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The issue with Air Water, sighs one Tokyo-based fund manager, is not the company’s world-class industrial gases operation, its newly enhanced pricing power or its attractive valuation relative to peers. The problem is its ham, sausage and cakes businesses.
Japan-focused investors have been highlighting the perils of excessive corporate diversification for decades. But the warnings now have a much sharper edge: if domestic consolidation and an inflow of foreign strategic buying does not happen now, it might never take off. But if it does, and Japan produces a slew of globally irresistible giants, it matters everywhere.
Shareholders of Japanese stocks want more mergers and acquisitions, the Japanese government actively wants more M&A and, though they are quieter about it, plenty of Japanese companies want more M&A. There are significant obstacles old and new, of course, but the hardest to fix may be corporate Japan’s historic addiction to the side hustle.
The debate around M&A is unusually hot, and the authorities deliberately made it so by introducing, last year, a fundamental revision of Japan’s guidelines on it for the first time since 2005.
Last week and this, fund managers from around the world descended on Tokyo en masse for back-to-back conferences by two of the country’s largest brokerages. The overseas funds are in Tokyo for two reasons and game theory is very much in charge. The visitors want to know whether the ongoing rally is the real thing or just another Japanese head fake. But they also want to know what conclusion all the other visiting funds have reached on that before taking the plunge themselves.
The resulting impasse could be unlocked by a clear momentum-assuring narrative for Japan, of which the most powerful would be evidence that the new M&A guidelines have reset on-the-ground reality, rather than just theory. Beyond dispute is that the new guidelines look game-changing. The 2005 rules were written at a time when companies started unwinding the protective stakes they held in one another. To offset that collective shiver of vulnerability, boards treated the guidelines as an encouragement to build takeover defences against the interests of ordinary shareholders.
The three biggest pivots are that “poison pill” and other defences require greater justification, that management should not dismiss bona fide talks or offers as hostile and, in perhaps the biggest Damascene conversion, that M&A should be considered critical to the overall Japanese economy.
A wave of big strategic buyers from overseas may take a while to materialise, say M&A lawyers and bankers, but an immediate jump in long overdue domestic consolidation is now explicitly endorsed from on high. The historic ballast on domestic consolidation still exists: chief executives generally have greater loyalty to staff than to shareholders, managements are not incentivised to seek transformational deals and job protection is paramount. But all of those are now being summarily dented: in particular, Japan’s labour shortage removes a lot of the squeamishness around workforce-slashing synergies.
In that light, Japan’s simultaneously congested and fragmented stock market becomes a much more compelling place: a potential forge of “fantasy global monster” dealmaking that should have happened long ago. What if, instead of six listed Japanese ballbearing specialists with a collective global market share of 40 per cent, there were two with 20 per cent each and a pair of trembling Swedish and German rivals wondering what to do about it?
Appealing though that is — the corporate ingredients for a potentially terrifying Japanese global giant can be found in almost every industrial sector — the difficulty, say bankers, is all that side-hustling done decades ago when corporate reputation was built on sprawl rather than focus.
This means the non-core businesses in Japanese companies are no longer just a shareholder annoyance but an active impediment to dealmaking: potential consolidators know that for every takeover they contemplate, there will be a resource-sapping divestment ordeal. Merger talks, say bankers, may well be derailed by demands for the other side to start slimming first. Japan needs an initial, enormous wave of M&A to get everyone close to being pure plays, before the consolidatory wave that creates world-trembling giants.
Meanwhile, investors will sigh at the invertibility of a market defined by companies such as Air Water — a conglomerate of well-run, exquisite parts that seem destined never to become more threatening than they are mystifying.
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