RPT-BREAKINGVIEWS-Japan’s takeover fears threaten record M&A boom

By Hudson Lockett

HONG KONG, April 8 (Reuters Breakingviews) - In 1989, Sony 6758.T co-founder Akio Morita co-authored “The Japan That Can Say No”, an essay in which he argued Japanese firms should reject, among other things, corporate America’s focus on mergers and acquisitions. Today Japan Inc is finally embracing those concepts, but the government body behind the recent surge in deal activity is poised to give companies new tools to rebuff unwanted takeovers—potentially imperiling the $4 trillion economy's nascent revival.

The move is a curveball from the Ministry of Economy, Trade and Industry, whose fair M&A guidelines published in 2023 lack the teeth of hard law but now carry so much weight with corporate boards that Japan-related M&A nearly doubled last year to $400 billion, per Dealogic. Private equity firms led by Bain Capital and KKR KKR.N, once decried as barbarians at the gates, are acquiring Japanese companies at a record pace. These and other foreign buyout barons have raised huge sums for their Asia funds to deploy in what has become the region’s most vibrant and lucrative market.

This frenzy is the culmination of a more than decade-long top-down push, further facilitated by reforms at Japan Exchange, to stir corporate activity that boosts efficiency and growth to offset the drag of the country's ageing population. Yet hostile buyouts and activist campaigns have brought with them a gut-wrenching pace of change and stoked concerns over ‘undesirable’ deals, judged solely on price, that could auction off economic crown jewels, undermine national security or disrupt vital supply chains.

Hence METI’s pledge in February to clarify the guidelines later this year — possibly as early as May — by foregrounding the concept of ‘corporate value’ which it defines as the net present value of future cash flows. Hiroyuki Sameshima, director of the ministry’s corporate system division, told Reuters that a board “has the right to say no if it believes that incumbent management can better enhance corporate value, or if it judges that a buyer could later engage in asset stripping or extract technology,” though he added, “the purpose of this update is not to encourage companies to implement takeover defence measures”.

Yet firms already appeal to such rejection rationales without METI’s prodding: Seven & i 3382.T deflected a $46 billion overture from Canada's Alimentation Couche-Tard ATD.TO last year by arguing management could better boost returns while also asserting its convenience stores were vital national infrastructure. The 7-Eleven owner's stock now trades at a roughly 20% discount to Couche-Tard’s last offer price.

At worst, the ministry's clarifications could slow deal flow and give boards a license to overlook the value that strategic and private entity buyers bring to many deals. That makes it worth scrutinising the current go-to example, widely cited in Tokyo's financial circles, of another 'undesirable' takeover: Mandom.

The 126 billion yen ($790 million) management buyout of men’s cosmetics group Mandom 4917.T has been used to highlight the risk of firms being targeted by less suitable offers at a higher price. Following the announcement of management-sanctioned tender offer from a CVC Capital Partners CVC.AS, Japan's activist Murakami Fund quickly built up a stake to press for a better price. Then KKR swooped in with a still higher offer and its own—in the target’s reckoning, less tailored—plan to revamp Mandom's operations. Yet the system appears to have worked as intended: CVC ultimately outbid KKR and won management’s backing for a plan to expand the brand in Southeast Asia, ultimately paying shareholders a 58% premium to its original tender offer price.

Beyond those deals, fears of activist omnipotence likewise look overblown. In the most notable victory to date, which saw Elliott Investment Management force insiders led by Akio Toyoda to fork over far more to take Toyota Industries 6201.T private, the pushy shareholder still failed to force the buyers funded by Toyota Motor 7203.T to pay full intrinsic value for the target, according to its own calculations. Even in this landmark success, the activist didn't get everything it wanted.

It is nonetheless eminently rational for METI to want tender offers that provide a specific, feasible business plan and come from a buyer with a track record of turning around targets’ operations instead of simply stripping them for parts. But if its planned clarifications diminish the central role in dealmaking of price based on market participants' assumptions, it risks a return to the bad old days of listed firms shrugging off legitimate offers.

Besides, there are better ways to address the ministry’s concerns: a Japanese version of the Committee on Foreign Investment in the United States (CFIUS) is now in train and a UK-style ‘put up or shut up’ rule to discourage frivolous tender offers is possible if METI, the Financial Services Agency and Ministry of Justice collaborate on the necessary reforms.

Such measures can address real fears that the torrent of deals could erode what global technological edge Japan Inc still holds. Take the acquisition of sensor maker Shibaura Electronics. The unsolicited bid from Taiwan’s Yageo 2327.TW prompted questions about its possible reliance on sales to China’s military from the target, which also brought in a Japanese white knight that failed to fend off the foreign suitor. But in September a review under Japan's Foreign Exchange and Foreign Trade Act gave Yageo official clearance for the purchase, with Reuters reporting per one unnamed source that the Taiwanese firm had agreed to prevent leakage of sensitive technology to protect Shibaura’s role in a strategically important supply chain. Regardless of whether that proves sufficient, Japan probably needs a more thorough and centralised CFIUS-style vetting regime.

None of this requires METI to diminish the supremacy of price in judging takeovers, however, which risks stymying the payoff of Japan's long drive for reform just as listed companies and investors, both foreign and domestic, are starting to come to grips with Japan's increasingly returns-centric variety of capitalism.

The irony is that, despite its co-founder’s now infamous jeremiad against corporate America, Sony has become a pace setter for Japan’s value push by streamlining its business and spinning off subsidiaries. The stock’s total return of more than 500% over the past decade far outstrips even the 260% delivered by Toyota Motor over the same period. As the head of one global PE house’s Tokyo office puts it, management’s safest guard against an unsolicited approach is to do a better job of enhancing value: “The best defence is not to be a target in the first place.”

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