A Case for Reform at Japan Tobacco

The Children’s Investment Fund was humiliated when it brandished the sword of shareholder activism at Japan’s corporate shogunates in 2008. Now the London hedge fund is back with what appears to be an even more foolhardy campaign — to prod the Japanese finance minister to shake up Japan Tobacco. But this time around the embattled government may have enough to gain to push for corporate reform.

Japanese companies are laggards in the shareholder value revolution. The country’s biggest enterprises have long put job preservation and market share ahead of profits and stock price performance. Past arguments that this reflected a laudable long-term focus have been thoroughly gutted by two decades of deadweight stock prices.

All this was part of the reason the investment fund and other activists previously banged on the doors of Japan Inc.’s medieval boardrooms. But there’s change in the air in Tokyo, largely as a result of the March earthquake, the government’s botched handling of the disaster and a growing urgency over the country’s huge fiscal problems. This makes the Finance Ministry, which owns half of Japan Tobacco, a potentially malleable target.

And the investment fund has a sound case against Japan Tobacco’s management. Over the last three years, the company has lost a third of its value while two international rivals, British American Tobacco and Philip Morris, have gained 42 percent and 32 percent, respectively. That’s before factoring in dividends. On that front, the fund notes that Japan Tobacco’s payouts have amounted to a quarter of its earnings, significantly less than its rivals have handed back.

In the past, the fund’s appeal would have been easy for the bureaucrats of Kasumigaseki to dismiss. But the Finance Ministry is weaker today. The government is about to put forward a supplementary budget that will ask its citizens to tighten their belts further, including by swallowing higher value-added taxes.

Just narrowing Japan Tobacco’s performance gap with rivals would restore some $13 billion of wealth to the government’s treasury. More importantly, fostering a business culture in which shareholders — including the pension funds entrusted with the retirement years of Japan’s aging populace — are no longer treated as second-class citizens should help enrich both the government’s coffers and those of its citizens. Whether attributed to any efforts of the Children’s Investment Fund or not, it’s hard to see how the Finance Ministry could quibble with that.

Perelman’s Price

Shareholders in M&F Worldwide shouldn’t rush to take Ron O. Perelman’s latest deal. The billionaire wants to buy the 57 percent of the company he doesn’t own. His offer includes a premium, but the shares traded higher until recently. With M&F’s boss involved in running Mr. Perelman’s investments too, skepticism is warranted.

Printing checks for banks goes against the tide of technology. So even with the odd counterweight of its licorice extracts business, M&F might be expected to post declining sales. But its first-quarter results showed a sales drop of 5.2 percent from the previous year, far sharper than the 1.7 percent decline for 2010. Earnings shrank by even more. And M&F’s shares steadily slipped, losing 30 percent by June 10.

So if nothing else, Mr. Perelman’s swoop is opportunistic. His offer at a 41 percent premium brings his target’s valuation back only to near early May levels. That’s a multiple of barely 5.3 times the last 12 months’ Ebitda, less than the trading multiple of its peer, R. R. Donnelley & Sons.

But it muddies the water that Mr. Perelman effectively controls M&F already. Not only does his holding company MacAndrews & Forbes have three board seats, one occupied by Mr. Perelman, but Barry F. Schwartz, the other top executive at MacAndrews & Forbes, is also the target’s chief executive.

Even though Mr. Perelman wants a special committee of independent directors to evaluate his offer and then a vote of the other shareholders, investors might consider the Revlon example. Shareholders exchanged common shares of the cosmetics firm for a new class of preferred stock in the fall of 2009, gradually adding to Mr. Perelman’s stake. Just weeks later Revlon posted results that sent shares skyrocketing. Despite the involvement of independent directors, some investors cried foul.

With M&F’s shares flat-lining at the offer price, it looks as though shareholders are inclined to take the offer. They may feel they have little choice. But they should make sure they ask some skeptical questions before rolling over.


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