Japan’s stock market has been on a tear lately. The Nikkei has rebounded 18 percent from the lows in August last year. But fund manager, Curtis Freeze, has managed to outperform the market by a huge margin and he’s done so by making bets on small, under-covered stocks.
Freeze’s Japan-focused Shareholder Consensus Fund is up 40 percent in the 6 months up to January 31st this year. For the whole of 2010, the fund posted returns of 214 percent, making it the world’s second best-performing fund worldwide according to EurekaHedge.
The outsized gains come after the fund suffered heavy losses in 2009, declining 82 percent.
Freeze, who’s been investing in Japan for the last 20 years, says he’s focused on companies that combine qualities of growth, value and the potential to be M&A targets.
Betting on Beverage M&A
The fund’s biggest holding currently is the rice wine maker, Oenon. The company, which has a market capitalization of $161 million, is the biggest independent brewer in Japan.
Oenon has an operating profit margin of just 2.7 percent, well below the sector average of around 7 percent. Part of the reason is that the sake maker doesn’t have the scale enjoyed by some of its larger competitors. And that, says Freeze, makes Oenon a good takeover target.
Japan’s beverage sector has been undergoing a wave of consolidation of late. Sapporo recently announced that it was ready to spend 100 to 200 billion yen in the next few years on M&A and capital outlays. Asahi also said it may spend 400 billion yen on acquisitions by 2012. Kirin, Japan's biggest beverage maker has already spent about one trillion yen on M&A in recent years.
The stock trades below book value and Freeze says that's largely because investors don't like the slow-moving management. Freeze expects a takeover eventually with a premium of at least 30 percent for Oenon shareholders. He’s so bullish that he’s accumulated a 12 percent stake in the company.
Another one of Freeze’s M&A picks is Growell, a Japanese drug chain with annual sales of around $2.9 billion. It’s one of the top holdings in his Prospect Japan Fund, which gained 17.1 percent in 2010. The fund owns about 5 percent of the company.
Growell is 30 percent owned by Japan's second-largest retailer Aeon. Freeze says Aeon has been trying to make the drugstore a wholly owned subsidiary for years and is still waiting for approval from the elderly founder of Growell.
Freeze expects Aeon to pay a 30 percent premium for the shares it doesn't already own. In the meantime, Growell’s profits have also been increasing, rising 64 percent for the full-year of 2010.
"Patience is Key"
Unlike other hedge funds, Freeze's funds are highly concentrated, increasing the risks. The Shareholder Consensus Fund, for example, has only 4 core holdings: the sake maker Oenon, real-estate information provider Next Co., Tokyo-based property developer Gro-Bels and Osaka-based diaper machinery maker Zuiko.
Freeze says people who invest with him believe in his strategy and his funds usually hold a stock for 4-5 years. "The hardest thing in investing is to have patience. It takes 4-5 months to identify and buy the equity and it takes 3-4 years for the market to care," adds Freeze.