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Corporate takeovers in Japan: embracing grafting; Japan looks to adopt Western practices again.

DESPITE the substantial amount of lip service being paid to the potential revitalizing role of mergers and acquisitions (M & A), the fact is that Japan remains a significantly underdeveloped market for public M & A activity. Year-on-year change rates are high, but M & A as well as inward Foreign Direct Inflows (FDI) are miniscule compared to those of other major OECD nations.

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JAPAN'S CUMULATIVE FDI between 1994 and 2003 was lower than Poland's, at $50.5 billion. Accumulated FDI outflows of $217.6 billion were tallied during the same period. Moreover, Japan's inward FDI in 2003 was roughly 1/10th that of China.

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While more attention has been paid to cross-border M & A into Japan, we believe that M & A, once considered a foreign import by Japanese management, is now in the process of being grafted into Japanese business culture.

The next stage of the Japanese grafting of Western M & A practices will be the evolution of M & A into contested takeovers, poison pill countermeasures and active participation by Japanese financial institutions. Ironically, much of this will be done outside of the Industrial Revitalization Corporation of Japan (IRCJ), a semi-governmental organization set up with the express purpose of revitalizing Japan's global competitiveness. The IRCJ has been acting too slowly and on too small a scale to make much of a difference.

Much of the substantial rally in Japanese stocks over the past year resulted from the repricing of weak companies that were being priced for bankruptcy. This rally came from the realization by investors that the government was committed to avoiding a hard landing in the restructuring banking sector, and that many of these companies could indeed be saved by revitalization funds of all stripes and sizes. This included several revitalized banks--like the recently re-listed Shinsei bank (the former Long-Term Credit Bank of Japan).

The unfulfilled promise of Japanese M & A

There has never been a successful hostile takeover here, and most market observers would say that there has only been one truly hostile takeover attempt in recent years: the offer by M & A Consulting to acquire Shoei in 2000. Conversely, the successful acquisition by Cable & Wireless plc (C & W) of International Digital Communications (IDC) in 1999 was not a hostile acquisition, but is the only successful "contested" acquisition in Japan to date.

The close relationship in terms of interlocking shareholdings between Japanese financial institutions and their industry clients, as well as the close relationship with government regulatory agencies, has worked to protect entrenched Japanese management against takeover attempts.

During the Heisei Malaise, which began when the bubble economy burst in 1990, there have been an increasing number of large public company mergers in Japan, with all ostensibly being friendly. In addition, almost all of these mergers have been either promoted, aided or abetted by the Japanese government and major financial institutions, for the express purpose of rationalizing and hopefully revitalizing Japanese industry.

These large domestic mergers have created much larger, more difficult to manage organizations and questionable results. Efficiencies from these mergers have been few and far between, as integration after the merger proceeds at a too leisurely pace from a global perspective. In many cases, these mergers lack any real strategy or synergy other than making the resulting organization "too big to fail" from the government's perspective.

Relative size of Japan's M & A activity is tiny vis-a-vis Japan's economy

Proponents of M & A in Japan point to the rapid growth in the number of cases and value of M & A. However, the vast majority of M & A activity in Japan to date has been "in-in," or mergers among Japanese companies, including management buyouts (MBOs). According to the International Monetary Fund, inward FDI as a percentage of GDP in 2001 was a mere 1.2 percent for Japan, compared to 25.1 percent for the US, 38.6 percent for the UK, 24.2 percent for Germany and 42.8 percent for France--and the percentage has not increased that dramatically since.

In terms of cumulative FDI, Japan ranked 16th during the 1994-2003 period. In 2003, FDI into Japan was a mere $6.3 billion, versus $53 billion of FDI that China attracted in the same year.

That said, the year-on-year change rate of Japanese M & A deals is high. The total amount of money put up by investment companies on corporate merger and acquisition deals between January and August came to [yen]1.08 trillion, according to a recent survey by Recof Corp.

That figure is far above the previous record of [yen]754.5 billion for 2003. There have been major M & A deals this year, such as the Phoenix Capital (a local revitalization fund) investment in Mitsubishi Motors Corp.

The number of M & A deals in the January-August 2004 period totaled 167, up more than 100 percent from the same period a year earlier. Domestic investment firms struck major deals, such as Nikko Principal Investments Japan Ltd., which bought into Bellsystem 24 Inc., and Nomura Principal Finance Co., which invested in Millennium Retailing Inc. Of the total value of M & A deals struck in the period, domestic investment firms accounted for 70 percent, up from 32 percent in 2003.

