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Japan’s corporate cash-hoarders have moment in the sun

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Via Financial Times

For years, the factory automation specialist Keyence used its cash to attract Japan’s top talent. The company had so much of it, Keyence boasted in its recruitment presentation, that it could survive for 17 years without any sales revenues.

To young graduates craving job security, the message was compelling. Across risk-averse corporate Japan the company’s “rainy-day” preparations were held up as a model in a country regularly pummelled by natural disasters and man-made financial crises. 

As the world’s third-biggest economy moves towards declaring a national emergency over coronavirus, Keyence’s balance sheet looks clairvoyant. More than that, after years of criticism from western investors, Japan’s model may emerge from the crisis more paragon than pariah.

To foreign investors, Keyence’s pride in its cash pile symbolised both the risk and the potential of a market where companies — from huge global brands like Nintendo, with ¥1.09tn ($10bn) net cash, to hundreds of small-cap minnows — hoarded cash while refusing to give shareholders the priority they enjoyed in the US and UK. 

Bar chart of % of total showing Asia Inc holds more cash than US and European groups

The contrast with the US market is stark: 14 per cent of companies in the S&P 500 are net cash, whereas in the Japanese market the figure for the Topix index is 53 per cent. According to calculations by CLSA broker John Seagrim, the 434 non-financial companies in the S&P 500 have a combined market capitalisation of $18.8tn but just $880bn of tangible book value — net assets minus intangible assets and goodwill. In the Topix 500, 451 non-financial companies with a combined market capitalisation of $3.6tn are sitting on $2.6tn of tangible assets.

For the past five years, since the government of Shinzo Abe announced major corporate governance and stewardship reforms, the central narrative of Japanese investment has been that the old resistances, many of them hardened by the financial shock of the 2008 Lehman Brothers collapse, were faltering. The theory was that a Tokyo gold mine — a market where more than half of all listed companies trade below their book value — was about to be unlocked.

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But the swift and unforgiving economic impact of coronavirus, with its punishment of highly leveraged companies everywhere — including, prominently, SoftBank — has given Japan’s cash- and asset-hoarding companies a powerful new justification. 

It may also, say analysts and investors, insulate them against the more aggressive forms of shareholder activism.

As the Japanese economy moves towards declaring a national emergency over coronavirus, the cash-rich balance sheet of Japanese factory automation specialist Keyence looks clairvoyant © AP

Nikko Asset Management strategist John Vail said Japan may now find the moment of “peak activism” has passed and that while calls from outside investors for strategic change and consolidation are likely to continue, the kind of activism that pushes for buybacks and debt-fuelled expansion will diminish.

Another fund manager analyst said the cash-rich Tokyo market could show the way for a new philosophy of why companies should exist at all.

“People have berated Japan for not going far enough down the shareholder reward route, but maybe that’s not the route the world is on now,” said Jonathan Allum, a Japan equity strategist at SMBC Nikko.

Akihiko Shido, chairman of Yorozu, a parts supplier for Nissan, credits stringent balance sheet management and a 4.5-month buffer of cash and bank loans for helping it weather the crisis that has halted its operations worldwide.

The company has been targeted by activists seeking greater returns to shareholders, but “this crisis has proved that our management policy was correct”, Mr Shido said. “I hope they [activists] will change their thinking.”

Alistair Dormer, the executive vice-president of Hitachi, said that in addition to their strong balance sheets and diversified sources of earnings — in the case of conglomerates — other aspects of the Japanese corporate model looked appealing in the crisis.

Column chart of As of Sep 2019* showing The number of activist investors in Japan has been rising sharply

“I think the world will probably change after this and companies will be viewed on how they looked after their people and how they looked after their customers,” he said. “Unusual situations do help people see companies in a different way. We’ve seen some pretty bad behaviour by some companies in this situation, and I don’t think that will be forgotten.”

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On the stock market, investors certainly seem to be re-evaluating the Japanese model.

Japan’s Topix index is down 16 per cent since February 21 in dollar terms but has been hit less hard than the S&P 500, which is down 26 per cent and the FTSE 100, which is 30 per cent lower. Japan’s banks, in particular, have fared better than their western counterparts because the balance sheets of their corporate borrowers are in better shape.

The virus hit Japan when its companies were under pressure from outside investors like never before.

By late 2017, in a tacit admission that the market mood had changed, Keyence had removed the slide about its huge capital-to-asset ratio from its presentations. Not because it was no longer true but because a new generation of activists was swarming over the Tokyo Stock Exchange on the premise that Japan was changing the way it did business, thanks to governance reforms that forced companies to focus on returns and bring in external directors and institutional investors to step up their scrutiny.

The number of activist funds applying public pressure to corporate targets quadrupled between 2014 and 2019 to 31, and dozens more are active behind the scenes.

Bar chart of By selected global stock markets (%) showing More than a third of Nikkei 225 constituent stocks have activist investor shareholders

As of last week, according to Mizuho Securities, a quarter of companies in Japan’s Nikkei 225 index have an activist on their shareholder register, and 10 per cent have two. The more undervalued the company, the bigger the cash piles and the portfolios of non-core assets, the greater the appeal to the activist.

To a significant extent, the governance reforms had begun to work towards rewarding shareholders. In the financial year that ended on March 31, share buybacks by Japanese companies reached ¥7.3tn — a second straight year of record highs and a 23 per cent year-on-year increase. The reason, said Nomura strategist Yunosuke Ikeda, was that the reforms had become entrenched and a larger number of companies now judged their own stock to be undervalued. 

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Richard Kaye, a portfolio manager at Comgest, said that while it was early to predict fundamental changes on activism in Japan, the rude health of corporate balance sheets would strengthen companies’ hands.

There had always been a suspicion, he added, that Japanese companies did not buy into the idea that a more aggressive Anglo-Saxon approach was the way forward.

“When we talk to our investors, there is a consensus that with Japan you look for something cheap and you rework the balance sheet, and I think that this is going to be challenged,” he said.

But as many now point out, views were already beginning to shift in the west.

Last year, the influential Business Roundtable in the US revised its definition of the primary purpose of a company to state that it should benefit all stakeholders: customers, employees, suppliers and communities — very close to what corporate Japan had been claiming were its priorities for more than four decades.

According to Mr Allum: “The supreme irony would be if the very traditional features of Japanese capitalism which the classic argument has always seen as backward — the addiction to holding large wodges of cash, the reluctance/inability to lay off workers, the pre-eminence of stakeholders rather than shareholders — will actually be . . . cherished by those who abide by them and adopted by those who do not.”

Additional reporting by Kana Inagaki in Tokyo

Editor’s note

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