Samsung and Elliott Associates

I’m not an expert on Korea.  In fact, I think of Korea in much the way I think of India or Indonesia–or Japan or Italy, for that matter.  They’re all places where very powerful family controlled industrial groups have enormous economic and political power.  As a result, the rules of the stock market game are very different from those that prevail, say, in the United States.  Piecing them together can take an enormous amount of time and effort.  I’ve believe that, except in the case of Japan in the 1980s, the reward for mastering these markets would never be large enough to justify the effort involved.

In the case of Korea, government policy, both formally and informally, is heavily tilted in favor of a set of family controlled industrial conglomerates called chaebols (much like the zaibatsu/keiretsu of Japan).  In my view, these are not American-style corporations.  They care little for profit growth/maximization or for the welfare of ordinary shareholders–Korean or foreign.  I’ve found the laws and regulations that govern them to be bewilderingly complex and their financial statements (admittedly I haven’t read one carefully in well over a decade) unreliable.

Recently, Samsung, a major chaebol, decided that one affiliate, Cheil, would buy another, Samsung C&T, at what appears to be a bargain basement price. US activist investor, Elliott Associates, then bought a bunch of Samsung C&T stock and challenged the takeover.  Its objective was presumably either to have its stake bought out at a higher price by some other Samsung company or to compel Cheil to raise the acquisition price for everyone.

My initial reaction on reading this was that Elliott was fooled by superficial similarities with the US and didn’t understand the deeper political and cultural barriers it would face in Korea.  That has, so far, proved to be the case.  Shareholders have voted in favor of the acquisition as originally proposed.  Elliott is apparently continuing to sue to try to prevent/reverse this outcome.

The situation is a little more interesting than I’d thought, though, and bears watching:

–the Elliott effort to have Samsung C&T shareholders reject the takeover failed by only 3% of the shares voted.  This is a surprisingly small amount, in my opinion.  On the other hand,

–the deciding vote in favor was cast by the government-connected National Pension Fund, which ironically has previously been a critic of chaebol behavior.

My guess is that it’s ultimately Elliott’s foreignness that swayed the voting, particularly at the NPS.  Were a Korean equivalent to attempt the same thing, the outcome might have been different.  If so, there may be hope for investors in Korea after all.  I’ll continue to be on the sidelines until there’s more tangible evidence of change, however.





business development companies

Last week, a reader commented on business development companies(BDCs).  I said I’m not a fan.

I’d like to elaborate.

BDCs are SEC-regulated closed-end investment companies that typically invest in small- and medium-sized firms.   In one sense, they can be regarded as a poor-man’s private equity.  In another, they can be viewed as the successor to the “blind pools,” a type of IPO that was in vogue when I entered the market in the late 1970s.  The issuer usually had no specific use stated for the funds raised;  the pools often ended in tears for sharehlders.

BDCs are often not SEC-registered.  That is, they aren’t subject to the detailed disclosure that publicly traded firms are.

They do have a tax advantage over ordinary industrial or service firms.  As investment companies, provided that they satisfy restrictions on the scope of their operations, including that they distribute virtually all their net income, they–like other investment companies, such as mutual funds, ETFs and REITS–are exempt from corporate tax on their earnings.

This is a powerful plus.  Because of it, BDCs tend to focus on owning mature, cash-generating businesses and they tend to have high dividend yields as their main attraction.

What’s not to like about this?

My issue is that the analysis of BCDs is a lot more complex than finding out what you need to know before buying the stock of an individual company or a mutual fund or ETF.  You’re not only becoming a part owner of a company, you’re investing side by side with the BDC operator, who has an extremely large degree of control and influence over the companies you own together.  Because of this, you have to not only understand the companies, but you also have to know and trust the people running the BDC.

In my experience, this second task takes a long time and considerable work.  Even when you’re satisfied, holding a BDC also involves accepting a higher level of risk than simply owning a garden-variety publicly traded stock or fund.  I question whether the returns are high enough to justify making this extra effort and exposing my portfolio to the extra level of risk.



inheritance tax changes as a lever for structural change in Japan

value investing and corporate change…

One of the basic tenets of value investing in the US is that when a company is performing badly, one of two favorable events will occur:  either the board of directors will make changes to improve results; or if the board is unwilling or incapable of doing so, a third party will seize control and force improvements to be made.

