Japanese M&A adventurism poorly directed abroad

June 2, 2011

By Rob Cox
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

TOKYO — Japan Inc’s latest mantra is that, with the domestic market shrinking, companies must hurry to make acquisitions abroad. But they should resist the temptation of international M&A adventurism. Creating more competitive enterprises through domestic consolidation would be better for the country in the long run — not to mention for shareholders, too often an afterthought in Japan.

For many companies, it’s already too late. Despite the disruption to supply chains, corporate planning and profit wrought by the Tohoku earthquake in March, Japanese companies have already managed to buy twice as much overseas this year as they did in the same period of 2010, according to Thomson Reuters data. Just five months into the year, Japanese purchases abroad are on pace to surpass their 2008 record of $68 billion.

Among these were the $14 billion takeover of drug-maker Nycomed by Takeda Pharmaceutical announced last month and Toshiba’s $2.3 billion purchase of Landis+Gyr, a maker of electricity metering equipment. In Tokyo, these deals are viewed with some pride — a sign that Japanese companies are regaining their mojo and taking advantage of cash-rich balance sheets, cheap financing at home and a strong yen.

Those advantages may be real. But it’s hard to avoid the impression that this thinking will lead to a sort of winners’ curse for Japanese companies. In the two examples just mentioned, the financial rationales are murky. In both cases, Swiss-based companies were sold by private equity firms — a worrying sign in and of itself — so there’s little public information to help determine potential returns.

Anecdotally, though, the acquirers do not seem to have struck bargains. Takeda paid more than 13 times historic EBITDA for Nycomed. That’s expensive given Nycomed has been shrinking. And in grabbing Landis+Gyr, Toshiba offered as much as 50 percent more than other bidders — a group that included General Electric, hardly the most disciplined of acquirers.

Deals like this may diversify the Japanese buyers’ earnings away from a domestic market challenged by an aging and declining population. But the danger is they amount to huge transfers of value away from shareholders. Neither Takeda nor Toshiba seems likely to generate returns on these deals, even in the medium term, that exceed their already-low weighted average costs of capital.

Japanese companies could still benefit if overseas acquisitions accelerate the adoption of internationally recognized best governance practices, starting with a greater focus on capital returns. Indeed, Japanese bankers and executives hold up the 2006 takeover of Britain’s Pilkington by Nippon Sheet Glass as a shining example of how this can happen. Two years after the purchase, the company promoted Pilkington’s managers, including its chief executive, to lead the global group. NSG’s 12-member board today includes five non-Japanese and five independent directors.

Yet while NSG has become a more worldly company, its share price performance is the worst among its peers. Since early 2006, NSG has lost half its value. French rival Saint-Gobain is down just 15 percent. Japan’s weak economy and the recent twin natural disasters only explain part of the gap. Shares of NSG’s home market rival Asahi Glass have also done less badly over five years.

That suggests even Japan’s poster child for internationalizing a business through M&A has been a dog for shareholders. A better alternative, though it may sound counterintuitive, is to stay much closer to home. There are huge opportunities for companies to merge or crunch together non-core holdings in the fragmented domestic market.

Among the components of the Nikkei 225 stock index alone, Japan boasts a dozen appliance makers, including six that make rice cookers. It has five car manufacturers and hundreds of components producers. Nearly every conglomerate makes telephone handsets at a loss. Four big brewers compete, alongside international brands, to slake the thirst of salarymen. And dozens of separate firms market soy sauce, tonkatsu sauce and mayonnaise to Japanese households.

By first creating more efficient businesses at home, Japanese companies would enhance their profitability and better prepare themselves for excursions abroad. It’s not easy to do that in a society where harmony and lifelong employment still trump returns on investment. And the potential loss of jobs would create its own problems. But it’s hard to see how squandering Japan’s corporate wealth on foreign shopping excursions will help the country’s long-term competitive position.

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