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Kawasoe, president of Mitsubishi resigns |
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Tetsuro Ishikawa ran from the media shouting: “I have not been sleeping.” The president of milk producer Snow Brand, he had just claimed he didn’t know how his company’s product had poisoned 15,000 people. Katsuhiko Kawasoe resigned as president of Mitusbishi Motors after admitting that the vehicle maker had covered up customer complaints for years.
Yoichiro Kaizaki, president of Bridgestone Corporation, snubbed US congressional inquiries into the recall of 6.5 million tyres made by its Firestone subsidiary allegedly linked to 120 deaths, then tried to pin the blame on the Ford vehicles that used the tyres.
It has not been a good year for corporate Japan. If not quite annus horribilis, every other day there have been some disaster-making headlines, not just in the country but worldwide. Japanese cringed when they saw how badly Masatoshi Ono, president of Bridgestone/Firestone, performed when questioned by the US congress. But they also had to stomach the sight of Renault of France riding to the rescue of Nissan, Japan’s number two carmaker, and German/US vehicle conglomerate DaimlerChrysler preparing to bring Mitsubishi Motors into its global embrace. That’s not all: Sogo, the department store chain filed for bankruptcy after foreign-owned Shinsei Bank refused to go along with a debt forgiveness scheme and there is a queue of sickly construction companies lining up to seek debt relief.
But these corporate failures are precisely why Japan is on the brink of a boom in merger and acquisition activity, say investment bankers in Tokyo. If Japan wants to lift its still-ailing economy, it must embrace M&A as the essential key to restructuring. “Globalization” may be a dirty word on the streets of Prague, Washington and even Melbourne, but it is becoming a fact of hard business life that is penetrating even the nationalistic fastnesses of Japan.
There are, it must be said, differences of opinion about how quickly the M&A boom will materialize. European investment bankers point to the cultural differences that tend to keep Japan as a law unto itself. The big US houses are altogether more gung-ho and believe that an inevitable and unstoppable market for corporate control has started. Masayoshi Nakamura, Morgan Stanley Dean Witter’s managing director, admits that the “market has not matured yet”, but he quickly adds that “the revenues which we are generating through M&A and strategic advisory services are increasing dramatically. The market is becoming mature enough to recognize the value of the advice of investment bankers.” He expects the value of Japan’s M&A business (counting any business involving a Japanese target) to increase in 2001 by between 50% and 100%.
At UBS Warburg, Taiji Okusu, managing director and vice-chairman, is more cautious and points to the hurdles that have to be leaped when doing M&A business in Japan, even though he believes the time is ripe for such activity to help strengthen the economy. He believes that the immediate pressure is off because the economy has picked up and the government has infused money into the banks, which has allowed them to relax on restructuring. “The trend remains unchanged, but the pace has slowed down,” Okusu asserts.
Katsuhiko Aoki, senior manager of Mitsubishi Corporation responsible for M&A, says: “M&A activity is not growing as rapidly as we expected two years ago. The Japanese economy has recovered slightly. We had expected major companies, in areas like heavy industry, would be forced to divest for strategic reasons. But now we may have to wait for another two or three years.” Nevertheless, he adds that there are “lots and lots of opportunities”.
Mitsubishi itself paid ¥170 billion ($1.6 billion) for a 20% stake in the 24-hour convenience store chain Lawson this year.
The essential pressures driving M&A are best illustrated in the auto business, where Japan has witnessed major changes in the past few years. From more than half a dozen independent manufacturers a decade ago, only Toyota and Honda remain today. Ford essentially took control of the ailing Mazda some years ago, and in the past year Renault put its own man into Nissan and DaimlerChrysler has all but built a controlling stake in Mitsubishi Motors. GM had made alliances with Suzuki and with Fuji Heavy Industries and Isuzu. “The auto industry is already going through global integration,” adds Okusu, “with common platforms for production across national boundaries”. So it’s no use being half a step behind the rest of the world if you want to survive against Detroit and the German-US alliance.
However, there are other Japanese industries that are patently having a hard time, such as chemicals, construction, heavy machinery, not to mention the retail sector, where there should have been consolidation by now, but there has been a great deal of resistance.
