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Cross-shareholdings biting further into corporate profits

Back in June 2007, we reported that cross-shareholdings had increased in fiscal 2006 for the first time since FY1990. Although the 2006 figure (11.2% of shares) was still much lower than the 1990 figure (32.9%), the increase in cross-shareholdings was newsworthy, as the trend toward unwinding cross-shareholdings seemed to be motivated in part by fears of hostile takeovers.

At the time, the Nikkei reported that the new breed of cross-shareholding was different than what had been seen in the past, by stressing that “unlike in the past, when cross-shareholdings were often aimless arrangements, they are now being used to highlight business partnerships.” As a result, much of the growth in cross-shareholdings was seen amongst manufacturing firms rather than financial institutions.

Now, that increase in cross-shareholdings is having an effect on balance sheets. Not only are products not moving in domestic or export markets, but the strong yen and lowered stock prices have have combined to further batter profits. According to the Nikkei, Japan’s electronics manufacturers are looking at losses somewhere in the range of 1.95 trillion yen for FY2008, while automakers stand to lose about 415 billion yen.

Losses exacerbated by low stock prices is hardly limited to manufacturing firms, however. Consider this excerpt from an article from today’s Nikkei entitled Stock Losses Blotting Out Japanese Banks’ Moment In Sun:

The six major banking groups posted a 89% drop in combined net profit for the April-December period, according to results released through Friday. The stock market downswing since last fall is the biggest contributing factor, with the six groups writing down the value of shareholdings by more than 1 trillion yen combined.

How did the banks get in this position? The Nikkei offers this:

Based on the lessons learned at that time, the banks cut their shareholdings from roughly 27 trillion yen in fiscal 2001 to about half that figure in fiscal 2006. But the rate of decline has slowed since then because, according to Nikko Citigroup Ltd. analyst Hironari Nozaki, “bank executives lost their sense of urgency when stock prices recovered.”

In other words, risk management dozed off, if not went out the window. As a result, banks are finding it increasingly difficult to keep up with the demand for credit. Although lending grew by about 9 trillion yen in the last quarter of 2008, there remains the risk that further growth cannot happen unless banks are able to find some way to cut costs or increase their capital bases.

Darrel Whitten on the Nikkei’s nosedive

Over at Seeking Alpha, Darrel Whitten has published a must-read take on the Nikkei’s recent nosedive. Entitled “Japan’s ’80s ‘Bubble’ Has Completely Deflated - and Then Some,” the piece includes this incisive passage:

On Monday, October 27, 2008, the Nikkei 225 index closed at 7,162.90, its lowest point since October 7, 1982, before the infamous 1980s bubble began. The trailing P/E multiple for the Nikkei 225 was 8.58X and the forward multiple 9.53X, while the Nikkei 225 PBR was 0.87X, while forward dividend yield was 3.07% versus a historical dividend yield of 2.97%. The Nikkei’s earnings yield (inverse of the P/E multiple) was 10.47% on historical earnings and 9.92% on forward earnings, while the market’s ROE was 10.1% on trailing earnings and 9.1% on forward earnings—versus a JGB (Japanese government bond yield) of 1.47%. In other words, market valuations are also back to pre-bubble valuations that existed some 30 years ago.

The full article is here.

Draft of the Emergency Economic Stabilization Act of 2008

For those eagerly awaiting an exciting read, here’s the most recent draft of the “Emergency Economic Stabilization Act of 2008.” (PDF)

Full name: “A Bill for the Federal Government to purchase and insure certain types of troubled assets for the purposes of providing stability to and preventing disruption in the economy and financial system and protecting taxpayers, and for other purposes.”

“Protecting taxpayers” is buried pretty far down that list, it seems to me.

Japan’s markets spared from Monday trading

Japan’s markets are closed for the national holiday, and Steven Towns explains why that’s a good thing over at Seeking Alpha. Still, Tuesday might not be much better. The US markets open in a few hours and large drops are expected. It’s not crazy to suggest that the Nikkei could move back below 12,000 points sometime before Tuesday’s lunch break.

And over at Alpha Sources, Claus Vistesen has posted a must-read entitled Japan - The Recession is Here.

Kuwati Investment Authority to triple its invesments in Japan

According to this morning’s Nikkei, the Kuwati Investment Authority has announced plans to triple the size of its investment in Japan, to $48 billion. The KIA has said that it intends to make investments in both real estate and equities. Such a move would bring between 20 to 25% of the fund’s global investment to Japan. The KIA is believed to be seeking value in firms that are expanding their operations in the Chinese market, and it has been speculated that the fund may be interested in taking up holdings in automotive firms.

Japan’s pension fund lost 5.65 trilion yen in fiscal 2007

As a quick follow-up to yesterday’s post on the creation of a sovereign wealth fund and the taking of seed money from Japan’s pension fund, it was announced today that the Government Pension Investment Fund lost 5.65 trillion yen in fiscal 2007. Although estimates had been published before, this is the first time we’ve seen detailed numbers from the government.

As one would expect, the fund made money from its investments in domestic government bonds, but lost about 7.5 trillion yen in equities positions both at home and overseas. This was the largest loss ever incurred by the pension fund, which has been investing full-scale in financial markets since 2001.

Nikkei average falls for tenth straight day, first time since…

The Nikkei just closed this afternoon at 13,286.37 - down 176.83 points. Today was the tenth consecutive trading day to finish at a loss. When was the last time the Nikkei declined for ten straight days? February 1965.