…hasn’t worked in Japan

Not so in Japan, as many Westerners have learned to their sorrow over the thirty years I have been watching the Japanese economy/market.

Two reasons for this:

culturally it’s abhorrent for any person of low status (e.g., a younger person, a woman or a foreigner) to interfere in any way with–or even to comment less than 100% favorably on–a person of high status.  So change from within isn’t a real possibility.

–in the early 1990s, as the sun was setting on Japanese industry, the Diet passed laws that make it impossible for a foreign firm to buy a large Japanese company without the latter’s consent–which is rarely, if ever, given.

The resulting enshrinement of the status quo circa 1980 has resulted in a quarter century of economic stagnation.

Abenomics to the rescue?

Abenomics, which intends to raise Japan from its torpor, consists of three “arrows”–massive currency devaluation, substantial deficit government spending and radical reform of business practices.

Now more than two years in, the devaluation and spending arrows have been fired, at great cost to Japan’s national wealth–and great benefit to old-style Japanese export companies.  But there’s been no progress on reform.  The laws preventing change of control remain in place.  And there’s zero sign that corporations–many of whose pockets have been filled to the brim by arrows 1 and 2, are voluntarily modernizing their businesses.  Mr. Abe’s failure to make any more than the most cosmetic changes in corporate governance in Japan is behind my belief that Abenomics will end in tears.

One ray of sunshine, though.

Japan raised its inheritance tax laws at the end of last year, as the Financial Times reported yesterday.  The change affects three million small and medium-sized companies.

The top rate for inheritance tax is 55%, with payment due by the heir ten months after the death of the former holder.   This development is prompting small business owners to consider how to improve their operations to make their firms salable in the event the owner dies.  More important, it’s making them open to overtures from Western private equity firms for the first time.  Increasing competition from small firms may well force their larger brethren to reform as well.

For Japan’s sake, let’s hope this is the thin edge of the wedge.



Tesla (TSLA) or Solar City (SCTY)–which to choose

TSLA and SCTY are terrestrial companies run by Elon Musk.  TSLA makes electric-powered cars; SCTY generates electric power with solar cells.

what they have in common

Both are publicly traded.

Both are speculative stocks, in the sense that assessing their value involves projecting results far into the future.

Both are trying to transform staid industries that have been around for a long time.

Both are big users of capital.

Both face substantial regulatory barriers to their success.

–For TSLA, it’s the regulations in many states that prohibit a car manufacturer from selling its products direct to the consumer.  Instead, the carmaker has to use an independent dealer network.

–Because at present they generally have no ability to store power on-site, SCTY clients generally sell the power generated by their solar panels to the electric utilities and purchase power from the grid as they need it run their electrical devices.  Utilities would, naturally, like to buy at 2 and sell at 4.  Regulations, however, force them to trade both ways at the same price, but only so long as solar is a tiny percentage of their business.  In addition, electric utilities are the ones who inspect any local power storage batteries that a household/firm may install.  The utilities aren’t falling all over themselves rushing to do this.

I have small positions in both.

how they differ

Personally, I find SCTY the more conceptually interesting company.

On the other hand, I feel much more comfortable with TSLA.


It isn’t the industry or the capital structure.

It’s the gigantic battery factory that Musk is in the process of building.

Both TSLA and SCTY can be seen as different ways to create demand for highly sophisticated batteries.  Both are certainly radically dependent on having cutting-edge battery technology.  Arguably, batteries are the main source of value in the products of either firm.

But who owns the battery factory?  TSLA.  To me, this means that Elon Musk’s main economic interest likes in TSLA, not SCTY.  History says an investor wants to have his money in the same place as the entrepreneur he’s betting on.


St. Gobain and Sika: are there implications for the US?

The French building materials company St Gobain recently agreed to acquire control of a Swiss adhesive and sealant firm, Sika, for SF2.8 billion (US$2.8 billion).  The move has caused quite an uproar in Switzerland.

The issue isn’t the purchase itself.  It’s that Sika has two classes of stock:  shares (Namenaktien) held by descendants of the firm’s founder represent 16% of those outstanding, but 52% of the voting rights.  St. Gobain is buying out the family at a very large premium. But it has no intention of buying in the publicly held shares (Inhaberaktien)   …which have lost about a quarter of their stock market value since the acquisition was announced.

Another day in the life of holders of an inferior security in Europe.


