AVI have been shareholders in Teikoku since March 2018. Since then, we have engaged with the company on a range of issues, in particular, those relating to the Teikoku’s inefficient balance sheet. However, despite improving corporate governance across Japan and widespread acceptance that hoarding excess cash and maintaining “strategic securities” portfolios erodes corporate value, Teikoku has failed to make adequate improvements.
Teikoku is a high-quality business, providing essential disaster prevention equipment through an impressive distribution network. It is the market leader and experienced manufacturer of fire hoses in Japan, commanding a 45% market share. Building on this strong base, Teikoku has developed a diverse product mix of disaster prevention equipment. Its low CAPEX requirements and high margins underpin a business that, with a more efficient balance sheet, could generate a ROE in excess of 20%.
However, Teikoku’s quality business is hidden under a mountain of non-core assets. 70% of balance sheet assets are allocated to low returning net cash and investment securities. These have a return on equity to Teikoku of less than 1%.
The status quo of stable dividends and sound financial base is not an adequate strategy. The obvious way to reverse value destruction is to sell down/distribute its stake in Hulic and return cash to shareholders.
Underneath Teikoku’s inefficient balance sheet hides a phenomenally high-quality business. Because of the capital light model, Teikoku could achieve a substantially higher ROE. Matching the capital efficiency of the average Japanese company, Teikoku could generate a ROE of 20+%. If conducted through a buyback, Teikoku’s share price could increase by +120%.
Over the past two years, Sparx submitted proposals to Teikoku similar to AVI’s. Although in the best interests of all shareholders, the proposals failed to receive majority approval because Teikoku’s “Group Shareholders” supported Teikoku’s management despite Teikoku’s unhealthy and value destructive balance sheet.
The core members of Teikoku’s “Group Shareholders” are well-known companies and financial institutions who hold shares in Teikoku based on business ties and historic relationships. They include Sompo Holdings (TSE:8630), Mizuho Bank, Meiji Yasuda Life Insurance, Marubeni (TSE:8002), Hulic (TSE:3003), Morita (TSE:6455), Nishimatsu Construction (TSE:1820) and Teijin Frontier, a wholly-owned subsidiary of Teijin (TSE:3401).
While they pay lip service to corporate governance, passively voting their shares in support of the Board harms the interests of general shareholders and is inconsistent with accepted principles of good governance. This is a systemic problem across corporate Japan and must come to an end to allow for much-needed reforms.
IT IS TIME FOR TEIKOKU’S “GROUP SHAREHOLDERS” TO STOP VOTING PASSIVELY WITH MANAGEMENT AND VOTE IN THE INTERESTS OF ALL SHAREHOLDERS AND BEST GOVERNANCE PRACTICES
* As at 31 May 2020
** Source: Morningstar, performance period 23 October 2018 to 31 may2020, TR net of fees, GBP
*** As at 31 May 2020, includes: management fee 1.0%, marketing and administration costs.
AVI Japan Opportunity Trust p.l.c is referred to as ‘AJOT’ throughout the website. AJOT’s investment managers, Asset Value Investors are referred to as ‘AVI’