Japanese Companies More than Ever Susceptible to Takeovers

The debate about why FDI (foreign direct investment) to Japan is so low rages on. As for the reasons why this is so,
the usual suspects include;

1-Does not meet financial and profitability standards
2-Impossible to buy anything but basket cases
3-Purchase made impossible by tight cross-holdings
4-Deeply ingrained fear of foreigners
5-Mainly limited to a few financially troubled sectors
6-Cross-holding system remains largely in place
7-Problems recruiting qualified (male) candidates,
etc., etc.

JETRO Survey of Attitudes of Foreign Firms in Japan


A survey by JETRO of the attitudes of foreign firms in Japan dated June, 2003 gives an indication of what managers of foreign firms in Japan themselves think. The first point that catche's one's eye is the low response rate to the survey, where 2,739 firms were targeted, but only 449 responded. It seems that foreign firms in Japan aren't interested in filling out more bureaucratic paperwork. Of those companies that responded, 46% thought their revenues would increase in FY2002, and this was down from those seeing an increase in the previous year. The most common view of the business environment in Japan was that the Japanese market would either remain sluggish for another 3-5 years, or that growth cannot be expected "for a while". Yet 44% said they would remain the status quo, while 43% said they would expand their business (maybe this was for their headquarter's management).


In terms of their perception of what's changed for the better, 58% cited a fall in land prices and rents, 53% cited lower infrastructure costs like electricity and communications, and 29% saw improvement in personnel costs and an improving labor market for foreign companies. Also interesting was the fact that this group ranked Japan first above China in their overall evaluation of the business environment, where they ranked Japan highly for; the ease of procuring professional/high quality resources, the IT environment, and support/collaboration from universities/research,
among others. As for measures specifically effective in improving Japan's M&A environment, 45% cited the lowering of effective corporate taxes, and 33% had expectations for 24 hour/365 day customs/quarantine services, 27%
for approval of international accounting standards, and 18% for the easing of residential status rules.

JETRO Survey

(TT's Take ) As for the problems in recruiting suitable (male candidates), from TT's own experience in hiring investment research analysts for foreign investment banks, the leading foreign banks actually ended up with "the best and the brightest" in the industry, forcing institutions like Nomura to train another generation of top-flight research analysts. They came to the foreign banks because, a) they could earn a lot more, b) they were confident in their abilities, and c) they actually felt the top-flight foreign firms would offer better stability.


As for the network of cross-holdings excuse, the network of cross-holdings and main bank relationships has also rapidly
unravelled. As the major banks have been unloading their holdings of "non-productive" equity, the corporations have been returning the favor. Nearly every Japanese corporate that TT talks to is concerned about how to deal with the unwinding of significant amounts of not only "cross-holdings", but "strategic holdings" as well. An annual survey by NLI Research Institute of cross-holdings in Japan shows that real cross-holdings had fallen to just 8.9% by FY2001, and that more broader "strategic" holdings were down to 30%. As there has been substantially more unwinding during FY2002, both of these ratios could well be down by another couple of percentage points–to the point that the many listed companies in Japan that are trading well below their book value are actually susceptible to corporate "reformers" like Mr. Murakami of M&A consulting.


With the entire TSE Second section trading under book value, and up to half of the TSE First section in the same boat,
Japanese companies have never been more vulnerable to take-overs. TT is not exactly sure what the trigger(s) will be, but the current situation in Japan does resemble the US market in the early 1980s, when the entire S&P 500 temporarily traded below book value. With stock swaps and now leveraged buy-outs now available in Japan, the only real impediment would seem to be low expected returns on investment, but as someone has pointed out other
forums, the evidence would indicate that actual Japanese returns on foreign FDI are not that bad.

Equity Rally versus Bond Market Plunge: Financial Cannibalism

The Government and bureaucrats in Tokyo are masters of finger-in-the-dike economics. Nowhere will you find policy makers more adept at averting financial crises. Japan has managed to avoid the revolutionary changes needed to make the economy strong and globally competitive. The only consistent policy these last 13 years has been papering over cracks and punting them forward to be dealt with down the road. It's best to think of Japan as a big game of musical chairs; everyone's hoping the music doesn't stop while they're in charge, putting off painful change so that the next guy can deal with it. Because it's been able to avoid serious banking crises, Tokyo is under little pressure to change its tune. (William Pesek)


(TT's Take) During the Heisei malaise, the Japanese market has repeatedly fallen prey cycles of panic and relief, as well as periodic bouts of optimism by foreign investors. When the foreign investors get bullish, Japanese investors simply go along with the flow, all the time scratching their heads to figure out why those crazy foreigners have gotten so bullish. Only several months ago, the markets were in a panic that another shoe was about to drop in the banking sector. When stock prices fall below a certain point (ostensibly the break-even point of the equity holdings in bank portfolios), stock prices enter a "Catch 22" spiral, where increasing valuation losses at the banks push stock prices down, and fear of an upsurge in bankruptcies grows, as does the perceived negative impact on the economy.


As stock prices have rallied, the government has heaved a sigh of relief, and business sentiment has improved. But stock prices are only one of 15 leading indicators of economic activity. The biggest support for Japan's manufacturing sector appears to be exports to Asia, particularly China, and the fact that Japanese companies have now finished a substantial draw-down of excessive inventories. Just rebuilding inventories to "normal" levels can cause a mild upturn in the numbers.


