TOKYO - UFJ Holdings and retailer Daiei
were the poster children of what was wrong with Japan
during the its long economic malaise. However, the
solution for the problems these two companies face
underlie the salvation that will allow Japan to emerge
from its decade-long economic stagnation.
Japan's banking industry is evolving from a
"protected species" into a (hopefully) globally
competitive industry, with each participant being left
to find its own unique positioning. Substantial
consolidation is already taking place in many Japanese
industries. This is accompanied by a growing
globalization of Japan's domestic economy as well as
freer cross-border capital flows that have fostered
substantial net portfolio purchases of Japanese
equities. As a result, we are seeing both a growing
domestic and cross-border merger and acquisition
(M&A) wave that that is accelerating the
consolidation and revitalization of Japan Inc.
UFJ Holdings Inc Japan had 19 "major"
banks in the early 1990s. By 2004, the number had shrunk
to primarily five: Mitsubishi Tokyo Financial Group,
Sumitomo Mitsui Financial Group, UFJ Holdings, Mizuho
Financial Group and Resona Financial Group. But the
consolidation is not over. Resona Financial Group was
effectively bailed out by the government while UFJ
Holdings is now on the block, with the government being
content to stand by on the sidelines and let the other
banking groups bid for it.
UFJ was formed by the
merger of two second-tier city banks and a trust bank,
effectively creating an infrastructure comparable to
other financial groups. But UFJ was always considered
the weakest of the major financial groups, with one of
the worst balance sheets in terms of troubled borrowers.
Generally, strong banks were merged with weak ones to
create "an average" bank in the consolidation process.
But in the case of UFJ and Mizuho, the weak were
gathered together in the hope of creating an average
bank.
Subsequent FSA (Japan's Financial Services
Agency) inspections revealed that UFJ forged documents
and minutes of meetings to give a false impression of
its bad-loan problem, lied to FSA inspectors, hid data
on a separate computer system and destroyed potentially
incriminating documents. In addition, UFJ extended loans
to companies that were not in need of funds in an
apparent bid to inflate the amount of loans extended to
small companies. These shenanigans convinced the FSA
that the group should not continue its banking
operations under the current regime.
[The FSA
has passed details of its probe to the Tokyo district
public prosecutor's office and recommended criminal
charges be brought against UFJ, according to the Nikkei
Shimbun.]
The special bank inspections that the
FSA undertook in August were unprecedented in that the
agency looked into the books of major banks only four
months after last doing so. Banks have drawn up
rehabilitation plans for retailers and other troubled
borrowers, but these plans have often been criticized as
too optimistic and thus unworkable. Speculation in the
banking industry holds that Daiei was the prime target
of these special inspections. In early June, the FSA
conducted onsite inspections of large banks under a
supervisory program drawn up in April. Although it did
not disclose the names of these banks, they were
eventually revealed to be UFJ, Sumitomo Mitsui Financial
Group and Mizuho Financial Group - Daiei's three largest
lenders.
The FSA is making doubly sure that
there are no hand grenades in the major financial
institutions' balance sheets as blanket deposit
protection will be lifted from next April. Additionally,
the FSA deadline for banks to reduce stock holdings to
within their shareholder capital and non-performing
loans to FSA-specified levels is March 31, 2005.
UFJ's fate is in some respect linked to Daiei's
as the bank is Daiei's biggest creditor, with more than
400 billion yen (US$3.6 billion) in loans to the
retailer. It is leading resistance to Daiei's demands
for more money, in part because it has to meet a
government deadline of March 31, 2005 to cut its own
4.62 trillion yen load of bad loans by two-thirds.
As banks scrambled to bolster capital in late
2002 and early 2003 by 2 trillion yen, some foreign
investors were quietly accumulating bank stocks as Tokyo
stock prices were plunging. It is believed, however,
that the foreign buying of UFJ was conceptual rather
than based on in-depth knowledge of UFJ's real financial
condition. Since Resona was bailed out, many believed
the worst that could happen to UFJ was that it would
also be bailed out. As news of UFJ's fraudulent behavior
with the FSA broke, however, foreign investors moved to
dump the stock.
Now that UFJ Holdings is clearly
on the block, the bank has positioned itself fairly
well. Both Mitsubishi Tokyo Financial Group (MTFG) and
Sumitomo Mitsui Financial Group (SMFG) badly want UFJ's
trust business and their retail exposure in Osaka, or at
least do not want their competition to have them. Some
analysts argue that SMFG could better leverage UFJ's
assets and thus can afford to pay more. However, so far
the courts have supported MTFG's assertion that they
have a window within which they can negotiate with UFJ.
SMFG's offer of a 1:1 merger, however, has raised the
stakes for UFJ, and its perceived value in the market
place.