What’s most interesting to me about this transaction is that it’s being offered as a cautionary tale for holders of shares in US internet companies like Google, Facebook…which also have a number of classes of stock, with voting control held by the founders.


While a repeat of the Sika experience might in theory occur in US social media, I can see three factors that argue against this:

1.  St. Gobain/Sika is a case of a large company swallowing a smaller one.  The US internet companies with voting control by insiders are by and large already whales.  Who’s big enough to be the buyer?

2.  In my experience, obtaining operational control either through a large minority interest or a small majority–and without the possibility of tax consolidation–is a particularly European phenomenon.  US firms typically strive for at least 80% ownership, which allows funds to pass between parent and subsidiary without triggering a tax bill.

3.  This is an especially nasty sellout of minority shareholders in Sika by the controlling Berkard family.  Perfectly legal perhaps, and a possibility minority shareholders should have contemplated before buying, but nasty nonetheless.   For a firm that makes industrial forms of glue, there’s not likely to be significant negative fallout for the business.  In the case of GOOG or FB, treating loyal user/shareholders this poorly would be bound to have severe negative business consequences.


the Market Basket saga: taking Arthur S’s position

Market Basket is a privately held New England discount grocery chain controlled by two third-generation branches of the founding family.  One branch, owning 50.5% of MB, is led by Arthur S. and has no role–other than being on the board of directors–in the day-to-day running of the firm.  The other is led by the largest single shareholder, Arthur T.

MB recently deposed Arthur T. as CEO and replaced him with two non-family members.  Warehouse and delivery workers struck when they heard the news (with the encouragement of Arthur T., some have suggested), preventing the 71 stores from restocking and effectively hamstringing the firm.  Recently, the Arthur S. branch has agreed to sell its shares of MB to Arthur T. for $1.5 billion.

Throughout this highly public dispute, Arthur T. has been portrayed as a benevolent retail genius, creating an immensely successful business with fanatically devoted employees and extremely loyal customers.  Arthur S., on the other hand, has been seen as a money-grubbing child of privilege who wants to fund his yacht and string of polo ponies by pillaging the workers’ retirement plans.

A lot of this may be true, for all I know.  And the issues rocking MB are all pretty routine third-generation family owned company stuff (see my earlier post on MB).  But in the feel-good story line being taken by the media, one fact is being overlooked.  From what little has been in the press about MB’s profits, it doesn’t appear to be a particularly well-run company.  Arthur S. is probably right that Arthur T. isn’t a good manager.

the case for Arthur S.

Let’s say I’m a member of the Arthur S family and I hold 5% of MB’s outstanding stock.  I receive a yearly dividend of $5 million.  My genetic good fortune is significantly better even than winning the Megamillions jackpot.  So in one sense I should have no complaints.

On the other hand, my share of the assets of MB is worth about $175 million.  Therefore, my annual return on that asset value is 2.9%.  That’s about half the return on assets that Kroger achieves.  It’s also just over a third of what Wal-Mart generates, but I’m confident MB doesn’t aspire to be WMT.

I presumably also know that good supermarket locations are extremely hard to find in New England and that those MB has established over prior generations are immensely valuable.  It’s conceivable that if MB were to conceptually divide itself into two parts, a property owning one and a supermarket operating one, and have the property arm charge market rents to the stores, MB would see that the supermarket operations lose money and are only kept afloat by subsidies from the property arm.  (This situation is more common than you’d think.  It was, for example, the rationale behind the hedge fund attack on J C Penney.  That fact that inept activists botched the retail turnaround doesn’t mean the underlying strategy was incorrect.)

Even back-of-the-envelope numbers suggest something is very wrong with the way MB is being run.  Personally, my guess is that the inefficiency has little to do with employee compensation or with merchandise pricing, although the former has apparently been the focus of the AS’s discontent.  I’d bet it’s in sourcing and in how shelf space is allocated.

At the same time, Arthur T is presumably blocking my every attempt at finding stuff out and is rebuffing board suggestions that he bring in help to analyze why his returns are so low.  If MB were a publicly traded company, I could sell my shares and reinvest in a higher-return business.  I’m probably not able to do this with MB.  Even if I were, the public intra-family feuding would suggest the stock wouldn’t fetch a high price.

I have two choices, then.  I can accept the status quo, or I can try to create a consensus for the family to sell the firm.  That latter is what Arthur S. chose to do.

the Market Basket supermarket feud

I decided to write about my sense of the stock market tomorrow.