Okusu of UBS Warburg puts his finger on the main problem. It has business and cultural roots: “Management is concerned about the people, this is their excuse,” he says.
“It’s very much a people issue,” adds Izumi Nishizaki, managing director and head of the M&A-global advisory group in UBS Warburg’s corporate finance division. “It is very difficult to fire people,” given the so-called lifetime employment system, under which Japanese expect to join the government or a big company from school or university and stay there for life. Even though the system is of post-war origin and never applied to a large proportion of workers employed by small supplier companies, it is well entrenched.
Indeed, in big companies workers passed over from promotion are handed down to a subsidiary or affiliate, so that the system can be preserved and the corporate ethos preserved.
In addition, the complex spider’s webs of the keiretsu groupings, such as Mitsui and Mitsubishi, which have dozens of companies and affiliates tied by complicated cross-holdings, have reinforced the difficulties of anyone jumping from, say, a Mitsubishi company to a Sumitomo company. So the labour market is much more inflexible than in the West. The big keiretsu each have their own culture, so selling off one of them “is like cutting off part of the family,” according to the UBS Warburg executives. Aoki of Mitsubishi adds that bought by foreigners is the greatest fear because they might disrupt the old culture and systems completely, as well as indulging in large lay-offs.
One of the strongest statements of the potential of M&A activity comes from Kathy Matsui, chief strategist of Goldman Sachs, who sees it as the weapon for rejuvenating the economy. Summing up a seminar that her bank held in the summer, she believes that M&A is likely to accelerate as a means of helping companies to restructure and the process will be driven by private-equity investors seeking better returns. She asserts: “The key to a sustainable bull market is improved returns on capital, and one means of achieving this goal is ‘real’ restructuring via increased M&A activity. Japanese M&A is most comparable to the zaitech [financial engineering] stage of US M&A during the late 1980s. At present, 50% of Tokyo Stock Exchange First Section firms are trading below their book values, and over 100 listed firms are trading at discounts to their net cash, meaning that many firms are vulnerable to takeovers. Recent legislative reforms should lead to increased value-creation opportunities, particularly for conglomerate-type companies seeking to focus on their core businesses.”
Goldman Sachs says that return on equity in Japan — currently 3.3% against almost 10 times that in the US and about five times in Germany — has helped to produce the prolonged slump in stock market prices. Whereas other world markets have been going from record to record, the Nikkei 225 index is at about 40% of its peak 39,000 level achieved in 1989. But Matsui is optimistic and predicts that return on equity will rise threefold to 10% by fiscal 2003 as companies resort to more aggressive M&A as a way of bringing about restructuring that will lead to a sustainable improvement in returns on capital.
She points to changes in Japan’s economic, cultural and even legal framework that will make it easier for mergers and acquisitions, even hostile ones, to be contemplated. These changes include unwinding of the webs of cross-holdings and a growing emphasis on corporate governance, deregulation, changes in laws to make M&A easier, accounting reforms that demand improved disclosure, and growing pressures to restructure.
Tatsuya Terasawa, director for policy planning in the economic policy unit of the ministry for international trade and industry (Miti), also believes that M&A is “an important means of revitalizing the Japanese economy”. He lists four ways in which it can help: by improving corporate profitability, rebuilding companies whose balance sheets have deteriorated, enhancing the global competitiveness of Japanese companies, and helping them to respond to the speed of the revolution in information technology. He cites US internet router maker as a leading company that has used M&A to help it keep pace with the speed of change of IT.
“During the early 1990s,” Terasawa says, “M&A was a concept that Japan embraced reluctantly at the behest of the US. However, in the second half of the 1990s, and particularly from 1999, promotion of M&A has become an integral part of Japanese economic policy and is now regarded as an important means of stimulating growth within the corporate sector and the Japanese economy.”
He cites a string of legal revisions that will make M&A easier and more in the accepted mainstream of Japanese business life.
Revisions to the Commercial Code in 1997 simplified merger procedures by easing reporting requirements and abolishing the need for two general shareholders meetings. This was followed in 1998 by revisions to the anti-monopoly law narrowing the range of companies subject to reporting requirements.
Introduction of a stock-swap system was permitted by changes to the commercial code and the ban on holding companies was lifted by the revisions to the anti-monopoly law.