Japanese managers embrace "grafting"

Thus it is increasingly clear that M & A is no longer a foreign concept, as the vast bulk of the M & A activity in Japan is now in-in--or between domestic companies and their domestic intermediaries.

Indeed, Japanese managers are increasingly embracing the concept of grafting, which was first described in a book by Inazo Nitobe called Bushido: The Soul of Japan.

"Bushido" is the so-called way of the Samurai, which was recently glorified by Tom Cruise in the Hollywood film The Last Samurai. However, unlike Ken Watanabe's character, who vainly resisted the lurching of Japan into the modern era with the Meiji Restoration, modern Japanese executive "samurai" are rereading Bushido: The Soul of Japan. A key concept in the book was grafting, which Mr. Nitobe repeatedly used to describe the concept of grafting Christianity onto the essence of bushido.

In modern terms, this means adapting and incorporating Western concepts, technology and business methods that work in Japan and within Japanese culture and business practices.

Mitsubishi Tokyo and Sumitomo Mitsui slug it out

Heretofore, Japanese companies have depended on their network of cross holdings and strategic stakeholders to fend off corporate predators. However, the fight between Mitsubishi Tokyo Financial Group and Sumitomo Mitsui Financial Group for control of the UFJ Group has the potential to erupt into a full-scale takeover battle.

The long and short of it is that the management of UFJ Holdings committed fraud in lying to the Financial Service Agency (FSA) inspectors and falsifying board meeting and management committee meeting minutes. They also lied to shareholders about the true extent of the NPL credit costs they would incure, and the true extent of profit losses that would be involved in realizing these losses.

From the onset, however, an inside deal seems to have been struck between UFJ management and MTFG management. Given [yen]400 billion in losses in 2003, even larger losses now expected in 2004 because of massive NPL write-offs exceeding [yen]1 trillion, and a law suit that the FSA intends to file against the bank, it is increasingly obvious that UFJ Holdings has no future as an independent entity.

UFJ released a business revitalization plan projecting a [yen]1.13 trillion nonperforming-loan disposal loss for the year ending March 2005. It also plans to suspend dividend payments on both common shares and government held preferred shares this fiscal year.

The key to the success of the revival plan is the prospective merger with MTFG, and with MTFG's agreeing to provide [yen]700 billion of financial aid, including a package that is effectively a "poison pill" to ward off a hostile takeover bid by SMFG.

Defending against the new "black ships"

When American Commodore Perry and his fleet of "black ships" sailed into Shimoda south of Tokyo to demand that Japan open trade with the West, it was a visible shock to feudal Japan.

The liberalization of stock swaps for foreign companies wishing to acquire Japanese companies has gained quite a lot of domestic attention as a black ships phenomenon.

This is because the Heisei Malaise has shrunken market valuations of industry leading Japanese companies to a mere fraction of their global competitors. For example, Wal-Mart Stores of the US already has a 37.8 percent stake in Seiyu, but has thrown its hat into the ring as a possible suitor for Daiei.

Wal-Mart's market capitalization exceeds [yen]20 trillion, which means they could procure up to [yen]2 trillion merely by issuing 10 percent more shares. With [yen]2 trillion of new stock to swap for a target Japanese company, Wal-Mart could ostensibly take over a dozen companies with market capitalization equivalent to Daiei with this [yen]2 trillion of new stock.

The same is true in other sectors, such as chemicals and technology--with the major exception being automobiles, where Japanese companies have managed to maintain their global competitiveness throughout the Heisei Malaise.

Indeed, upstarts such as Taiwan Semiconductor Mfg. and United Microelectronics in Taiwan would also ostensibly be able to take over Japanese hi-tech majors with stock that has a higher market capitalization than their Japanese peers.

Darrel Whitten is owner of Whit Consulting, LLC, and is editor and publisher of JapanInvestor.com. A veteran investment analyst, he has been following Japan's financial markets for over 20 years. Please mail comments to: dwhit@whitconsulting.com.
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Title Annotation:INVESTOR INSIGHT
Author:Whitten, Darrel
Publication:Japan Inc.
Date:Nov 1, 2004
Words:1588
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