Instead, I’m going to write about the struggle for control of the family owned, privately held New England supermarket chain, Market Basket.  That’s both because it says something about the value of supermarkets in the Northeast, and because the fight is typical of what happens in family owned firms in the second or third generation.

The story:  Two branches of the Demoulas family own Market Basket.  One, led by Arthur S. has no involvement in running the business; the other, led by Arthur T., does–or did until a short time ago.

As a result, according to Bloomberg radio, of some past impropriety on the part of the ATs, the ASs have voting control of Market Basket.  Last week the board voted to oust Arthur T. as CEO and replace him with two outsiders who presumably have a mandate to cut costs and prepare the 71-store chain for sale.

Hearing this, warehouse and delivery workers walked off the job, demanding Arthur T’s reinstatement.  Many other workers have staged protests.  Store shelves haven’t been restocked.  The chain is reported by the Boston Globe to be losing $10 million a day.

this is typical family owned company stuff

Many family owned businesses are started by one or two entrepreneurial relatives.  Firms like this tend to have:

–high financial leverage

–lots of family on the payroll

–content to have economic rewards come through salaries/perks for family members rather than paying out dividends

–concerned more about stability than growth.

By the second or third generation, ownership is diffused.  Grandchildren probably don’t want to be in the family business.  Recognizing the value of the stock they hold, they want to cash out.  They come into conflict with other family members, whose lives, heritage and hefty salaries are tied to the business.

New England supermarkets are valuable 

The Globe says Market Basket could be worth $3.5 billion.  There are apparently about a dozen shareholders.  That would imply something like a $100 million payday for even the smallest holders if the firm were sold.  Until recently, the firm had been distributing dividends of about $100 million a year, for about a 3% yield.

I haven’t tried to confirm any of these figures myself.

One important thing about New England, though, is that it’s a mature, heavily developed region.  This has two positive implications for Market Basket:

1.  It’s impossible for Wal-Mart, the ultimate supermarket killer, to get a strong foothold.  It simply can’t assemble parcels to build on or get local planning commission authorization to start construction.

2.  For the same reason, Market Basket’s 71 store locations have immense potential value to a competitor.

A side note:  in my town, the supermarkets are small, dingy and very dated.  Twenty years ago, a major chain purchased a large parcel of land which it thought was zoned for a supermarket, and on which it intended to build a superstore.  The project is still tied up in litigation spurred by “concerned citizens,” funded, I’m told, by the existing markets.

bones of contention with Market Basket

Store employees are reportedly much better paid than typical supermarket workers.  Starting pay is $4 an hour higher than the minimum wage.  Experienced cashiers can earn double the industry average of around $20,000 a year.  Market Basket puts 15% of wages into an employee 401k.  Arthur T. also apparently projects a sincere concern for employees’ welfare.

Employees assume, doubtlessly correctly, that Arthur T.’s ouster spells the end of above-average salary and benefits.  This for two reasons:

–Arthur S’s family understands that a dollar of wages to an employee is money that would otherwise be dividended to shareholders, meaning it’s money that comes directly out of their pockets.  If we assume that the average employee earns $4 an hour more than the industry median and that the 25,000 workers average 20 hours a week, then the  total “excess salary” paid by Market Basket yearly is $107 million.  My suspicion is that this is too low.  Still, a ballpark figure is that dividends to shareholders could double if wages and benefits are chopped back.

–Presumably, a trade buyer would pay less for a company if it had to take the reputational black eye of reducing staff and cutting compensation.  Market Basket could sell to a financial buyer, a private equity firm that would do the pruning.  In my view the equity owners have decided to maximize their personal payout by doing this unsavory task themselves.

To my mind, this is all par for the course for family owned businesses.  What is truly remarkable in this case, though, is how much publicity the ouster of Arthur T. has gotten.  The way employee sentiment has been galvanized is also noteworthy, although workers have a very clear–and large–economic interest in defending the status quo.

Company warehouse workers and truck drivers are playing a key role in the dispute, since their job action is the reason stores can’t restock.  Some press reports have even suggested that Arthur T., who is apparently one of a number of potential buyers of Market Basket, somehow helped them along in making their decision to walk off the job.  I have no idea whether this is correct, or whether it’s part of a movement to deny AT sainthood.