changing world, but to preserve the traditional social order even if that meant slower economic growth.  After all, the country did hide its banking problems for a decade.  Despite a shrinking workforce, it doesn’t allow immigration.  Its laws cement the management practices of twenty year ago–and most times the actual managers–in place and defends them from virtually all attempts at change. Iconoclasts risk social censure, or worse.

Sounds a lot like the Eurozone, doesn’t it–one currency, but keep the local power brokers in place?

risks

Without substantial structural pro-growth reforms, what’s likely to happen?

For a while, nothing much.  The character of the stock market will continue to change, as investors shift away from smaller, counter-culture secular growth stocks to larger, older exporters.  But for foreign investors, a large part of any local currency gains will be erased by currency losses.  So it will be even harder to make money in Tokyo than before.

The strategy, however, seems to me to be playing with longer-term fire.  The central government has piled up a huge amount of debt, which it can continue to service both because interest rates are extremely low and because–lacking other investment alternatives–Japanese citizens continue to buy tons of government bonds.  Reemergence of inflation will mean, at the very least, rising nominal interest rates, and therefore rising debt service for the government.  In addition, in an all too rigid economy, inflation may spread relatively quickly and begin to have negative effects on the value of Japanese assets.  If so, Japanese investors may shift their money away from government bonds and toward inflation-protection vehicles, like real assets or foreign securities.  That might lead to further currency weakness and compound the government’s funding problem.  So a sovereign debt crisis, while not imminent, may be ultimately waiting in the wings.

what I’m doing in response

I own two Japanese stocks, DeNA and Gree.  I like them both, although each has taken its lumps as the market orients toward exporters.  I’m certainly not going to add new money to Japan.  And I’ve got to consider whether I lessen my exposure.  If DeNA and Gree didn’t have substantial businesses outside their domestic market, I’d be doing that already.

 

 

a final note on the Olympus scandal

December 26, 2011 By in Current Market Thoughts, Japanese development, Stock ideas, tobashi Tags: , , , , , , , , , , Leave a comment

a recap

During the summer, the newly appointed CEO of Olympus, Michael Woodford, followed up on an account in a Japanese magazine of severe financial irregularities at Olympus (TYO: 7733).  He discovered a number of failed M&A transactions involving gigantic payments to obscure companies that disappeared from existence soon after receiving the money.

He was fired for his pains.  He promptly left Japan, saying he feared for his personal safety.  Once in the UK, he disclosed everything to the world financial press.

An independent panel was appointed by the Olympus board of directors to investigate the situation.  The panel determined that Olympus had engaged in speculative “financial engineering (zaitech)“, presumably arranged for it by its investment bankers, starting in the late 1980s.  Like virtually everyone else who did this in Japan, Olympus lost its shirt.  It covered the losses up, again presumably using a service (tobashi) provided by its brokers.  This generated a cycle of progressively larger cover-ups and money-losing speculations that lasted over two decades.  The fake M&A was an attempt to get money to pay off creditors and end the cycle once and for all.

what’s new

Olympus has avoided delisting by providing the Tokyo Stock Exchange with accurate accounting statements by a mid-December deadline.  The “new” Olympus has book value of about a third of what it had previously claimed.

The stock lost about 60% of its value since the Woodford firing.

Two American funds managers appear to have held close to 10% of the company’s stock at the time the scandal broke.

The newest chairman of Olympus appears to me to be proposing that:

–the company’s board needs only a symbolic shakeup (where one or two members make a ritual expression of regret and resign), and

–Olympus should recapitalize by issuing stock to other members of the Fuji group, like Canon or Fuji Film.

my thoughts

Olympus is a typical Japanese technology-related company.  It’s torn between the need for constant innovation to keep up in  an increasingly complex and rapidly evolving world and its presence in a social/cultural environment where preserving the status quo is acknowledged as perhaps the highest goal.

Current management seems to be in the process of arranging a “traditional” solution to Olympus’s problems–one that doesn’t probe too deeply and where a new corporate direction launched by change of management is completely out of the question.  It sounds like other Fuji companies are willing to help this happen.

In other words, business as usual in Japan.

My guess is that this is the most likely outcome.  After all, except for what I think of as counter-culture companies run by younger Japanese, this has been standard operating procedure when companies get into trouble for the twenty-five years I’ve been watching the Japanese stock market.

Any signs that this time will be different should be studied carefully for potential to be a bellwether of change. (I’m not optimistic, though.)

I’m most curious about the foreign professional investors who  held large positions in Olympus.  Didn’t they know anything about Japan?  Did they really think that buying companies with low price to book or price to cash flow ratios would bring the same kind of success it does in the US?  Didn’t they see that this approach has failed time after time in Japan?

Apparently not.

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