[SMFG has in fact announced that it has
bought a small stake, 300 shares, in UFJ Holdings,
securing the right to make proposals at a shareholders'
meeting slated for June when UFJ's management plans to
seek approval for a merger with MTFG, according to Dow
Jones. On the other hand, MTFG has announced that it
will raise 100 billion yen in its first-ever domestic
bond offering and will use the money to help pay for the
700 billion yen capital injection it made to UFJ's
commercial banking unit last month, the financial news
service said.]
Consequently, the winner in terms
of stock price is clearly UFJ, and whoever eventually
merges the company will have to pay at least a fair
price. It is still possible, however, that there will be
a contested takeover bid for the company, which would be
a first in Japan's banking sector. If a takeover bid
were to emerge, it is possible even foreign capital may
be tempted to jump into the fray.
Daiei
Inc Supermarket chain Daiei was founded by former
chairman Isao Nakauchi, who has since been forced to
resign. During the 1980s, Daiei was the symbol of the
retailing revolution in Japan. At its peak, it grew to
operate 2,252 regular stores and specialty stores
through its subsidiaries and franchisees. Its retail
businesses include supermarkets, discount stores,
department stores and specialty shops. Other businesses
include restaurants, hotels, and real estate services.
Domestic sales make up more than 90% of its revenues.
A 'bubble' poster child But in typical
"bubble" fashion, Daiei diversified haphazardly during
the 1980s, loading up on debt, but failing to keep up
with new, more efficient competitors. Finally in the
financial year 2001-02, the company effectively went
bankrupt, losing 322.5 billion yen at the net income
level, and reporting net negative equity of 297.4
billion yen. Interest-bearing debt that year ballooned
to 2,139.3 trillion yen, with 90% of this debt either
short-term borrowings, or long-term debt due within a
year.
Ever since, the company has been on life
support, courtesy of its banks and the Japanese
government, which have extended Daiei credit despite the
ongoing deterioration of its businesses. Daiei came to
epitomize the industrial sclerosis that befell much of
Japan in the 1990s and has proved to be one of the most
challenging restructuring efforts to date. This is
because Daiei had become "too big to fail". Bubble logic
dictated that Daiei couldn't be allowed to die because
it would bring down its banks, trigger massive
unemployment and cause heads in government to roll. With
over 2 trillion yen in debt, Daiei effectively owned the
banks, which were very reluctant to push for repayment
from the company, or to write down their loan exposure.
The latest restructuring plan represents the third such
plan to be created since 2001, all with marginal
success.
The Daiei management has continued to
reject requests by its main creditors to seek aid from
the Industrial Revitalization Corp of Japan (IRCJ),
which was ostensibly set up to facilitate such
restructuring. Daiei continues to insist it can halve
its interest-bearing debt of 1,638.4 billion yen of the
end of February 2004 by March 2005 by shutting outlets,
selling assets and asking banks and investors for more
financial aid.
"Previously we had envisioned a
new business plan that involved three banks and Daiei,
but now we're working on the premise we'll need new
business partners or investors," Daiei's president Kunio
Takagi said. Daiei is trying to persuade banks that the
involvement of lawyers and securities companies in its
latest plan will meet creditors' requirements for
greater transparency, one of the reasons the banks are
seeking the involvement of the bailout agency.
In Daiei's revised restructuring plan to UFJ
Bank and its other lenders, it is calling on Marubeni
Corp to assist it in its supermarket operations and
Tokyu Land Corp to help it attract and administer
tenants. The struggling supermarket operator also
intends to ask the two companies and Deutsche Securities
Ltd to buy most of the 100 billion yen worth of new
shares it plans to issue to increase its capital, while
seeking roughly 400 billion yen in loan waivers by
banks, a move that will cut the firm's interest-bearing
debt to less than half.
Daiei has been closing
stores over the past two years. As of February of this
year, its total stores had fallen to 1,677 from a peak
of 2,252 in fiscal 2001. But revenues continue to
undershoot plan targets. Same-store sales at Daiei
appear to have fallen about 6% on the year in August,
marking the sixth straight month the firm has missed its
sales target of a 1% decline for this fiscal year. This
partially reflects Daiei's priority in the fiscal first
half on generating profit rather than lifting sales, but
its efforts to slash expenses are nearing their limit.
Although a year-on-year fall in same-store sales was
factored into its business plans from the beginning, the
pace of decline is larger than expected.
President's resignation Investors
appear to be betting that Daiei will eventually lose its
battle to restructure without falling into the arms of
the IRCJ as president Takagi will reportedly be
resigning to accept responsibility for the company's
problems, and the intransigence of Daiei in responding
to creditor demands. This is because the new
restructuring plan failed to impress and the company has
had serious problems meeting its restructuring targets.
Japan's R&I credit rating agency recently downgraded
Daiei's credit again on August 11, lowering its rating
for Daiei's long-term bond by one notch from B to B-.
"The smooth relationship between Daiei and its main
banks, on which the evaluation of Daiei's
creditworthiness has been premised thus far, is changing
due to differences emerging between the company and the
banks over the formulation of a reconstruction plan,"
R&I said.
