Bloomberg published an article yesterday in which it pointed out that merger and acquisition activity by mainland China and Hong Kong companies in Japan is up by more than a third so far this year, to $437.7 million. (The same article gives the figures, but doesn’t do the math, to show that this amount is about 0.5% of the money Chinese companies have spent on m&a globally over the same period.) Must have been a slow news day.
Is there anything of significance here, though?
Maybe. …or maybe I’m just having a slow news day. In any event:
1. The targets are small companies. Larger firms are effectively protected against foreign acquisition by legislation enacted during the first of Japan’s “lost decades,” the Nineties. Unlike most other places, Japanese tax law (as I understand it) no longer regards all bids where the acquirer offers to exchange shares of his stock for those of the target as being tax-free exchanges. Instead–but only in the case of a bidder offering stock in a non-Japanese corporation–people tendering their stock are subject to special punitive taxes.
One unintended result of this protection, I think, is that ex the auto companies many major Japanese firms have fallen farther behind their global rivals.
2. American and European “activist” investors–hedge funds and private equity–have been stunningly unsuccessful at plying their trade in the small company arena in Japan over the past twenty years.
Western financial investors have been enticed by very attractive financial metrics (lots of net cash, how price to book, low price to cash flow) and the existence of bunches of “low-hanging fruit,” in the form of very inefficient work practices.
They’ve typically quietly acquired a substantial ownership stake in a target company and then approached management with proposals for change, including cost-cutting and layoffs. Management refuses.
The westerner starts a proxy fight but gets no support from domestic institutions and loses.
The westerner tries to increase his stake, so he can force changes, but finds that the target’s customers and suppliers counter these efforts by buying up stock that will vote in favor of current management.
The net result: the westerner is stuck in a highly illiquid position in a poorly managed company–and no one will buy his stock to allow him to exit.
3. There’s little love lost between Japan and China. The real issue, I think, is not recent territorial disputes between the two. It’s the history of Japanese militarism in Asia in World War II and earlier. …that and gestures like PM Koizumi’s visit to the Yasukuni Shrine in Tokyo, which suggest a lack of remorse for wartime atrocities.
4. There is one big difference between the western approach to small Japanese firms and the Chinese one.
In the former case, financial investors wanted to change the Japanese operations of their targets in ways that were culturally unacceptable.
In the latter, investors may want to acquire either relatively low-tech craft skill–how to operate a retail chain in an environment with a complex web of distribution partners, how to deliver fresh food frequently to convenience stores. Or the target may either have Asian distribution rights for western products, or options on those rights, or long relationships that will help substantially in securing those rights.
Chinese investors are willing to leave the Japanese operations of their targets to wither on the vine. They want technology they can transfer to the mainland.
Investment implications? No direct ones that I can see. You certainly don’t want to fool around on the low-tech small-cap Japanese arena, in my opinion. My guess is that we’ll see very rapid growth in the Chinese companies that benefit from Japanese craft skill.
Two things to note: the targets are all involved in domestically oriented businesses, suggesting the transformation of the mainland economy in this direction may take place more rapidly than the consensus expects. Also, it’s interesting that from a quality of life perspective, Chinese investors see the mainland and Japan as not being that dissimilar.