If imitation is the sincerest form of flattery, then Hitachi’s executives must be blushing. The company, once infamous for making Japan’s biggest ever corporate loss¹, is the newest idol for Japanese executives; “we want to do what Hitachi did” is a common refrain in our meetings with venerable but staid Japanese blue chips.
So, what did Hitachi do, and does it provide a blueprint for corporate renewal? Is it particularly hard to restructure a business in Japan, and is that changing? And how, as investors, can we try to spot the winners and manage the uncertainty associated with the will-they-won’t-they/can-they-can’t-they game of restructuring? Read on to find out.
Corporate metamorphosis
Hitachi’s is not the only story of corporate metamorphosis in Japan, it may not even be the best – see the elbow in Sony’s total profits in the middle of the last decade. It might, however, be the most complete in the range of steps taken to bring it about. Hitachi was early to reorganise its board to become more independent and global. Its strategic narrative became focused upon uniting its globally competitive divisions with growth and profitability in mind, deprioritising the rest. Listed subsidiaries were sold – in 2009 it had twenty-two, today it has none.² More than just a case study, Hitachi’s story serves as a menu from which peer executives can pick for shareholders’ delectation.
Sony – operating profit was rangebound until management refocused upon its strengths³
That the above initiatives read more like common-sense than lightning bolts of managerial inspiration tells us something – Japanese corporates languishing in low-growth, low-profit torpor are not short of ideas, but managerial will. But why so?
Partly this is to do with operating in an economy so flush with capital; large cash balances and supportive banks kept the wolf from the door. The web of strategic shareholdings, often reciprocal, crowded out more change-focused shareholders. Partly it is to do with the expectation – reinforced by regulation and legal precedent – that the corporate sector will keep Japan in full employment even in the worst of economic times. So hard is it to reduce headcount in Japan that specific vocabulary emerged to describe it – madogiwa zoku (lit. ‘window tribe’) to refer to workers stationed with a view so that they might be distracted from their lack of actual work and oidashibeya (lit. expulsion room) for the purgatory, often a windowless room, reserved for unwanted staff who have rejected the option of early retirement.⁴ Finally, there is Japanese managerial culture itself. For most CEOs, their elevation to the role is the culmination of a lifetime of professional monogamy, of building alliances within their organisation, so a reluctance to make hard choices such as to exit a business division is easy to understand.
The corporate-social contract has changed
Fortunately, these constraints on restructuring are weakening. Pressure from the financial establishment – not least the returns-focused Tokyo Stock Exchange – has modified the corporate-social contract. To become more profitable and dynamic is no longer a betrayal but to participate in a wider national revitalisation. More engaged shareholders, ourselves included, mean that for the first time executives risk losing their jobs publicly and embarrassingly at AGM if they perform badly. Examples of success such as Hitachi and Sony have created a peer pressure for other companies to keep up. Crucially, Japan’s declining working-age population has made restructuring much easier. Layoffs are less necessary when headcount is trending down naturally. For management, reallocation is a whole lot easier than redundancy.
Investors should be thrilled by these changes, not least because the impact of successful restructuring on share prices can be vast. Over the last five years, Hitachi’s share price has quadrupled as operating margins have shifted from mid-single digits to near ten percent. Sony’s stock has done the same since that elbow in profits we highlighted earlier. NEC, our strategy’s preferred enterprise IT play, and another beneficiary of restructuring, has more than doubled since inspirational President Morita took the reins in 2021 – see below.
NEC – market response to corporate renewal has been profound, but took time⁵
‘Do they have anything worth keeping?’
How should investors approach this tantalising opportunity? The first task is to determine what a company’s restructured endpoint looks like. We are constantly asking the question “do they have anything worth keeping?”. Once the cutting is done, we want to be left with a diamond rather than a lump of coal. Next – and this is the hardest part – we must assess the likelihood of success in reaching management’s goal. Firstly, there must be a plan, then we must judge its plausibility – is it achievable or a moon-shot? Are the executives true believers in their vision or just making a show for investors? We are unembarrassed about making such qualitative assessments. Finally, we should consider the downside if no path to higher ground can be found.
By these measures, NEC scores highly across the board. President Morita is savvy and persuasive. His plan to more than double group profits to ¥300bn was both ambitious and plausible. The external environment has been conducive to NEC’s up-shift in profits – its enterprise customers are hungry to digitise their businesses using NECs services, and the Japanese government is keener to pay up for national security given the reemergence of great power threats. But even in the case of NEC, we have had to show patience – our strategy first invested in 2021 – this itself is a lesson.
Other restructuring plays held by our strategy have more mixed scorecards. Asahi Kasei for example is a company whose business divisions occupy a broad spectrum of profitability, asset intensity and growth. To shrink the worst – in this case, petrochemicals – and grow the others will be transformational, and this is President Kudo’s plan. This is easier said than done when the petrochemicals business is founded upon a low-utilisation ethylene cracker co-owned with another company. We are persuaded that this can be resolved but the market is so far reluctant to agree.
A thrilling asymmetry
Our final case study, and most recent new position for the fund, is Panasonic. This company, once amongst the most valuable Japanese brands, has become a byword for corporate ossification. Several previous restructuring plans have suffered failure to launch. The firm’s darkest days may be over but returns show no clear direction north.⁶
Panasonic – no longer on life-support, but can management put the business on a truly different path?
President Kusumi, in charge since 2021, certainly hopes that he can steer Panasonic’s stagnant returns higher. We hope so too, but we are far from certain. An important additional detail, as summarised in the chart below, is that Panasonic stock has rarely if ever traded at its current valuation.⁷ To us, this represents a thrilling asymmetry – if management can make the changes they hope, the shares could reprice on a double-whammy of higher profits and richer multiples. If it fails – as the current valuation shows is the consensus expectation – then the downside should be limited.
Panasonic – rarely if ever has it traded at these levels
The market is still hungry for change
Since the noisy criticism by the Tokyo Stock Exchange last year – calling out Japan’s low returns and valuation multiples versus other markets – investor attention has been fixed upon the prospect of Japanese corporate self-help. Early enthusiasm was for companies with large cash balances or holdings in marketable securities which could be used to buy back stock and manipulate returns north. To us, this was always just an amuse bouche; enjoyable but ultimately not satisfying. For that, a more comprehensive reworking of Japanese companies’ operations is necessary. Fortunately, Japan has a growing anthology of good news stories here – current market darling Hitachi, restructuring OG Sony and NEC to name a few.
Japan still has more than its fair share of businesses which punch well below their weight – hamstrung by excessive organizational complexity and low-growth, low-profit legacy products. Pressure from the financial establishment, not least the TSE, is giving these companies the social cover to make changes which would otherwise have been unpopular. An ageing workforce makes managing of staff levels easier and a growing body of blueprints of previous success should make management teams less timid to make change. We are still hungry, and we think the market is too, so it is time to move on to the main course.
¹ Hitachi set for biggest loss suffered by Japanese firm | Global recession | The Guardian
² Hitachi reinvents itself in sign of hope for Japan – The Japan Times
³ Bloomberg, July 2024
⁴ Layoffs Taboo, Japan Workers Are Sent to the Boredom Room – The New York Times (nytimes.com)
⁵ Bloomberg, 2024
⁶ Bloomberg, July 2024
⁷ Bloomberg, July 2024
The value of active minds: independent thinking
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