Barbarians are knocking on Japan’s corporate gates

If you go to YouTube, click on the film Barbarians at the Gate, and watch from the 45m30s mark, you will find Jonathan Pryce playing KKR co-founder Henry Kravis at the late-1980s apex of the private equity predator.

“I’d be very surprised if you ended up buying RJR Nabisco at 75,” he informs the head of the rival bidding group like a torturer laying out his instruments, “ . . . 75 is cheap. Very cheap.”

I only know this because, since the European private equity group CVC proposed an audacious $20bn leveraged buyout and privatisation of Toshiba earlier this month, a weblink to the film and the accompanying explanation “this says it all” have been forwarded to me repeatedly by shareholders, M&A bankers and other private equity firms. 

For a short while, this reference to private equity’s most famous historical coup did seem to suggest thrilling prospects for Japan in 2021. It was clear that other major PE funds, including KKR and Bain, have long been interested in a Toshiba buyout. The fact that CVC’s proposal seemed to involve the conglomerate’s politically well-connected management suggested that an unexpected government green light had been granted to the concept of a deal — and that Toshiba’s fate would be decided in a heavyweight bidding war. 

But much has since changed. Toshiba’s chief executive, Nobuaki Kurumatani, has abruptly resigned and, rather than submitting the more detailed offer proposal it once promised, CVC last week sent Toshiba a conciliatory letter saying it would “step aside”. The Toshiba board has dug in against a deal and seasoned navigators of Japan’s bureaucracy say the implied governmental support has hidden itself somewhere in a quiet corner of the trade ministry.

Other PE firms have said privately a full buyout could now only happen via an uprising of Toshiba’s largest investors, which may be possible if unlikely.

For all of the chaos and dashed expectations, though, one clear message has emerged from the episode: that Toshiba, even at a price elevated by CVC’s approach, is cheap, very cheap. But so too, by many metrics, is a vast acreage of the Tokyo stock market. As well as undervalued, many Japanese companies are cash hoarders on a scale that dwarfs their counterparts in the US, UK and continental Europe. PE would not be this interested in Toshiba — and Japan in general — if it had not identified a killer valuation disjoint and potentially eye-watering returns.

That prevalence of underrated value has been around for a while, and has persisted even as activist investors and PE have demonstrated that there are increasingly acceptable ways to unlock some of it. Still, the reticence of big global funds has frustrated brokers who cannot pinpoint the reason that foreigners, although already substantial holders and traders of Japanese stocks, are not piling-in with enthusiasm.

Still, the kerfuffle around Toshiba creates two potential shifts in coming weeks and months. The first centres on corporate Japan’s tightly clustered season of annual shareholder meetings in June, and the deadline for submitting shareholder proposals at the end of April. Some of these — particularly investor demands for buybacks — could be surprisingly aggressive.

As CLSA strategist Nicholas Smith points out, activists went easy on Japanese companies this time last year, conscious that squeezing managements to return capital during a global pandemic was a terrible look. It has since turned out, however, that despite all the Covid-19 headwinds, those once vital-looking rainy-day cash-piles have been barely touched. So the activists’ gloves may now be removed, and the fight to convince management to focus on enhancing corporate value resumed in earnest.

If that does not produce quick revaluations — or if it proves ineffective, as global funds seem to fear — the Toshiba episode should still prompt many companies to at least consider the alternative of being taken private in a buyout. If PE funds have been submitting proposals to a company as sensitive as Toshiba since last year, you can be sure that hundreds of less controversial proposals are sitting in CEO inboxes across corporate Japan.

Lots of companies, when viewed through the lens of what private equity might do if let off the leash, look enticing. And, critically, few of them enjoy anything like Toshiba’s swaddling of deal-breaking, political insulation. 

Toshiba’s privatisation prospects may have evaporated for now. But the episode’s value could be to convince other CEOs that the idea of a management or other form of buyout could be an acceptable option. Even now, many might be warming to the idea of sitting in a leather-bound PE fund’s office and hearing that “75 is cheap. Very cheap.”.

leo.lewis@ft.com