Vigilance is required
The start of the year has already brought five $100 million-plus Japanese takeovers, representing a decade-plus high for the month of January. It contrasts with a 36% year-on-year slowdown in global M&A. What is behind the uptick?
One possible factor: the upcoming transition at the Bank of Japan. The announcement regarding Kuroda’s successor is expected as soon as February, and whoever it is may finally call a halt to the country’s ultra-loose monetary policy.
With this in mind, it is likely that investment bankers are rushing through as many deals as possible before the era of virtually-free yen financing comes to an end.
Commercial banks (mainly, the three megabanks) are happy to facilitate the rush. With demand for traditional corporate loans still nowhere near enough to absorb their massive deposit bases, banks must make up the difference with alternative sources of yield.
Acquisition finance fits the bill nicely as it is yen-denominated and secured while offering attractive returns versus government bonds, particularly in larger transactions with mezzanine tranches (which are entirely bank-financed in Japan in contrast to other countries). It is not surprising that, in recent years, cash has almost wholly replaced stock as an acquisition currency (figure 1).
Succession remains a key driver of activity. Over 64% of Japan’s small and medium enterprises have a president above retirement age, and 52% of these companies do not have an identified successor. Selling out to competitors or PE funds – many of whom still have substantial dry powder – can sometimes be the only route to survival.
Governance is another catalyst. Tokyo still has 219 listed subsidiaries with a listed parent. In the face of a multi-pronged assault on these structures by regulators, stock exchanges and shareholders, it is not surprising that parent / subsidiary clean-ups are behind many deals. Participating institutions also gain the reputational benefits of “enhancing ESG”.
Furthermore, Japanese equities look cheap globally at 1x book and with the yen at 130.
Minority shareholders must be extra-vigilant. The flood of deals inevitably causes some acquirers to bet that even manifestly unfair transactions will get waved through without proper scrutiny.
For example, although Japanese takeover premiums are generally high compared to elsewhere and indeed have been trending upwards over the years (figure 2), we have already seen one PE-led deal this year with a sub- 10% premium.
In other recently-announced transactions, parent companies are forcing through deals for listed subsidiaries at unattractive prices and with a lack of procedural protection for minority investors.
Shareholders in Japanese takeover targets must raise their voices when terms are disadvantageous (Metrica will continue to do so in private and in public) and be prepared to follow through with appraisal actions through the courts. This will ultimately lead to better outcomes for investors and corporates alike.
Metrica Partners will not tender its funds’ shares in SK Chemicals to SK Discovery
- SK Discovery’s tender offer price is very low, representing a 74% discount to net assets.
- SK Chemicals has still not adequately compensated its shareholders for the split-off of SK Bioscience. The Korean regulator has recognised how split-offs can hurt the interests of investors.
- Only a wholesale restructuring can restore the market’s trust in SK Chemicals.
Please refer to the dedicated website for more information.
Pockets of value
We have been writing about the recovery in the performance of the Value factor since November 2020, and have since highlighted a few corners of the market which fall squarely within the Value category but which have been slow to join the trend.
Another example is the Japanese regional bank sector, which has only just started to move off its lows.
As is well known, Japanese regional banks trade at steep discounts to NAV due to 1) balance sheet volatility caused by their large portfolios of listed securities holdings, built up over the years to strengthen relationships with corporate customers, and 2) poor profitability in their core lending businesses, caused by zero / negative interest rates and sluggish loan demand.
Currently the sector trades at 0.35x book, which is only slightly up from the all-time lows of around 0.30x recorded in 2020 and 2021 (figure below). Regional banks have lagged major banks since 2020 (same chart).
Are there any specific catalysts for regional banks besides the global recovery in Value? We see four:
- The number of regional banks announcing share buybacks has reached at a record high (figure below). Investors have been calling for this for years, and it is finally happening. Some of the amounts are quite meaningful: for example, Yamaguchi Financial Group recently announced plans to repurchase 8.4% of outstanding shares.
