the curious case of Olympus Corporation (JP:7733)

the Olympus story

I have had a nodding acquaintance with Olympus Corp. for a long time.  At one point, I even owned it in one of the portfolios I managed.

I was attracted to the company by its strong market position in endoscopes and its leadership in digital cameras.  But I soon came to the conclusion that Olympus was, at least at that time, pretty set in its ways–resistant to change and not particularly keen to make profits for shareholders from its operations.  So I sold the stock.

The excitement surrounding the recent appointment of Michael Woodford, a foreigner, but a 30-year Olympus employee, as the company’s CEO six months ago suggests that I wasn’t alone in that view.  So too does the 44% plunge in the stock’s price since last Friday, when Mr. Woodford was summarily fired.

According to the Wall Street Journal, soon after Mr. Woodford became a member of the board of Olympus he read a series of  exposés in Japanese magazines about acquisitions Olympus had made in 2006-08.  He was concerned enough to bring in auditor Price Waterhouse to conduct an investigation.   The Financial Times has examined documents provided by Mr. Woodford that he says are copies of the auditors report and his correspondence with other members of the board.

Mr. Woodford has reportedly also related his tale to the anti-fraud authorities in the UK (at least one of the acquisitions was British).  Based on the press reports, the facts seem to come down to this:

–during 2oo6-2008 Olympus made several acquisitions in businesses not directly related either to endoscopes or cameras, spending a total of over $2 billion

–the seller of all the companies bought was a single special purpose vehicle whose owners have not been identified

–Olympus paid inexplicably high investment banking fees–amounting to 50% of the cost of the underlying assets being bought–to a Cayman Islands company that has since disappeared

— in 2009, Olympus wrote down about $1.6 billion of the balance sheet value of the acquisitions.

In a meeting closed to the press, Olympus has apparently denied Mr. Woodford’s allegations and threatened to sue him for disclosing confidential company information.  It says it dismissed him because of his management style.

what to make of this?

Assuming Mr. Woodford’s story is true–and it’s hard to believe he just made this all up–the most benign explanation I can see is that Olympus was the victim of a massive fraud in these acquisitions and covered the whole affair up.   That would square with what I’ve observed over the years as the psychological inability of traditional Japanese managers to confront operating problems or to report anything other than good news to their superiors.

The bigger issue for investors, however, isn’t just Olympus.  It’s how many other asset-rich, performance-poor Japanese firms of the type Western value investors have been attracted to over the years have similar hidden problems.  My guess is that Olympus isn’t alone here.  And no matter how the Olympus case finally plays out, it will certainly not be something that will motivate competent Western corporate turnaround specialists to accept Japanese jobs.

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