Is Sony 'Un-Japanese' Enough to Entertain Change?
Few foreign activist investors have made much headway in forcing change in Japan, where a conservative corporate culture favors long-standing ties with banks, business partners and workers rather than shareholders seeking value.
Struggling electronics giant Sony, though, with more foreign and fewer bank shareholders, may prove something of an exception. That's the hope, at least, of Californian billionaire Daniel Loeb, whose Third Point hedge fund has built up a more than 6 percent stake in Sony, making it the group's biggest stockholder.
Loeb wants CEO Kazuo Hirai to sell as much as a fifth of the group's money-making entertainment arm - movies, TV and music - to free up cash to revive an electronics business that has been battered by competition from Apple and Samsung Electronics. He reckons the shake-up could increase Sony's market value by 60 percent.
The target and timing of his polite hand-delivered overture are not accidental.
Sony earns two-thirds of its revenue overseas and, for corporate Japan, appears more westernized. Hirai, who spent most of his childhood in the United States, was picked by former CEO Howard Stringer, a Welshman, in part for his ability to be both a Japanese boss in Sony's domestic electronics hub and a western CEO in the U.S.-centered entertainment business.
(Read More: Loeb's Move on Sony: Did Traders Have Advance Word?)
Also, investors are clamoring to get back into the world's third-biggest economy where Prime Minister Shinzo Abe's promise of deflation-busting policies has triggered a share bonanza.
"He (Hirai) is very accessible to a western person," Loeb told Reuters in Tokyo the day after announcing that his hedge fund had built up a $1.1 billion stake in Sony. "And we wouldn't be here if we didn't think there was a tailwind from the economic policies in Japan."
Sony shareholders will be able to gauge Hirai's response to Loeb's proposals when the CEO gives an update on his revival strategy - with a focus to date on growing sales of smartphones, digital cameras and PlayStation game consoles - at a press briefing on Wednesday.
Sony's share registry could work in Loeb's favor.
The $21.2 billion electronics group has a large pool of foreign shareholders, who could be more easily tempted by the lure of a near-term valuation gain. Before Third Point amassed its stake, 35 percent of Sony stock was held overseas, compared with 22 percent at rival Panasonic.
Sony's foreign ownership peaked at 53 percent six years ago, but has been whittled down as the group's losses ballooned and investors exited deflation-snarled Japan.
Sony also stands out among its Japanese peers by having less of its stock held by conservative banks and insurance companies. Prior to Third Point's arrival, Sony's top 20 shareholders held around 13 percent of its shares, with Japan's big banks accounting for about half of that. At Panasonic, with an ownership structure similar to most Japanese blue chips, banks and insurers hold more than half of the 22 percent owned by the top 20 investors.
While driving change in Japan can be tough - foreign activist investors are often stigmatized as asset stripping sharks - Loeb may be in the vanguard of a new wave of activism attracted by 'Abenomics'.
"Westernized companies are in the minority among large caps, for sure. Boards tend to focus on stakeholder management at the expense of shareholder value," said Oscar Veldhuijzen, a London-based fund manager at The Children's Investment Fund Management (UK) LLP. "The background of activism is very negative as it used to be a sort of Mafioso involved with a very different type of activism involving a lot of violence."
A preoccupation by Japanese companies in the 1980s and 1990s to keep shareholder meetings benign created a niche for sokaiya - gangsters who extorted money by threatening to disrupt carefully orchestrated annual meetings.
Veldhuijzen can boast a rare success for foreign activist shareholders.
Rebuffed in a 2007 bid to raise dividend payouts at Japan's Electrical Power Development Co, or J-Power, The Children's Investment Fund Management bought a stake in former state-run monopoly Japan Tobacco in 2011, and called for higher dividends, management changes and a share buyback.
(Read More: Dan Loeb Sees a 'Huge Game Change' in Japan)
At the time, the government was looking for cash to help the reconstruction effort after the devastation of the March 2011 earthquake and tsunami. It agreed to increased dividends and this year sold a third of its stake in Japan Tobacco for more than $10 billion. At the same time, Japan Tobacco bought back stock worth more than $2 billion.
"They needed the money and the popularity of the government was very low. It was a very unique activist situation in that respect," said Veldhuijzen, who says his fund's return on its Japan Tobacco stake is "close to half a billion dollars."
Veldhuijzen said 'Abenomics' could spur foreign activists to seek out Japanese targets, though he warned there are few big-name companies where their attentions would be welcome.
"When I look at Japan, I struggle to find large caps with attractive business models," he said, though he noted that Central Japan Railways, which operates the country's most lucrative bullet train lines, could be a "phenomenal" company if management could be persuaded to raise prices and ditch plans to spend $50 billion on a high-speed magnetic levitation rail line from Tokyo to Osaka in western Japan.
To tap into the 'Abenomics' effect, Veldhuijzen said his fund recently raised its stake in Japan Tobacco - which now accounts for 15 percent of the fund - hoping a return to inflation will push up cigarette prices, which at around $4 a pack are far cheaper than in other developed markets.
Josh Schechter is another investor who has succeeded where others have failed in Japan. Schechter is a partner at activist fund Steel Partners Holdings, which forced the removal in 2008 of management at Japanese wig maker Aderans. A year later Steel Partners wrested control of the board, and still owns 28 percent of the company.
(Read More: Volatile Bond Market Puts Bank of Japan in a Spin)
"It's important you have a credible plan," said Schechter, who sits on the Aderans board. He said his fund aligned itself with local shareholders unhappy with the board and with managers wary of where the company was heading. The fund, though, could not repeat its success in 2010, failing to place its candidates on the board of brewer Sapporo Holdings. It later sold its 18 percent stake in the company.
Schechter declined to say whether his fund would chase new Japanese targets in the current climate, but noted Japan could spur investors if it tweaked its tax code to let companies turn business units into separate entities and offer their shares to existing stockholders free of a capital gains levy - the type of corporate rejigging at the core of Loeb's proposal for Sony.
Short-Term Vs Long-Term
Loeb needs to convince other Sony shareholders that selling part of the entertainment business would both generate cash to help the struggling maker of Bravia TVs and Vaio laptops and improve profitability at Sony Entertainment, which would remain under Sony's control.
"I think the proposal will be welcomed by foreign shareholders, but won't be 100 percent acceptable to Japanese ones," said Yuuki Sakurai, CEO at Fukoku Capital Management, the investment arm of Fukoku Mutual Life Insurance, which owns Sony stock. Although Sony looks westernized, its "culture is heavily rooted in Japan," he noted.
"The American way of focusing on efficiency is not the only way to raise profits," Atsushi Osanai, associate professor at Waseda Business School, told Reuters Insider television. Osanai worked at Sony from 1997 to 2007. "Japanese companies are not very efficient, but they make very good products and have the ability to create new things. That's more valuable on the long-term scale.
(Read More: Japan's '3 Arrows' May Run Into a German Wall)
Chasing after short-term benefits isn't necessarily good for shareholders," he said.
An investment banker in Tokyo, who has worked on projects for Sony, said the risk of Loeb's plan would be that it could deliver a $2 billion gain, but depress the share price by putting at arm's length one of its few stable profit centers.
Sony considered, and dismissed, such a plan over a decade ago, said the banker, who didn't want to be named because he was not authorized to speak to the media.