Parent-child listings are up for negotiation
As we discussed in our first post, when markets are in crisis, corporate Japan tends to err on the side of caution when it comes to deploying capital. However, the longer term trend of corporate governance reform remains in play - and one of the highlights of that for us is the government’s encouragement of reform in companies with a group structure. As longtime observers of Japan’s most diverse, complex and often challenged companies (a thankless task, but someone has to do it), we are very interested in how those groups address the thorny issue of listed subsidiaries.
Why think about this now? We believe managements are not stupid, and at this time of market dislocation it may be that a subsidiary previously deemed expensive to buy in, becomes substantially cheaper because of greater exposure to the ravages of coronavirus; in some cases it is possible the subs become distressed (some are already at distressed valuations). Alternatively, it may be the parent struggling - and the sub thriving, at least in terms of its valuation, making it a source of funds.
Better group governance is a government policy
The background to this thinking is nearly a year old - that’s how long we have waited, in vain, for METI to translate its Group Governance System Guidelines released in June 2019 (here - a mere 142 pages, 20 in summary form), but there is no sign; thankfully, Nagashima, Ohno and Tsunematsu have provided a very helpful English précis (here). The guidelines emphasise how Groups are expected to manage their businesses as a portfolio, and to consider who is the “right” owner of a given business: therefore there should sometimes be a need for disposals as well as additions to optimise the Group’s structure.
In relation to listed subsidiaries, the guidelines identify the many conflicts of interest between majority and minority shareholders, as came to the fore in Z Holdings’ (then Yahoo! Japan) spat with Askul. Historically, a listed parent could dominate the subsidiary at will, and without penalty, apart from potential reputational damage; but this state of affairs is no longer to be tolerated. There will also be times when a subsidiary - ostensibly independently managed - takes actions (large M&A for instance) which substantially impact its balance sheet, and therefore that of the parent too, through consolidation; especially if the sub takes a rather different view on the use of leverage.
Leading groups are already walking the walk
Managements who read and fully digest these guidelines will reach the conclusion that in many cases, their Group’s governance structure does not really allow for majority-owned (or deemed-controlled) subs to be both listed and independently managed, as the guidelines require. As it turns out, the managers who helped write them took them to heart: it’s no coincidence that Mitsubishi Chemical Holdings’ Chairman, Mr Kobayashi, who was heavily involved, soon after saw fit to buy-in drug-making subsidiary Mitsubishi Tanabe Pharma. Hitachi (also represented on the committee) is also committed to tidying up its listed subs, a process that has been ongoing for years, but accelerated recently. Also involved were representatives of Toshiba, Mitsubishi Heavy, and Shiseido; not coincidentally Toshiba has also been hard at work buying up its subs. We expect far more listed subsidiaries to be rolled up, or sold down, in the coming year or two, and the recent price action may accelerate the process where it has created a disparity in valuations.
We have screened for Japan-listed names with 40%+ ownership by another Japanese listed entity, and include the indebtedness of the parent and the size of the outstanding unowned stake in relation to market cap to give some idea of “affordability” at today’s prices - this list is just the subs who have underperformed their parents and therefore increased the likelihood of being bought in. Please contact us to learn more and to receive the rest of the list - names that have outperformed, and might be sold down by a parent needing cash, for instance.
Source: S&P Capital IQ, Vido Research
The Aeon Group is the prime example of a parent outperforming because it is hit less hard than its subs by coronavirus: its core is the supermarket business serving daily needs, while the tenant areas of Aeon Mall have mainly been shuttered, and Aeon Fantasy’s game centres have been forced to close. Some other groups have several subs currently “on sale” - Shin-Etsu Chemical and Itochu for instance.
Cash crunches and weak end markets could prompt reforms
We also wonder whether the current crisis might bring about some long-anticipated changes: is it too far-fetched to think Toyota Motor might finally begin reforms of its convoluted group structure and governance? This network of holdings of course stretches far beyond just the listed subs in the table above. As the Nikkei writes here (JP lang only), the cash crunch from production and sales stoppages (not to mention damage from falling residuals of leasing fleets) is going to put greater pressure on auto OEM and parts maker balance sheets at a time when CASE (connected, autonomous, shared, electric)-related R&D and investment still need to be ramped up; but that’s a story for another post.
Speak softly, but carry a large “brick”
Investors in Japan may, in many cases, be unfamiliar with the Group Governance System Guidelines (METI, please translate them). This is a shame, given both Japanese companies' propensity to own large numbers of unrelated businesses with no synergy, and also the sheer volume of listed subs where either the listing, or the capital relationship itself have outlived their usefulness. At least minority investors are now encouraged to engage with company management on this topic; our suggested approach is to speak softly, but carry a large “brick” - in the form of a hardcopy of the GGS guidelines.
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