Further revisions to the commercial code in May this year now permit the introduction of a corporate spin-off/demerger system.
Other important changes came with last year’s industrial revitalization law and with a new bankruptcy law in April this year modelled on Chapter 11 of the US bankruptcy code. The former marks a departure from Japan’s longstanding policy of maintaining full employment and acknowledges that corporate restructuring may involve painful retrenchment. Both laws have been used by more than a dozen companies each, suggesting that there is a growing realization that Japan has to make difficult economic choices if it wants to be an international player.
On top of these measures, there have been accounting reforms that are intended to make it difficult for companies to hide problems in group accounts. New rules about to come into effect will also force companies to disclose the extent of their underfunded pension obligations and use mark-to-market accounting for their financial assets.
Miti’s Terasawa admits that these legal and accounting measures may not be sufficient. In particular, he says that there is a need to change attitudes: “In order to help companies dispose of unprofitable subsidiaries or business units, the traditional corporate/employee ‘mindset’ must be altered so that the focus shifts away from company unity and firm loyalty toward profitability and returns on capital.” That may prove more easily said than done, especially when mutual loyalty between company and worker has been said to be the root of Japan’s postwar economic success.
Aoki of Mitsubishi amends this thesis of Japanese success slightly to say that another vital factor driving Japan’s economic machine to excellence and success was the quality of teamwork. “Nobody wants to be a hero, everybody wants to be part of a good team,” he says. Whether good teams can be maintained when mutual loyalty and lifetime employment no longer go hand in hand may prove more difficult.
Investment bankers say that 1999 was a banner year for M&A activity in Japan. In total, according to Morgan Stanley Dean Witter, M&A volume in Japan last year was about the same as that in Europe in 1994. By transaction value, M&A rose sharply to $152 billion from a mere $17.9 billion in 1998. Last year, M&A in Europe was $1.2 trillion, while that in the US was $1.7 trillion. The bullish mood was seen most notably in purely Japanese transactions, which shot up from fewer than 400 in 1998 with a value of ¥1.4 trillion to more than 1,250 transactions with a value of ¥13.1 trillion last year. There was also a big rise in so-called out-in M&A, involving foreign companies buying Japanese concerns, from fewer than 100 deals worth ¥769 billion in 1998 to more than 200 deals worth more than ¥3 trillion last year.
Just to keep a sense of global perspective, figures from Goldman Sachs citing Thomson Financial Securities Data are slightly higher, $202.3 billion for 1999, but this was just 6% of total world M&A activity, whereas Japan’s GDP accounts for 10% of the world total.
There were a number of path-breaking deals, even though they were not in the same multi-billion dollar league as activity in the US or Europe. Most noteworthy, for the first time last year a foreign company made a contested bid for a Japanese company, and won. Cable&Wireless already had a founding stake in International Digital Communication, but its bid for the company caused resentment about the barbarian invasion. The IDC company management clearly favoured the alternative offer by Japan’s telecom giant Nippon Telegraph&Telephone (illogically because NTT with its huge staff and experience of the domestic telecoms business would have quickly thinned the ranks of IDC staff).
“In the end,” recalls Steven Thomas, executive director of UBS Warburg who was on the team backing C&W, “the deal was decided on the financial terms.” For this the even-handed dealing of Toyota, another founding shareholder, was responsible. “They were pleased that they could do the right thing,” Thomas says.
This year there was another hostile foreign bid, with German pharmaceutical company Boehringer Ingelheim’s move to purchase a larger stake in drug-maker SS Pharmaceutical.
In addition, the activity also helped to stimulate unsuccessful hostile Japanese takeover bids.
The main domestic M&A activity has involved the restructuring of the banking sector, which is now consolidating into five or six big groups. After the Industrial Bank of Japan-Fuji Bank-Dai-Ichi Kangyo Bank announced its plans to form MIzuho Holdings, the various parts of the Mitsubitshi banking empire (the Bank of Tokyo Mitsubishi, Mitsubishi Trust Bank and Nippon Trust Bank} announced their plans to form the Mitsubishi Tokyo Financial Group. In addition, Softbank controversially bought the nationalized Nippon Credit Bank (to be renamed Aozora Bank, meaning Blue Sky), and Sanwa said it would team up with Tokai Bank.
