The Capital Cycle Podcast - Japan Merger Mania

Episode Date: June 30, 2025

Three contrasting bids in Japan and what this says about evolving shareholder capitalism. Edward Chancellor talks to Justin Hill, a Developed Asia Portfolio Manager.For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk Hosted on Acast. See acast.com/privacy for more information.

Hello, this is Edward Chancellor with another edition of the Capital Cycle podcast. And I have with me today for the first time, Justin Hill, who's a portfolio manager for Marathon Asset Management, covering Japan and Asia Pacific. Welcome, Justin. Thank you. So last September, I discussed with your boss Bill Ara on why the prospects for investors in Japan were getting better. Can you recap to listeners a sort of thrust of the shareholder value revolution, if we can call it that in Japan? Yes, well, I'm not sure I'd quite call it a revolution yet, but maybe a slow burn revolution. There's a lot going on.

I think, you know, you've got macro factors and micro factors pushing in the same direction. On the macro side, you've got the return of inflation after a very long time without it. And as a consequence of that, you've got interest rates normalizing. as well. And then on the micro side, you've got a lot of changes in terms of the way companies are run. And I think that's, you know, the really interesting bit. We've talked for a long time, and you talked with Bill as well about governance and how that's changing in corporates. A lot of that is really being driven by pressure from the top. And that feeds down into the Tokyo Stock Exchange, who've made a number of pronouncements on the subject. And you've got the pot being stirred

by activist investors as well and M&A. So from a sort of capital cycle perspective, which from an investment approach that emphasises capital allocation, these corporate governance reforms or shifts are on the whole beneficial. Absolutely, yes. I mean, I think you could describe it as a huge cycle in Japan since the bubble burst in the late 80s, since when we've been in a deflationary world. and corporates have got away with hoarding capital on their balance sheets essentially for a large number of years. That's combined with the retail, public, households, hoarding cash.

And I think part of the drive and the way that the government thinks about it is that they want to mobilize some of that savings pool, which is huge. Japanese households hold around 50% of their assets in cash and deposits. That comes to around 7 trillion US dollars. that's pretty big in the context of a Japan market cap of around 6 trillion. So to go back to not so much investment flows into the equity market, but actual the underlying capital allocation of corporate Japan, what we're going to talk about is how M&A mergers and acquisitions are part of the stories. You've got this environment where corporates are looking at running themselves more efficiently,

and I suppose there's two levels of that. There's balance sheet efficiency, sympathistically, not sitting on a load of cash, thinking more about shareholders and the fact that they deserve a return on their capital. So on the one hand, you've got a huge surge in buyback activity. And if you look at what happened in 2024, buybacks rose, I think, around 85% in the year.

So you've got capital being reallocated in that way, but you've also got this, I think, fairly unique structure in Japan where still there are around 200 listed subsidiaries on the stock market. One of the ways in which companies are looking at simplifying their business models and making the balance sheets more efficient is to do something about these subsidiaries. And that's something that the Tokyo Stock Exchange has been pushing for recently, just saying, look, we want you to rethink these sort of slightly unusual and usually unhelpful setups and the end game is that either these subs should be consolidated back into the parent

companies or spun off. That's kind of, I suppose almost you could call it internal MNA within Japanese corporate structures and that's happening alongside external MNA of which there's been some, a couple of big examples recently. And as with regards what you call the internal MNA, the rationalization of Japan's Kairetsu organizations, you've written a recent global investment review looking at how this affects two of Marathons' investments. And we'll get on to this. So they reveal these two rationalizations of Toyota and Toyota industries and NTT data reveal slightly different stories.

But let's talk first about Toyota and what's going on there. Well, Toyota's a classic Kiritsu structure. Before the war, you had these huge conglomerates called Zibatsu's that were really dominated the industrial landscape. The idea behind them really was to promote growth, promote GDP growth, and also to develop a stable environment and jobs for life would be very much part of that. So you had these webs across shareholdings. They were somewhat unwound after the war and the Zibatsu became... By the Americans. Yes.

And the Zibatsu became Kiritsu, which weren't as dominant, but they still retained a lot of the characteristics. If you look at the Toyota group, the original founding company of that group is a company that's now called Toyota Industries. And they are the biggest single shareholder of Toyota Motor Company. Toyota Motor Company are the biggest shareholder of Toyota Industries. and surrounding those, there is a kind of maze of cross shareholdings, which I'd give a hat tip to John Seagram at CLSA, who coined it the Toyota Tangle. Yes. So there's Dentso, the ancient parts company. Yes, so it's companies like Densso and Aishin and a number of others, and they all hold shares in each other.

You have seen early signs of these starting to unwind. And what's happened now is that Toyota Motor, or the Toyota Motor Group, has put in a tender offer to take over Toyota Industries, which in a way could be viewed as an attempt to, I put it, before one of the GIRs, as cutting the GORDIRs of this mess across shareholdings to try and simplify them. So they put in a tender offer to take over the listed portion of Toyota Industries, also known as Tico for short. That's where it gets a little bit controversial. Before we get on to the controversy, I'd say that I don't know if you wrote the December 2024 Global Investment Review, which mentions Toyota Industry, but that piece actually predicted that something would be happening with Toyota Industries and the unraveling.