The shipping, automotive, machinery and insurance industries all felt the sting of decline. Now it’s time to see if the dollar can hold above that 105 position against the yen…

Steel Partners sells off stakes in Bull-Dog and Kikkoman; TCI is holding paper losses in J-Power

Earlier today, the Nikkei reported that Steel Partners has sold off all of its shares in the Bull-Dog Sauce Company, as well as Kikkoman. A year ago, Steel Partners held about 10% of Bull-Dog shares, and launched its takeover offer in May. After the Supreme Court declared that Bull-Dog’s anti-takeover defense measures were legal, Steel Partners brought in about 2 billion yen from the company when it bought back its stock warrants. It has been speculated that Bull-Dog has spent up to 70% of its sales revenue from the past year on boosting its cross shareholdings.

According to the paper, Steel Partners also made about 2 billion yen from its investment in Kikkoman. Although we don’t know the reasons exactly why Steel has decided to pull out of its Kikkoman position, it is certain that Kikkoman is gearing up to spend quite a bit of money on a new ketchup factory in China as well as 6 or 7 soy sauce factories in South America, China, North America, Oceania, Southeast Asia and Eastern Europe. The construction is expected to cost tens of billions of yen and bring Kikkoman’s production volume near the range of an annual 1 million kiloliters.

Back on April 1, the Nikkei published a piece entitled Firms Begin To Dismantle Takeover Defenses As Benefits Remain Unclear, which highlighted the fact that there have been no successful hostile takeovers in Japan, that courts tend to be friendly to management, that takeover measures hurt share value, and that poison pill measures can be quite costly to a firm.

Six days later, the Nikkei published a piece entitled More Firms Adopt Takeover Defenses That Seek Shareholders’ OK which stated that 443 firms had adopted anti-takeover measures by the end of FY2007.

Finally, it’s worth noting that just as Steel Partners exits now from its Bull-Dog chapter with a profit, that The Children’s Investment Fund is estimated to be holding 16 billion yen in paper losses deriving from its investment in J-Power. Today’s Yomiuri tells us, “If TCI refuses to obey the government order (to stop purchasing shares in J-Power), the fund or its executives may face a fine or prison term of up to three years.”

J-Power has no anti-takeover measures in place.

Nikkei highly critical of Japanese government’s decision to block The Children’s Investment Fund

Now that Japan’s government has effectively blocked TCI from upping its stake in J-Power from 9.9% to 20%, a slew of negative reactions to such action is bound to be published, and some pressure is expected to be put on Japan’s government to allow the nation’s current stunted form of capitalism to develop on its own.

The Nikkei got the ball rolling today, in an opinion piece titled Govt ‘Selection’ Of Shareholders Costs Japan Dearly. Some selections:

[M]arket insiders are wary of an acceleration in Japan selling by overseas investors. “TCI had offered an alternative plan restricting its voting rights even if it was allowed to increase its stake,” said Kengo Nishiyama, a strategist with Nomura Securities Co. “The government failed to give a convincing explanation of why the plan was not acceptable.”

…Each time a foreign activist fund’s attempt to take over a Japanese company has been blocked — a typical case is the aborted bid by Steel Partners to take over Bull-Dog Sauce Co. — or calls to control foreign investment in sensitive sectors have emerged, foreign investors have rushed to sell Japanese equities, regarding Japan as remaining closed to them…

…It is unusual for the government to get involved so directly in private-sector investment activities.

(I’m not so sure about that last statement; this just seems like a particularly egregious example.)

“Japan must now face the question of whether management of a company or the government has the right to choose shareholders,” said Yoshihiro Ito, director of Okasan Capital Management Co. The effective selection of stockholders through cross-shareholdings — a practice that is reviving in Japan — listings of both parents and subsidiaries, and government intervention will distort the stock market and cost companies dearly.

Bull-Dog Sauce is a case in point. The company has spent a total of more than 12 billion yen, or about 70% of its sales, to purchase cross-shareholdings and other securities in the past five years since Shoko Ikeda became president.

The government needs to be extremely cautious and have a clear justification to intervene in private-sector investments. Otherwise, it could seriously damage the national interest.

The word “could” seems a bit light in this sentence; The LDP has been damaging national interest for decades. One question they will be faced with in the future is whether the population will believe that their actions are in the voting public’s best interest or if they are more akin to amakudari back-scratching. Although this may not seem like a bread-and-butter issue at first glance, it certainly looks as if the public is going to have more of a “choice” on these matters in the coming years, if you’ll pardon the pun.

Have Japanese equities hit bottom yet?

Today was the last day of financial 2007, and the Nikkei Index dove 294.13 points to finish at 12,525.54 - marking a 27.5% decline since April 1, 2007. To make matters worse, paper gains on shareholdings at Japan’s six major banking groups dropped by 62% over the same time period, according to the Nikkei. This was the first time that unrealized profits from equity holdings declined at the six major banks since 2003. On the other hand, the same six banks saw 100 billion yen in paper gains in bond holdings, the first time they’ve been in positive territory since 2002.

At the same time, the Nikkei also estimates that the market value of shares held by publicly traded firms in Japan declined 30% in fiscal 2007. This would represent a loss of 8.7 trillion yen of (paper) wealth. There seems to be heightened risk developing if the Nikkei should move lower, as many Japanese firms are boosting their cross-shareholdings in an effort to thwart would-be takeover attempts. Read more

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