Daniel Loeb (Trades, Portfolio)’s conviction on Japan he made public several years ago has not abated this year as he made clear by taking several stakes in the country in recent months. As he discloses a new activist long position in the country, Seven & i, several of his positions have yet to post gains.
The investor’s interest in Japan lies primarily in Prime Minister Shinzo Abe’s economic reforms. Loeb believed they could open Japanese companies to American-style investor influence for the first time, laying bare corporate weaknesses and creating a hotbed for activist investors such as him. Loeb, founder of the hedge fund Third Point, declined to comment, but his staff pointed to a Wall Street Journal piece from several years ago in which he outlined his views on the country.
“Japanese corporate assets are inefficiently managed by international standards… Simply put, each unit of Japanese private capital produces only one half the amount of output generated by one unit of American private capital,” Loeb said in a 2013 op-ed in the Wall Street Journal.
Loeb also explicitly listed increased shareholder activism as part of a list of recommendations to both the government and companies to “reshape corporate Japan.”
“Second, the role of the major shareholder should be reconsidered, as it has been in the United States,” he said. “In the U.S., for example, it is not unusual for large ‘activist’ shareholders to join boards to drive better corporate results. In Japan, the idea of shareholders as active owners is undeveloped.”
The grand plan for the country depends on the effectiveness of Abe’s reforms. The first two “arrows” – aggressive easing and new public works spending – helped spur foreign investment that pushed up Japan’s market. The crucial third arrow, structural reforms to generate growth and bring more private investment, began in 2014 and has seen limited success.
“The original third arrow (growth strategy to stimulate private investment) has been accused of being slow in its implication,” said Sun Saito, senior research fellow at the Japan Center for Economic Research in a column, Japanese Economy Update.
"However, focus of the third arrow, which should have concentrated on structural policies, has been blurred by including some demand-side measures as well (e.g. exporting infrastructures abroad). Many of the important issues, including the reconstruction of the Japanese economic system that has become outdated, are still to be tackled.”
Since November 2012, Japan’s Nikkei Stock Average gained 112%, and has dropped 5.7% since the end of June.
The progress of some of Loeb’s investments in the country had similarly stalled, he said in the second quarter.
“Taking a look at the current landscape, the decline in overinflated sectors, though painful in the short term, is healthy in our view. We have seen an equally painful reversion to the mean on many popular trades. Consensus positions entering this year – long Japan, long momentum and short bonds – have all underperformed, while value and emerging markets have accelerated. This reversion has created a violent bout of deleveraging, particularly among hedge fund holders, creating chances to add to our portfolio at attractive levels,” he said.
For the year through October, Loeb’s Third Point Offshore Fund Ltd. returned 0%, compared to a gain of 2.7% for the S&P 500. Since inception, it has recorded an annualized return of 16.4% compared to 7.5% for the S&P 500.
After success with Sony, several of Loeb's bets on Japan are still down since he bought.
Loeb took an almost 7% stake in Sony beginning in May 2013, becoming its largest shareholder. He then exchanged letters with the company’s management, proposing structural reforms and spin-offs, seeing 60% upside in the company by focusing on increasing value in its entertainment business, not just its electronics business.
Loeb ended up selling the stake in October 2014, after a 20% increase in the share price. Year to date, Sony shares have gained almost 39% as financial results improved due largely to sales of Playstation 4 games, cameras and other electronic devices. For the third quarter, announced Oct. 29, Sony had net income of 33.6 billion yen ($278 million), compared to a net loss of 136 million yen a year earlier.
Suzuki Motor Corp. (TSE:7269, Financial)
Loeb disclosed a $1 billion stake in Japanese automaker Suzuki on Aug. 3, pushing its shares to a record high. The price eventually came back down almost 8% since the start of that month though.
When he disclosed the stake, Loeb said the company’s greatest value lay in its subsidiary Maruti Suzuki, a dealership and service shop owner in India. Believing the lucrative assets were overlooked by investors, Loeb valued them as “worth more than the parent company’s entire market capitalization.”
In the company’s first quarter, from April to June 2015, it reported an 8.8% increase in net sales year over year, with a 3.4% increase in Japanese domestic net sales and a 15.7% increase in net sales overseas driven by an increase in car sales in India.