- There has been progress on reducing listed securities holdings. The Bank of Kyoto recently announced that it would cut the book value of “policy holdings” (securities held for non-investment purposes) by 10% over three years. This should encourage other regional banks to follow suit, catching up to the major banks which have made more progress in this area.
- Consolidation is a longer-term catalyst. The Ministry of Finance and Bank of Japan have created incentives for regional banks to merge, aimed at reducing over-capacity and boosting profitability. As a result, the number of regional banks has been falling gradually (figure below).
- A potential macro driver comes from the yield curve. The Bank of Japan’s insistence on keeping 10-year government bond yields below 0.25% is causing severe consequences to the Japanese economy, including a sharp depreciation of the currency at a time when global energy prices are spiking. This is unsustainable in Metrica’s view; it is likely that within the next year the BoJ will relax its policy after declaring that domestic inflation has recovered sufficiently. This will cause long-term yields to rise, which will be positive for bank earnings, all else being equal. Regional bank profits in particular are more sensitive to yield curve shifts (figure below).
Higher inflation may also encourage Japanese savers to move cash out of deposit accounts and into stocks and other assets, boosting bank returns on equity through reduced capital requirements.
If the regional bank recovery is real, another point to consider is dispersion. To what extent have names been moving together?
The figure below shows a price-to-NAV chart, considering the market capitalisation of regional banks versus the mark-to-market value of their listed securities portfolios and ignoring other net assets. It can be seen that, within the overall sector move, some individual names are still close to five-year lows, while others have started to rally. The wide divergence of returns creates attractive trading opportunities for RV strategies.
Engagement and activism may rebound
We looked at the Factset SharkWatch database, which tracks global activism campaigns for the last ten years. The dataset initially covered only US campaigns but in recent years has improved its non-US coverage to the extent that we believe it now provides meaningful statistics for Asia-Pacific.
The primary observation is that, while global activism has already started to rebound from the depths of the pandemic – rising 5.2% since 2020 – this growth has all been driven by campaigns outside Asia-Pacific. Figure 1 shows how Asia-Pacific activism (which accounts for around 17% of the total) is still down by 37% compared to 2020, even as the rest of the world has risen 13.7% (note that we considered only campaigns announced in January to May of each year, to make the results comparable across years).
Why the divergence? We believe it is simply explained by the fact that the three countries which account for 91.1% of the “rest of the world” dataset – namely the USA, Canada and the UK – have all been rolling back Covid restrictions faster than most countries in Asia-Pacific. This has made activism easier to execute and more effective in these markets.
Within Asia-Pacific, we see a similar trend. Activism targeting Australia-headquartered companies, which typically accounts for around half the regional total, has been rebounding in 2022 (figure 2), in line with Australia’s re-opening of its economy. Conversely, countries such as Japan and China which persist with closed border policies are still seeing activism falling year-on-year. (more…)
A resurgence of catalysts
The Ukraine conflict could have interesting implications for relative value (RV) strategies.
Historically, the worst period for RV strategy performance has been the low-yield, low-growth environment of the years between 2008 and 2020 (the shaded region in the figure below). By contrast, prior to 2008, when yields were higher, RV did well in both high-growth (1960s and 1980s) and low-growth (1970s) eras. It suggests that RV performance is more sensitive to yields than economic growth.
Even prior to the outbreak of the Ukraine conflict, inflation and growth data had started to point to an end to the low-yield regime. This had caused RV trades to gradually recover since November 2020. Wars are generally inflationary (Edward Yardeni, Fed Watching for Fun & Profit). This has been evidenced in recent weeks by soaring prices for soft commodities, energy and metals. All else being equal, inflation should eventually lead to higher yields.
The opposing view is that heightened economic uncertainty will slow down the pace of Fed rate hikes and balance sheet normalisation, keeping a cap on yields.
Metrica’s view is that the inflationary factor will prove to be more significant, meaning that a return to the post-2008 macroeconomic environment is unlikely. So whether or not global growth is affected by the war, the medium-term outlook for RV strategies is positive.