Oct 2005

LONG ONLY JAPANESE EQUITIES

Over 90% of Japanese company fiscal year's end in March. This allows most annual shareholders meetings to be arranged on the same day, in late June, making it less likely that individual company meetings could be disrupted by Sokai-ya, a gangster organisation that specialises in extorting money from corporations.

Companies used to pay off the Sokai-ya to guarantee a quiet time, a practice stopped by the authorities in the 1990's. Even though Sokai-ya activities have been curbed, now, some company's mistakenly hope that holding their annual general meetings on the same day as others might make it less likely that investors would bother to exercise their voting rights. In fact institutional investors such as life insurance companies take their ownership rights far more seriously. For instance in June a number of companies tried to implement 'poison pills', such as the approval of a massive increase in authorised share capital, allowing them to dilute a potential aggressor in the event of takeover. Some passed but others failed, notably where foreigners owned substantial proportions of the outstanding equity and, in a limited number of instances, where Japanese institutional investors voted down similar measures. Now, following the recent surge of foreign buying of the market, non-Japanese ownership has risen further. 77 companies have foreign ownership above 35% (owning 65% of companies in Japan is necessary for total control not just a simple majority). We own 10 of these. With such ownership increasing it makes it more likely that managements will act in active shareholders' interests, which should become increasingly visible with the improved allocation and investment of shareholders capital over time.

Late October and early November is the time for reporting semi-annual results. Nintendo, one of our largest holdings revised down annual profits expectations reflecting disappointing sales of the 'Game Cube' consol and related software in advance of the launch of its replacement, currently named 'Revolution'. We think it will live up to its expectation as it has a new controller that is touch and motion sensitive rather than button driven, which should materially enhance the game experience. The company's dividend used to be linked to operating profits alone and would have declined had the company not announced that the dividend will in addition be determined by net profits as well. As net profits should be boosted by the depreciation of the Yen the dividend should be little changed from the level anticipated at the beginning of the year. Astellas reported better than expected results, a hike in its dividend and a share buyback. Mabuchi Motor whose 9 month results were in line with low expectations intends to buy back 3% of outstanding shares by the end of December. Fuji Photo's business remains a under pressure not least because reported results were depressed by rationalisation costs. Kirin reported results in line with expectations, a good result, in another difficult year for beer sales. Kansai Electric Power and Takefuji both reported results better than expectations and the former extended its buyback programme. Rohm's results were bad as expected but, encouragingly, it extended its share buyback plans for the second half of the year. Impact 21 and Mandom both missed targets, but nonetheless remain good value on account of the strength of their respective brands in clothing (Polo Ralph Lauren) and in men's hair care (Gatsby). Taisho Pharmaceutical's results were poor following another half-year of declining sales of its tonic drinks and OTC self-medication products. Although the company owns some valuable brands, especially in this area, the management seem dilatory in responding to this decline. Kao and Nissin Food reported in line with expectations. Although cash generative Nissin still pays a paltry dividend of 1.0%. Even worse the company encouraged two trading houses, Itochu and Mitsubishi Corp to take 5% shareholdings to help protect the company from unwanted outside shareholder pressure, a regressive example of an increasing cross-shareholding ratio against the general trend. Encouragingly, an activist foreign investor has just recently bought a 4.3% stake potentially throwing down a gauntlet in a battle for better shareholder returns. The share price has responded by rising 10% since the end of October.

Following its results we added to our long position in Meiko Network. The company provides extra-curricular educational to Japanese school children. The education is tailored to the pupil as the ratio of teachers to students is far higher than in traditional cram schools. This tutorial system proves a far more effective way of learning, especially for less academic pupils, and helps them achieve better results in examinations, justifying its greater cost. Meiko runs some of its own schools but most are franchised which makes for a particularly cash generative business. Having doubled its size in the last 5 years the business has stagnated as Meiko has not been able to recruit enough suitable school owners and headmasters. Also, some of the newly opened schools need more time to fill up to capacity. As a result, with the shares have fallen 40% from the peak and now trading on a free cash flow yield of 9.5% we increased our weighting to 4%. We note that another competing business, Tokyo Individualised Education, which we used to own and sold earlier this year has just taken a 6% stake in Meiko.

Michael Lindsell
Nov 2005