This was a story that, if you say, the market. market was waiting for. But I think actually, even before we get into why this is a bit controversial, will you just tell people a bit about Toyota industry's business activities? It contains within itself the original Toyota business, which was a loom business or textile manufacture, which I think, I remember reading that it was actually, that Toyota family actually borrowed, let's say, call it plainly borrowed a British design for a loom and then perfected on it only later did they get into making, I think, lorries for the Japanese military and then

so forth. Anyhow, yes. So the Japanese name for it is still a Toyota automatic loom, which was the original business. And it was founded 99 years ago, 1926, and then in 1933, it spun off Toyota Motor while retaining a shareholding in it. But obviously Toyota Motor ended up being the giant that we know today. And aside from the shareholders, holding in Toyota Motor that Toyota Industries has, its main operations are what of forklift truck? Yes, it's the world's biggest maker of forklift trucks, and that includes the exciting ones that are automated and run off batteries. But it's also a big player and everything that surrounds that in terms of materials handling and warehouse automation. We've got an investment in Japan's biggest

online fashion retailer, which is a company called Zoso. and they've been spending a large amount of money over the last few years, automating their logistics network. You put this equipment into a warehouse, and you can essentially reduce the number of staff you need by about 70%. So they make these massive efficiency savings. Who supplies them? Well, it's Toyota Industries via a subsidiary of theirs called Vandalanda,

which is a very big player in automation. It supplies nine out of the top 15 global, food retailers, for example. That's just one part of Tudor Industries offering. And this is a big deal by Japanese standards, this takeover bid. Yes, I mean, it would be the biggest ever. It's the tender offers valuing the equity at around 34 billion US dollars. And that's easily the biggest, I think, correct me if I'm wrong, but I think the next biggest was Toshiba, when that got taken over a few

years ago, and that was only 14 billion US. So let's Let's get on to the controversy surrounding the deal. Whereas the investors are happy by and large with the rationalisation of these gross shareholders. In this instance, there have been a certain amount of complaints that the premium is not particularly generous. So if you start with what the share price did, as you mentioned, I wrote about it back in December when the company was trading at a 40% discount to book. essentially saying that was just wrong. And where was it trading then? So this is back in December 24. It was more or less valued at the value of its cross shareholdings with zero in there and possibly less than zero for the operating businesses. So it just looked ridiculously cheap back then.

So when the rumor first came out that Toyota was going to make a tender for it, the shares jumped by 40% for zero. eventually the actual details of the offer came through, which was at a 10% discount where the shares were then standing. So you can see that initially there was obviously a certain amount of disappointment in the price being offered. And that price is precisely book value. And apart from anything else, I think when you've got a company that's valued on exactly book, there's very, very little in there of anything for the underlying businesses. So essentially you're assuming that the business never makes a proper economic profit. So there's nothing in there for growth potential.

There's nothing in there for the intangibles that have built up in the business. As mentioned, this is a 99-year-old company, and they've been spending close to a billion dollars on R&D for many years. They've built up all the know-how in the industries they're operating in. You've got these customer and supplier relationships. So it's a huge pile of intangibles effectively in there that aren't reflected in the balance sheet value. And the offer is, what, 16,200 yen or thereabouts. And MUFJ, Morgan Stanley, had an estimate fair value.

Obviously, there are a range of estimate fair values, but Morgan Stanley has a value, an estimate of 20,000 yen, which is 20% above the buyout offer. How do you think this is going to resolve? I mean, the Toyota Group, the Tangle, has a lot of clout, and there are supine institutions in Japan that might go along with the deal too. So how will it? I mean, it's not a great author, but you think it'll probably go ahead this deal.

If you look at where the shares are trading, they're trading at a premium to the tender price right now, which I think suggests that there is still something to play for. Just on the valuation of jotted down the numbers in dollar terms, because down at least we avoid trillions, we can stick to billions. book values $34 billion and of that $27 billion are cross shareholdings so Toyota being the largest part of that

which is fine but if you look at the book value on the balance sheet they've depressed the value of those cross shareholdings by around 8 billion US for deferred tax liabilities which is a huge amount and as it happens if you look through

corporate Japan no one has more deferred tax liabilities than Toyota industries. From accumulated losses? From accumulated gains on these cross shareholdings. So in other words, the assumption is if they aren't sold these cross shareholdings for 27 billion, they'd have $8 billion of tax to pay on that. The reality is, I think, going to be slightly different to that

because it's all being combined within the Toyota Group. In terms of the way we've looked at it, we think there should be at least a 50% tax shelter on that $8 billion of liability. So you shouldn't really be discounting the book value by $8 billion. Possibly you could discount it by $4 billion, possibly less. But if you assume that it's only around half of those tax liabilities apply, as seems likely, then you get to a valuation of around $9 billion for the operating company, which is around six times operating profit,