Loeb also said the company’s five-year arbitration with Volkswagen (XTER:VOW) had “paralyzed” the company, “leaving it unable or unwilling to fix its inefficient balance sheet.” Suzuki was seeking to repurchase Volkswagen’s 20% stake in the company, though Volkswagen wanted to retain the shares. If Suzuki won, Loeb said he saw it significantly increasing its cash position, but if it failed, Loeb saw the companies working together to increase shareholder value.
“With a resolution to the arbitration finally on the horizon and the improving cyclical tailwinds to its dominant Indian business in place, Suzuki seems undervalued today,” Loeb said.
On Aug. 30, Suzuki held a press conference to announce an international arbitration court Volkswagen would be forced to sell its stake in the company.
Instead of canceling the shares as Loeb suggested, however, Suzuki bought the shares back in September and did not say what it would do with them.
IHI Corp. (TSE:7013, Financial)
Loeb disclosed a stake in Japan’s largest maker of aircraft engines, conglomerate IHI Corp., in May 2014, basing the play “Abenomics-led real estate reflation in Tokyo,” and two other trends: commercial aerospace fuel efficiency.
Loeb recommended in his shareholder letter that the company streamline its business to increase value. Specifically, the company should spin off its land bank in the central district of Tokyo, which he appraised significantly higher than the company. By his estimate the land bank and buildings were worth more than half of IHI’s entire market capitalization.
IHI Corp. traded around 430 yen per share at the time Loeb revealed the holding, and has since declined 17%, after reaching a peak of around 620 yen per share in January. Loeb gave the shares an intrinsic value of more than 1,000 yen each.
Shares began trading lower in August when the company announced a 99% year over year drop in operating income due to its F-LNG/Offshore structure business and costs related to a bridge construction accident in Turkey in which part of its scaffolding fell into the sea.
On Oct. 21, IHI revised its results forecast for the first half year ended March 31, 2016, down to 680 million yen in revenue from 700 million yen, operating income from 20 million yen to zero, and profit from 6 million yen to a loss of 4 million yen. The decline was driven by continued weakness in its F-LNG/Offshore Structure Business and increased costs of the bridge construction project in Turkey.
The company has not as of yet announced a possible spin-off of its real estate assets.
Seven & i Holdings (TSE:3382)
Finally, Loeb discussed his newest position in the owner of the 7-Eleven franchise, Seven & I Holdings, in his third quarter shareholder letter released today. Since Japanese media reported the less than 5% stake last week, shares have gained about 1.5%.
The company should benefit from a tight labor market and more women in the workforce in Japan, Loeb said, and a recovering economy and lower gas prices resulting in more extra consumer cash in the U.S. Continued urbanization and the 7-Eleven brand would also drive growth in emerging markets.
Overall he was upbeat on the changes management was making toward aligning interests with shareholders.
“… There are signs that management’s focus is shifting in the right direction and that Japan’s renewed emphasis on corporate governance is bringing shareholders’ interests to the forefront,” he said. “We are encouraged by CEO Suzuki’s announcement earlier this month that 20% of underperforming Ito Yokado stores will be closed and 30% of its corporate office staff will be streamlined.”
Loeb called the retailer “grossly underlevered and undervalued” as it traded at 7.2 times forward EBITDA versus 10 times for competitor Couche-Tard and 12 times for Walgreens (WBA).
He also saw several value generators at the company. First, it should separate its underperofmring Ito Yokado stores, leaving Seven & I to evolve into a global convenience store pure-play. Second, 7-Eleven U.S. should have a partial listing, which management had considered, Loeb said.
“As Seven & i’s growth capex spend in Japan comes to an end due to industry consolidation, free cash flow generation will accelerate meaningfully and a significant capital return story will emerge allowing for substantial dividend increases and buybacks in the years ahead. The review of shareholder returns should start immediately, however, as the company’s balance sheet is vastly overcapitalized, and its dividend is only half of what most shareholders desire,” Loeb said in the letter.
See more of Daniel Loeb (Trades, Portfolio)’s holdings in his portfolio here. Not a Premium Member of GuruFocus? Try it free for 7 days.
