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.

Why?

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.