lessons from Olympus Corp (7733:JP)

the latest chapter in the Olympus story

In an earlier post, I’ve written about the events that led up to the firing of Olympus’s newly-appointed CEO Michael Woodford.

On Halloween, according to the Wall Street Journal, long-time Olympus executive Hisashi Mori revealed to replacement CEO Shuichi Takayama–who had been defending Olympus vigorously against Woodford’s accusations–the truth about the situation.

That is, the apparently bizarre investment banking activity Olympus had engaged in was a sham.  The excessive payments, the shell companies, the subsequent writedowns, were all designed to funnel hundreds of millions of dollars out of operations.  The cash was used to cover massive losses run up in speculative portfolio trading.   A small coterie of company insiders had kept them from public view for as much as twenty years through fraudulent accounting.

My immediate reactions?

Two of them:

Wow!   …like a bad novel.


Wow!  …welcome to Japan.

on further consideration

As to Olympus itself, I think there’s lots more to come.  You don’t need a half-billion dollars to fix inflated balance sheet entries.  Writedowns do that.  This isn’t about paper losses that haven’t been recognized.  It’s about active investment accounts that can’t be closed until debts are paid off.   Who are the lenders?  Was the debt collateralized by, say, Olympus plant and equipment?  How was this all hidden for years?

In general, Olympus illustrates how traditional Japanese companies have one foot–and perhaps both–firmly planted in a samurai-like world that’s governed by a rigid system of rights and obligations among insiders.  In this world, shareholder value has no place.

Companies like this can trade at far below the value of their assets.  But that doesn’t mean they’re cheap.  Nor is it, in my opinion, because investors think the books of such companies are as cooked is Olympus’s seem to be.

I think they trade at prices that make a Western value investor salivate because experienced market participants understand that the company won’t use its assets for the benefit of shareholders.  Managements are happy to destroy the assets, if need be, so they can preserve the jobs and relative status of management and employees.  Outsiders, including holders of the company’s equity, don’t count.

investment implications

One is to avoid these apparently asset-rich companies.

More important, it seems to me there has been a wholesale rejection of this modus operandi by younger Japanese citizens.  The “counter-culture” companies the latter run operate along profit-maximization, shareholder-friendly principles.  They also find their samurai-generation rivals easy pickings.  That’s where I think any investor interested in Japan should look.  Many are worth considering even for those with no need to be in Japan, because they then to be really good companies.

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.