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UFJ
and Daiei: Japan’s Malaise and its Salvation
By
Daryl Whitten
TOKYO
(KWR) UFJ Holdings and retailer Daiei were the poster
children of what was wrong with Japan during the
Heisei malaise. However, the solution for the problems
these two companies face, underlies the salvation
that will allow Japan to emerge from its decade-long
period of economic stagnation. In other words;
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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;
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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, and
-
As
a result we are seeing both a growing domestic
M&A as well as cross-border M&A wave that
that is accelerating the consolidation/revitalization
of Japan Inc.
UFJ Holdings Inc.
Japan had 19 “major” banks in the early 1990s. By 2004, the
number had shrunken to essentially five banking groups: 1) Mitsubishi Tokyo
Financial Group, 2) Sumitomo Mitsui Financial Group, 3) UFJ Holdings, 4)
Mizuho Financial Group, and 5) Resona Financial Group. Moreover, 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 UFJ.
UFJ Holdings was formed by the merger of two second-tier city banks and
a trust bank, effectively creating an infrastructure comparable to the
other financial groups. But UFJ was always considered the weakest of the
major financial groups, and to have one of the worst balance sheets in
terms of big troubled borrowers. In effect, strong banks were merged with
weak banks to create “an average” bank. 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.
For these fraudulent transgressions, the FSA slapped UFJ’s hand with
a “business improvement order” and said they would “consider” taking
the matter to court. These shenanigans also convinced the FSA that the
group should not continue its banking operations under the current regime.
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 Holdings
Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc.
-- 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 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 load of bad loans by two-thirds.
As the banks scrambled to bolster capital in late 2002, early 2003 by ¥2
trillion, 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 they would also be bailed out, and shareholders rescued in the
process. 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 MTFG and 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.
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 take-over bid
for the company, which would be a first in Japan’s banking sector.
If a take-over bid were to emerge, it is possible even foreign capital
may be tempted to jump into the fray.
Daiei
Inc.
Supermarket chain Daiei Inc. was founded by former Chairman Isao,
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 FY2001 (to February 2002),
the company effectively went bankrupt, losing ¥322.5 billion
at the net income level, and reporting net negative equity of ¥297.4
billion. Interest bearing debt that year ballooned to ¥2,139.3
trillion, with 90% of this debt either short-term borrowings, or
long-term debt due within one 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 they'd bring down their banks, trigger massive unemployment
and cause heads in government to roll. With over ¥2 trillion
in debt, Daiei effectively owned the banks, who 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.
Daiei management has continued to reject requests by its main creditors
to seek aid from the Industrial Revitalization Corp. of Japan, which
ostensibly was set up to facilitate such restructuring. Daiei continues
to insist it can halve its interest-bearing debt of ¥1,638.4
billion as of the end of Feburary 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 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 Cop. 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 a ¥400 billion 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 (FY2003), total stores (regular stores and specialty
stores) had fallen to 1,677 stores from a peak of 2,252 in FY2001,
including 84 regular store closures and 1,009 specialty store closures.
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 Will
Tip the Scales
Investors appear to be betting Daiei will eventually lose its battle
to restructure without falling into the arms of the IRC, as president
Takagi reportedly will 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 Aug. 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-MartÅfs 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 U.S. unit, to $25.6 billion.
Wal-Mart tentatively entered Japan in May 2002 by buying a 6% in
Seiyu, and has an option to raise its current 37% holding to as much
as 69% in 2007.
Wal-Mart is just beginning to work its magic on Seiyu Ltd.. It is
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 as of December
2003, versus ¥633.3 billion 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, then
Wal-Mart is one of just two or three players in Japan with the experience
and cash to turn around a retail operation as massive as Daiei. Secondly,
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 in Q3 2001 to a mere ¥100
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
that new FSA Minister Takenaka would push the banking sector to the
brink of another financial crisis.
From Q2 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
a new organization called the Industrial Revival Corporation of Japan
(IRCJ) was formed with the express purpose of revitalizing such troubled
borrowers. Daiei’s stock price soared from the ¥100 level
to a ¥635 high by April 2004, representing a massive 6.3-fold
gain, and more than making up for the ground lost since Q3 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 high to a recent low of ¥156, or basically
where it was in early 2003.
Presently, there is an overhang of cumulative trading volume between ¥150~¥300,
and the stock is still in a bear market, trading below its 13-week
and 26-week MA. In reality, the stock is not worth ¥635 a share,
unless it is broken up, the best pieces sold off, and the remainder
successfully revitalized by someone such as Wal-Mart.
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.
More Similar Corporate Culture
As Japan's corporate culture becomes more similar to that of Europe
and the U.S., 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 Inc. and Kirin Brewery Co. 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.
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