Toshiba buyout heralds a big step back for Japan

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Toshiba Corp. Chief Executive Taro Shimada poses for a photograph during an interview with Reuters at the company headquarters in Tokyo, Japan, June 7, 2022. REUTERS/Issei Kato

MUMBAI, Jan 20 (Reuters Breakingviews) - The end of a long battle to wring some value from Toshiba (6502.T) is finally within reach. Foreign investors, who for years have sought to shake up the stodgy and cloistered Japanese conglomerate, are likely to cede to local owners in a deal that may not have been worth the wait. Such an outcome won’t encourage private equity firms, and big policy shifts underway may stifle the industry just as it hits a new high.

The 147-year-old maker of everything from elevators to thermal power systems once symbolised the technological prowess of one of the world’s most advanced countries. Instead, after an accounting scandal in 2015, Toshiba came to epitomise Japan Inc’s pervasive value destruction. The compound annual growth rate of shareholders’ equity at the company was minus 1.9% over two decades, per a 2020 presentation by 3D Investment Partners. And the company typifies the tortuous journey required of pushy shareholders to get Japanese executives to allocate capital more shrewdly.

It would be Japan’s biggest take-private, though the contours of the leveraged buyout slowly emerging for the $15 billion enterprise looks set to fall short of the one originally envisioned by investors including Paul Singer’s Elliott Management, Daniel Loeb’s Third Point and Farallon Capital back in 2017. At the time, Toshiba tapped overseas hedge funds for a $5.4 billion bailout in exchange for 35% of the company.

The crisis, itself the result of a series of bad decisions including on capital, provided outsiders a rare drawbridge into one of the country’s cosiest boardrooms. What should have been a full-blown coup turned out to be anything but. While aggressive investors elsewhere can make serious headway in forcing corporate change with small stakes, as Engine No. 1 did with a less than 1% holding at ExxonMobil (XOM.N), the resulting fight at Toshiba only serves as a reminder of the lengths to which Japanese executives will go to avoid any imposed changes.

As Toshiba edged back from the brink of disaster, some foreign investors withdrew by selling their shares. The ones that stuck around encountered a messy slog. In 2021, for example, a damning independent investigation concluded that Japanese government officials and the company colluded to lean on overseas shareholders to back the management in a key vote. A subsequent breakup plan that Toshiba proposed flopped, too.

After all the pressure, the company and its $26 billion of revenue and 116,000 employees is set to wind up in domestic hands again instead of with a more dispassionate private equity owner such as CVC or Bain Capital, which bought control of Toshiba’s chip unit in 2017. Domestic buyout fund Japan Industrial Partners, Toshiba’s preferred bidder as reported by Reuters and other media outlets, is cobbling together a consortium with some 20 members, per Nikkei, including chipmaker Rohm (6963.T) and Tokyo- and Osaka- headquartered financial services provider Orix (8591.T).

SETTING SUN

Getting so many buyers on the same page as the banks complicates securing the necessary funds. And Toshiba’s stock price, which peaked in June, is steadily falling. The shares trade at about 4,600 yen apiece, less than 2 times the price of its 2017 capital call after adjusting for a stock consolidation. It is also well below the more than 6,000 yen that Oasis Management and 3D Investment Partners earlier indicated as the company’s minimum fair or intrinsic value.

As cast, the transaction is unlikely to deliver the world-beating returns that can be achieved. Japan typically outperforms private equity deals in other developed markets, partly because existing incentive structures for company bosses are so poor. Buyouts, though far fewer in number, generate a median multiple of 2.8 times invested capital, compared to 2 times in the United States, before adjusting for currency conversion, according to data supplied to Breakingviews by consultancy Bain & Co, citing analysis by research outfit DealEdge. It’s a big reason why KKR (KKR.N), Blackstone (BX.N) and others keep pounding at the fortress walls in the Land of the Rising Sun.

And yet the environment for cutting aggressive deals has dramatically deteriorated, and that may leave fund managers grateful for any terms that materialise as leveraged buyout financing dries up in the United States and Europe. Japanese megabanks – including Mizuho Financial (8411.T), Sumitomo Mitsui Financial Group (8316.T) and Sumitomo Mitsui Trust – are awash with money, but they have more reasons to play hardball on the terms of a possible 1.4 trillion yen (roughly $11 billion) loan.

For one thing, they can weigh up the prospect of a less risky and quicker boost to earnings if the Bank of Japan (8301.T) at long last shifts away from more than two decades of ultra-low interest rates. The central bank cautioned only last year of potential vulnerabilities as financial institutions seek higher yields by greasing deals with debt. Although Japan’s buyout market is small, borrowing levels can be as high as 80% of the total deal value. A massive debt restructuring at KKR-owned auto-parts maker Marelli also served as a warning to lenders about the buyout industry’s dangers.

There’s probably too much embarrassment at Toshiba, which has suffered through a merry-go-round of chief executives since 2015, for a deal not to proceed at this stage. A bigger angst for foreign investors knee-deep in the mess may be what comes next in the exhausting battle to extract value from Japan Inc.

The country’s private equity industry is only just finding its feet. After stalling in the wake of the global financial crisis, it was gaining traction under Shinzo Abe’s initiatives as prime minister prodding companies to raise profitability and improve corporate governance. In fact, 2021 was a record year, logging 134 deals at a value of 2.7 trillion yen, about $21 billion.

As Japan’s era of free money draws to a likely end and the policy influence of the assassinated Abe wanes, Toshiba is set to be a very different poster child than it might have otherwise been. Instead of representing an agent of corporate change for investors and the country, it could emerge as a marker signalling private equity’s premature peak.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

Editing by Jeffrey Goldfarb and Katrina Hamlin

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