The past two years have also seen increased involvement of foreign companies in buying into Japan. Apart from the alliances in the increasingly global auto industry, most of these deals have involved foreign financial concerns buying stakes in Japanese business.
Besides Salomon Smith Barney taking 49% of Nikko Securities, Merrill Lynch purchasing the rump of Yamaichi Securities and Ripplewood buying the Long-Term Credit Bank (now Shinsei Bank, meaning New Beginning), there were deals in which foreign financial concerns, such as GECC, AXA, Manu Life and Artemis, took stakes in Japanese financial concerns, a prelude to potentially greater activity once the M&A climate becomes warmer.
Some leading industrial companies have already taken advantage of the new mood. Toshiba has sold off some of its non-key subsidiaries.
Sony took advantage of the share-swap scheme by turning three of its listed subsidiaries, Sony Music Entertainment, Sony Chemicals and Sony Precision Technology, into wholly owned subsidiaries. As soon as the announcement was made, the valuation of the Sony group rose sharply.
In spite of this burst of activity, there is still plenty of scope for further restructuring through M&A. The UBS Warburg executives say that the easier way out for hard-pressed companies seems to be to strike strategic alliances or joint ventures, where they may not have to grasp the nettle of getting rid of staff. But the risk is that they thereby fall further behind the global competition.
The financial sector is moving faster than others, and the rapid expansion of all of the foreign investment banks has benefited from hiring bright executives from Japanese banks.
But UBS Warburg’s Thomas notes: “It is not like the UK or the west where you have headhunters chasing executives or where you have pages and pages of executive job advertisements in the newspapers.” In the west now people have got accustomed to moving jobs, but in Japan losing a job is a matter of disgrace.
The entrenched problem comes in those industries that are sheltered from global competition because they are operating domestically in Japan and where they may be protected. For example, the construction industry, many of whose companies would have been declared bankrupt in the west, are still expanding, says Okusu. There are 500,000 companies employing 6 million workers. The clue is that construction, along with agriculture, enjoys choice political connections, and it is said that some companies that have filed for bankruptcy to avoid paying interest are still doling out contributions to favoured politicians.
But investment bankers say there are a number of triggers that may still lead to a shake-up in the coming months. One factor is the big bank mergers. Since they cut across the old keiretsu groupings, for example with Sakura Bank, the flagship of the Mitsui group, merging with Sumitomo Bank, they will shake some of the old shareholding relationships.
The mergers may also take the new bank over the trigger point of the maximum 5% ownership of an individual company, which would mean the bank would have to offload shares. More important may be the fact that the merged banks will have to assess not just their loan books, but their whole corporate relationships and will be keen to see that they are not just clean but have good potential for profits.
Still stronger potential pressure should come from the rapid greying of Japan’s population and the fact that life insurance companies have promised returns of 5% or 6% a year to their clients but are currently realizing what Okusu of UBS Warburg charitably calls returns “in the very low single digits”.
Sooner or later, and Japan’s pensioners must pray the sooner the better, the giant insurance companies have to do something to raise their game. Demutualization seems not yet to be on the agenda for discussion.
Alliances between Japan’s insurance companies and foreign partners that will provide access to modern technology and techniques can play an important part. But investment bankers say they are looking for the insurance giants to use their shareholdings and influence to urge the wholesale corporate and economic restructuring that is probably the only answer to the problem of rejuvenating Japan’s economy.
Nakamura of Morgan Stanley Dean Witter adds the importance of global pressures and globalization. Just as Japanese companies have to be aware of what is happening and try to keep up with the world at large, so international companies will have an eye on getting a slice of the Japanese market. Some of the most powerful players, such as AOL-Time Warner, interested in expanding their position in Japan, he predicts, “don’t have to acquire a Japanese company: Japan will want to invest in them. Japan should recognize how bad the situation is: they may think about shopping around for foreign partners, but the foreigner may be the snake waiting for them.”
He reels off a list of categories that will feel global pressures after the auto industry, though he questions whether thinking in terms of industry categories is too old-fashioned for the modern internet age. But the bottom line in the 21st century is that “in Japan, a small player with a small presence here is not going to be able to survive”. Time to embrace M&A or think of getting out before it is too late.