which basically shows there's no control premium being paid whatsoever. And if you compare that implied valuation with other players in the industry, like Keon or Daifuku, they're trading at 15 to 20 times earnings. Compared with that, you've got an implied single-digit earnings multiple on the operating businesses of Tico. Right. We'll see whether the Toyota family gets what it wants or whether the investment community puts up a bigger fight. In some ways, when people I spoke to said this deal was more, if you will, a reflection of old corporate. Japan, the new corporate Japan. And what we're going to talk about now is another marathon

investing company in Japan with another unwinding of cross-shareholdings with a subsidiary, namely NTT, the telecoms company, and NTT data. This is in a way, I think it's more straightforward story of advancing corporate governance and unraveling. Tell the listeners It's a bit about what's going on. Yes, as you say, this is relatively straightforward. There's the telecoms giant NTT, and they are buying in the 40% of their listed subsidiary entity data that they don't already own. NTT data being a systems integrator, what NTT are arguing is that as a single entity, they can operate much more efficiently, and they'll effectively be a Japanese national champion that can operate on a global scale,

combining the hardware and embedded network assets of NTT with the software and cloud and AI capabilities that NTT data bring with them. And in your piece, you're suggesting that this do you have the blessings of the Japanese authorities? Yes, it's been waved through. it would seem by the regulators and the government, I think there is an aspect you could argue that they are much more relaxed than they might have been 10 years ago about the prospect of having a dominant domestic player.

I think the Japanese competition authorities would have worried about it a bit in the past, and that was part of the reason why you had a separate listing for NTT data. But I think today the attitude is more that they want to have strong companies, they want to have national champions. And the combined entity is pretty meaningful on a global scale. And I think that's, if the general theme of the shift in corporate Japan towards better corporate governance, it's Japan becoming a bit less like Japan and a bit more like some of the other developed markets, where, as you know, in the last 20-odd years, some pretty hefty mergers have been allowed in the Western markets.

Now, I spoke to a friend of mine, Pellam Smithers, who's been writing back Japan for a long time, and he said with regard to these takeovers, he said, well, the rule of thumb is that the premium should be around 35% to the understirpriced price. Now, the Toyota Industries one didn't quite get there, but this one is more or less on the spot. Bang on, 33%. Yeah. So the investors are reasonably happy with that one. I think so, yes. I mean, it's interesting that quite a lot of people haven't tender their shares. So I think there's still around 18% who didn't tender. But I think from Marathon's perspective, the price offered seems fair. It's at around 30 times earnings. And by the way, I mean, we own both NTT data and NTT. And so we were quite pleased to see that the NTT share price actually also went up on this deal. I think that's quite unusual in this sort of deal and suggests that Mr. Market is taking a positive. you. And Justin, finally, you want to just give an update on the bid by Alimentation Couchard, the Canadian store operator, convenience store operator for another marathon hoarding, Seven and I?

Yes, this will be the biggest ever deal in Japan if it goes through. It's around 50 billion US equity value. The interesting thing about it is how Seven and I have reacted to it, because the initial reaction was very much old Japan. And like Toyota, there's a founding family, the Ito family, who have a relatively small economic stake in the business, less than 10%, but who still exert a major influence on the way the thing is run. So initially, unsurprisingly, they were not keen on entertaining this deal. I think there's been a certain amount of behind the scenes tussles, so to speak. But what we have now, I think the modernizers basically have won within management. management to the extent that they're now treating the deal properly. They're doing the right things, so they've established an independent committee to look at it. They are engaging finally

with Kushtar, which took a while, but now they're talking to each other. And they're communicating their thinking quite openly with shareholders. So they're perfectly willing to discuss whether they think that the valuation is fair and they're coming at it from the point of view of, well, what could we do internally? What's the alternative to being taken over and evaluating that alongside what's being offered by Kustard? So I think even if the bid doesn't go through, the group is going to be in better shape than before. Because for example, they're really putting their foot on the gas in terms of restructuring it, getting rid of some of the underperforming parts. So they're selling down their supermarket business, for example, which has been a perennial

underperformer and has dragged down returns. So I think this. This is positive in general for corporate Japan. And the sheer size of it also suggests that really nothing is off the table when it comes to foreigners looking at Japanese assets. And Japanese management will be watching this deal and realizing that they need to improve their own capital allocation to avoid these unwanted foreign or even domestic bits. Yeah, absolutely. I mean, if you're not running a tight ship, it's becoming increasingly possible for someone else to do it for you, whether that's domestic. or overseas, I think this is an additional impetus to management teams to improve governance to run their companies more efficiently. And that, in short, is the bull case for Japanese equities that's been running for a while, but has got further to run, I'd say. Anyhow,

Justin, thanks a lot, very interesting conversation, and I hope to speak to you again soon. Thanks, anybody. Thank you for your time today. I hope you will listen to the next edition of the capital cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information, including important disclosures.