US companies tend to dominate the global corporate news flow, but a silent bombshell went off in corporate Japan recently. Akio Toyoda, the grandson of the founder of the Toyota Motor Group, has made a take-private offer for Toyota Industries.
The latter is a listed holding company with a range of businesses, the crown jewel of which is the world’s largest forklifts business. Although the Toyota Industries holding company is a separate company with its own listing on the stock exchange, the Toyota Motor company has maintained a heavy involvement through a c. 25% shareholding. Toyota Industries in turn owns 8% of Toyota Motor, an arrangement known as a ‘cross-shareholding’ which is commonly used in Japan to allow corporations to support one another and thwart outside shareholders. It is also an inefficient use of scarce capital. Akio Toyoda’s offer to take Toyota Industries private – one of the largest privatisation deals in history, valued at $42 billion – is thus a clear victory for shareholder value realisation in Japan.
According to Asset Value Investors (AVI), managers of the AVI Global Trust, AVI Global UCITS Fund and AVI Japan Opportunities Trust, Toyota ‘has long embodied the ideals and core values of Japan Inc.’, so that Toyota’s embrace of corporate reforms in Japan is likely to not just ensure a continuation of the improvements already occurring but speed up the wider adoption of these important reforms by Japanese listed companies.
It was the late Prime Minister, Shinzo Abe, who initiated corporate reform in Japan. And it was badly needed. Decades of cross shareholdings, hoarding of cash on balance sheets, the lack of proper disclosures, life-long employment practices and a lack of any focus on shareholder value left Japan plc earning much lower returns on shareholders’ equity compared to the other developed markets.
Foreign investors avoided Japanese equities for nearly three decades. Value traps were the norm (a value trap describes a company with significant assets not valued by investors and where the Board does nothing to realise the value of those assets for shareholders. They are ‘traps’ because they look cheap but ultimately the underlying value is rarely realised).
Abe’s 2014 Stewardship Code was followed in 2015 by the Corporate Governance Code, in 2020 by the Guidelines for Corporate Takeovers and in 2023 by the Tokyo Stock Exchange’s Enhanced Disclosures and more.
The net result has been a significant increase in independent directors on plc boards, a surge in shareholder proposals for improvements by activist (foreign) investors, a huge reduction in cross shareholdings, a meaningful increase in share buybacks, take-privates and dividends and, ultimately, a significant improvement in returns on shareholders’ equity.
More importantly, and as AVI also points out, Japanese smaller companies have generally outperformed their larger brethren over the years. However, the sharp weakness in the yen over the past few years (declined by 33% against sterling) has upended that pattern (see chart opposite). The rising line on the chart signifies more yen per sterling pound, which, of course, means a weakening yen relative to sterling. The weakness in the yen is more pronounced against both the euro and the dollar.
Exporters, which tend to be larger companies, benefitted from the significant tailwind of a cheaper yen and significantly outperformed small-cap companies in the past few years (see the chart opposite which compares the performance of the Nikkei Index, which typically reflects the performance of larger companies, to the MSCI Japan Smaller Companies Index). The weaker currency and the positive impact of Japan’s corporate reforms fuelled a strong rally in Japanese equities over the past few years.
But small-cap Japanese companies have been left behind with the result that the value to be unlocked by the corporate reforms has yet to occur in any meaningful way. In AVI’s view, we remain at the early part of this trend towards the realisation of shareholder value in Japanese smaller companies.
A slow and steady normalisation of Japanese interest rates (still well below 1.0% today) should fuel a recovery in the yen in time, providing a further catalyst for improved returns from Japanese smaller companies.
The AVI Japan Opportunities Trust provides full exposure to the deeply undervalued Japanese smaller companies sector. In our last update on this trust in late-October 2024, we highlighted a portfolio where cash and other non-essential assets (like property or listed shares) made up an average of 48% of the market value of the portfolio companies.
If you exclude these assets, which could be sold with no impact on earnings or cash flows, the average free cash flow yield on the portfolio was 15%. That creates a lot of incentive when Japanese interest rates remain under 1.0%. With Japan open to corporate reforms, foreign private equity firms are circling ready to provide the finance for buyouts and other forms of corporate action which should unlock the value.
It’s still a relatively small trust (£224 million) and the shares can be somewhat illiquid, so if you have an interest, you might consider utilising a limit price when buying. The AVI Japan Opportunities Trust is the largest holding in the Regular Investor’s Funds Portfolio.
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Rory Gillen
2nd May 2025
GillenMarkets is an Irish-based Investment advisor, a provider of investment training courses and the publisher of Ireland’s only subscription-based investment newsletter.