Wal-Mart to the
rescue? Wal-Mart Stores, the world's leading
retailer, has visited the IRC and has hired banks to
advise it on a possible investment in Daiei. The world's
biggest retailer should make a bid for Daiei, say many
Wal-Mart shareholders and analysts who follow the
company. Adding Daiei may help Wal-Mart overtake Aeon Co
and Ito-Yokado Co to become Japan's biggest retailer by
sales at the parent level. Wal-Mart's international
sales in the six months to July 31 rose 19%, or almost
twice the pace of its US unit, to $25.6 billion.
Wal-Mart tentatively entered Japan in May 2002
by buying a 6% stake in Seiyu, and has an option to
raise its current 37% holding to as much as 69% in 2007.
It is just beginning to work its magic on Seiyu,
plugging Seiyu into its international supply network and
introducing new inventory controls. Those moves helped
Seiyu narrow its first-half loss to 2.9 billion yen from
50 billion yen a year earlier. Interest-bearing debt was
down to 460.4 billion yen as of December 2003, versus
633.3 billion yen in February 2002. But Seiyu, which
reported losses in two of the past five years, recently
cut its full-year sales forecast 1.3% to 1.09 trillion
yen. Moreover, investors have yet to buy into the Seiyu
restructuring story. Its stock is the second-worst
performer on the Topix Retail Index in 2004, dropping
21%.
Will the Wal-Mart ploy work? There are a
couple of conditions. Daiei first has to fall into the
hands of the IRCJ. If this happens, Wal-Mart is one of
just two or three players in Japan with the experience
and the cash to turn around a retail operation as
massive as Daiei. Second, Wal-Mart's Seiyu success story
is still a work in progress.
Daiei's stock: A
roller-coaster ride Daiei's stock had plunged
from 500 yen in third quarter of 2001 to a mere 100 yen
as the Nikkei 225 was hitting 7,600 at the height of
investor concerns about financial fragility, deflation
and Japan's exposure to external shocks. In short, Daiei
was being priced for bankruptcy. Thereafter, the major
banks scrambled to bolster their balance sheets and
Resona Bank's rescue by the FSA greatly relieved
concerns.
From the second quarter of 2003, stock
previously priced for bankruptcy soared, on the
assumption that if other troubled banks were rescued,
their most heavily indebted borrowers would also be
saved, especially because the IRCJ had been formed with
the express purpose of reviving such troubled borrowers.
Daiei's stock price soared from the 100 yen level to a
635 yen high by April 2004, representing a massive
six-fold gain, and more than making up for the ground
lost since the third quarter of 2001.
But then
the war of words between Daiei and its major creditors
began, exposing serious differences about how the
company was to be revitalized. Moreover, the company was
refusing to consider revitalization under the IRCJ. As
speculators bailed out of the stock, it plunged 75% from
the 635 yen high to a recent low of 156 yen, or
basically where it was in early 2003. Solving "the
Daiei problem", however, will not only represent a major
turning point in Japan's bad debt problem but also a big
turning point in the restructuring of corporate Japan.
Similar corporate culture As Japan's
corporate culture becomes more similar to that of Europe
and the US, Japanese companies are less resistant than
before to personnel reductions and the sale of
operations. The stock cross-holding structure, which had
impeded M&A bids, has disintegrated as well. A
Commercial Code revision in early 2006 will make it
easier for overseas companies to acquire Japanese firms
through equity swaps.
Buyouts of well-managed
Japanese companies could remain difficult in light of
past experiences with failed takeover bids. To ward off
unfriendly takeovers, managers of Japanese firms are
likely to seek realignment of domestic companies and
launch stock repurchasing programs and other measures to
boost corporate value. These moves could lead to higher
stock prices as corporate value is improved.
However, the fact remains that the stock market
capitalization of leading Japanese companies is but a
fraction of their largest global competitors. Major
corporations such as Canon and Kirin Brewery are seeking
increased flexibility in their stock buyback structures
so they can be prepared for potential mergers and
acquisition deals that involve these arrangements.
Until the changes to the Commercial Code were
implemented last September, companies were bound for an
entire year to a ceiling for stock buybacks that was
decided at a shareholders' meeting. So even if an
unexpected acquisition opportunity presented itself,
methods involving stock swaps faced restrictions. Under
the revised Commercial Code, the board of directors at a
company has the freedom to set buyback amounts, in
exchange for more information disclosure. This allows
companies more flexibility in their capital strategies
that make use of stock swaps. The changes will raise the
number of options available to companies involved in
M&As. However, it will also increase the corporate
governance burden on companies to ensure that decisions
about capital policies are fully explained to
shareholders.
As a result of these changes, one
can expect to see more restructuring and
rationalizations over time, and continuing progress in
Japan's attempts to move further along the road toward a
sustainable economic recovery.
(Posted with
permission from KWR
International, Inc, (KWR) a consulting firm
specializing in the delivery of research, communications
and advisory services.)