The Catch 22 is that, while foreign investors are beginning to suggest this could be the equivalent of 1982-1983 in the US (when the US was on the verge of pulling itself out of a 10-year malaise), the bond market has jumped way out in front of the recovery, and could pose a self-regulator on the very economic recovery that everyone wants so badly to see. The BOJ of course remains cautious. If they really believed the broker hype on the recovery, they would already be moving to; a) plot an end to their zero interest rate regime, b) start taking some the excess liquidity off the table, c) cease purchases of stock from the banks altogether, d) even consider trimming the JPY1.2 trillion a month of bond purchases they are making to support the bond market.


What Japan could be left with, as William Pesek points out, is a "zero-sum" investment environment--i.e., bond yields falling when stocks are rising, and vice-versa. Bond funds have already been decimated, with long-term bond funds now trading at under their par value of JPY10,000. As Lehman Brothers points out, the bulk of Japan's stock market is cyclical companies--not by business structure, but by extremely high break-even points. In the best of business cycles, operating ratios are barely above break-even, whereas in a downturn, vast chunks of corporate operations plunge into deficit. This makes for very volatile earnings year-on-year change rates, and "flash-in-the pan" rallies based on this transient recovery in corporate profits. With the majority of their business being commodity products, the businesses of Japanese companies recovery lag the global recovery, and taper off first as the cycle begins to peak. This is as true of Japan's technology majors as it is for any other sector.





Bloomberg

Investors bet China will Yield on Yuan

The U.S. Treasury secretary, and the European Central Bank have been urging China to abandon its eight-year policy of pegging the yuan at a rate of 8.28 to the dollar. They argue that the fixed link to the dollar, which has declined 9 percent in the last year, makes Chinese exports artificially cheap. Consequently, investors are betting China will eventually cave in. The bets are most apparent in the currency forward market. The discount between the rate for one-year yuan forward contracts and the fixed rate for the currency against the dollar stood at 1,310 points at the close of last week, implying that the dollar would weaken to 8.146 yuan within a year if the Chinese currency were freely traded.


Investors are also dumping dollar-denominated B-shares and trying to get yuan exposure, causing the B-share index and the A-share, yuan-denominated index to move in different directions. Goldman Sachs said last week that China may decide to let the yuan appreciate before a Sept. 20 meeting of Group of Seven finance ministers.


Publicly, Chinese government officials from the prime minister to the central bank governor have reaffirmed the nation’s commitment to a steady currency. But not all investors are convinced. Bankers in Hong Kong say that they have been getting a lot of enquiries lately from our local institutions and companies about converting their dollar and even capital accounts into yuan.


(TT's Take ) A nominal appreciation in the yuan may not make that much of a dent in the trade deficit with China for the US or Japan. In addition, China may be more resistive of this pressure than traders currently assume. A recent article in the China Daily used Japan's yen appreciation from a fixed JPY360/US dollar after 1949 as an example for all countries, particularly developed countries. The article described all the problems that Japan brought upon itself after it let the yen float. The claim was that the 20 years of fixed exchange rates allowed Japan to achieve a swift recovery and produced a boom in Japan's economy.

Bloomberg

MOF Eyes Consumption Tax Hike as Early as FY2006

Japan has no choice but to raise the 5% consumption tax as early as fiscal 2006 as a measure to tackle the aging of society, Finance Minister Masajuro Shiokawa said Saturday. "We have no choice but to definitely raise the rate in fiscal 2006 or thereafter as society ages," Shiokawa said in a dialogue with the public on tax reforms. Asked for the reasons for his projection, Shiokawa said, "Because such administrative reforms as those on special accounts (of the state budget) and the review of the social security system and the relationship between the national and local governments will be completed by fiscal 2006." In May, the finance minister indicated the possibility the consumption tax could be raised in fiscal 2007, but the idea was downplayed by Chief Cabinet Secretary Yasuo Fukuda who said "The government has not made a decision."


(TT's Take) Shiokawa's comments comments go against the proposed tax alleviation by the Tax Commission in an interim report in June for the Finance Ministry to consider. The panel's chairman, Hiromitsu Ishi, has even suggested leaving the rate on foods at 5%. The dialogue on tax was the fourth since July and final one, and saw more opposition to Tax Commission members than support for them.


But the MOF (particularly the Tax Agency) has been scheming to raise consumption taxes all along. While other governments use tax breaks to stimulate economic growth, Japan's government continues to be hobbled by a
Tax Agency that marches to the beat of its own drummer. Instead of attacking the graft and shenanigans rife in the government and government-related agencies, such as the Japan Road Corporation and the free-wheeling spending being done using the salaried worker's unemployment insurance fund, the bureaucrats in the MOF simply want to raise taxes. The obstinant stance of the MOF's tax agency has been a real hinderance to more flexible government policies to promote restructuring and reinvigorate Japan's economy. For example, it was the Tax Agency's resistance to tax breaks for bank write-offs of NPLs that gave us the infamous deferred tax assets (DTA's) that now account for the bulk of the banks' reported Tier 1 capital.



Kyodo News