Japan emerges from the shadows | A new generation embraces M&A | Debt is not a dirty word | Funds get activist in Japan | Living in the past; paying with the future
WOULD YOU BUY shares in a Japanese bank? It might already be too late. In October 2005, Mizuho Group launched a ¥531.6 billion ($4.6 billion) secondary equity offering. It was the biggest new equity issue in Japan since 2002 and the largest ever in the banking sector.
Although the recovery in Japanese bank share prices from their lows was already far advanced by the time the deal was announced last August – Mizuho’s stock sank to a low of ¥58,300 in April 2003, recovered to ¥448,000 one year later, hit ¥507,000 at the end of March 2005 and rallied 30% after the announcement of the deal to stand at ¥722,000 at the end of September 2005 – the rationale for it provided a stark reminder of the troubled recent history of Japanese banks.
Its proceeds were intended to fund the repurchase and cancellation of ¥250 billion of preferred stock remaining from the injection of public funds into the banks to rescue them from the bad-loan problem of the 1990s. The deal was intended to underline Mizuho’s revival, pave the way for full repayment of public funds and improve its capacity to lend into Japan’s economic recovery.
The deal was fully subscribed, with strong demand at home and abroad. The bookrunners were able to price at ¥696,780, a 2% discount to the previous closing price of ¥711,000 – the bottom of the tentatively indicated range of 2% to 4% for the discount.
Would this hefty new supply now end the stock’s stunning 18-month rally?
Actually, no. The price rose by 1% after launch and by 18% between pricing and settlement. It proved a good buy for investors even back in October when the bank’s stock had already appreciated twelve-fold from its lows. At mid- January 2006 the share price stood at ¥851,000, almost 15 times what it was less than two years earlier.
“I think it shows more than just great confidence in Mizuho and the financial sector. For any issuer to do a deal that big, for the market to absorb $4 billion of demand and for the stock price then to continue to rally by more than 20% shows how robust the Japanese market is,” says Alex Woodthorpe, head of equity capital markets at Merrill Lynch in Tokyo. Merrill was bookrunner on the deal.
Much more to come
Woodthorpe thinks that the good times have only just started in Japan. The Nikkei 225 index rallied from 11,000 to 16,000 last year, more than 40%; he sees much more to come. Even after the Livedoor affair knocked investors’ confidence in January, Woodthorpe suggests the market might end noticeably higher this year. Bullish Japan strategists ponder a possible move to 24,000 by 2010.
| Net purchases of stocks by Japanese mutual funds |
 |
| Source:BoJ |
| Cash hoarding – currency holdings as a percentage of GDP |
 |
| Source: Cabinet Office, BoJ, Merrill Lynch |
That will permit more new-economy companies to do sizeable initial offerings and set a promising background for established companies seeking to fund new investment with equity.
But is this any more than wild optimism? What might draw new capital into the Japanese market to support new issues?
Over the past 18 to 24 months the Japanese market has benefited from substantial inflows of international money that is unconstrained by index weightings and can go anywhere for performance. Japan has simply been the brightest spot in a world awash with liquidity.
Hedge funds came in at the bottom in April 2003 and kept investing until the end of that year. As they took profits, more conventional institutional money followed in the first half of 2004. The continued resilience of the Japanese market attracted further flows in 2005 and the hedge funds returned to a market where borrowing costs are low.
The first stocks to be massively re-rated were those of the banks, which had been reconstructed through a government-sponsored bail-out of NPLs and forced to sell off industrial holdings and submit to wholesale consolidation. Next it was the turn of high-growth new-economy stocks, many of which floated in 2004 and 2005. As the economic recovery seemed to strengthen last year, raw materials stocks caught the momentum – iron and steel, real estate, almost any large-cap company that stood to benefit from domestic demand. Finally, even old-economy names that weren’t doing a terribly good job, such as Sony, found their share prices moving up.
Has it all been a bit indiscriminate, or is there really a good earnings story to tell and can the early leaders drag the stock market up to the next level in the second half of 2006? The bull case is that Japanese corporations, with balance sheets restored to health, are headed for brisker sales and higher profits than they themselves are at present forecasting. All this needs to generate quite mouth-watering returns is a little leverage. Leverage made no sense in the era of deflation. Now it does. And although corporations have only just got through cutting their debts, corporate and investment bankers are out there pitching the benefits of increasing debt to optimize weighted cost of capital and improve returns to shareholders.
There are many good Japanese sayings about the stock market. One of the best is that rallies begin in scepticism and end in confidence. The rally will end only when everyone is confident it must continue and the last bear has finally turned bull and bought in. It can continue as long as there are more sceptics yet to be won over.