The article below is from our BRIEFINGS newsletter of 28 July 2020
Last year saw a new trend in M&A involving Japanese companies—a sharp increase in large tender offers, including rarely seen hostile bids. The trend has continued in 2020, and may accelerate as a result of the pandemic. Goldman Sachs Research’s Hiromi Suzuki explains the changing times.
Can you explain the backdrop for M&A activity in Japan? How do current levels compare with the historical trend?
Hiromi Suzuki: We’re seeing a noticeable rise in tender offer activity, which is simply an offer to the shareholders of a publicly traded firm to purchase a portion or the entirety of their shareholdings. While this year is only just half over, the planned value of such offers to date in 2020 has risen to 3.0 trillion yen, with the country’s second- and third-largest ever offers announced during the first half. This already exceeds the previous record of 2.5 trillion yen for the full year of 2007. The pickup is being driven by an increase in large deals, with both the average and median values of planned tender offers at record highs in 2020.
What is driving the surge?
Hiromi Suzuki: Broadly speaking, corporate governance reforms and business restructuring are the key contributing factors. One long-standing bugbear among investors has been the prevalence of listed subsidiaries in Japan; there are still 281 such companies as of the end of June. These so-called parent-child listings have often been criticized for harboring potential conflicts of interest between the parent and minority shareholders of the listed subsidiaries, and make it more complicated to assess corporate value. In February, Japan Exchange Group, which operates the Tokyo Stock Exchange, announced revisions to listing regulations aimed at enhancing the governance of listed subsidiaries by tightening the criteria for independent directors and corporate auditors. Also from this year, proxy advisory firm Institutional Shareholder Services has begun calling for at least one-third of directors in companies with a controlling shareholder to be independent.
Parent companies can use tender offers to take full control of a listed subsidiary by making it a wholly owned entity. And with the screws tightening, some Japanese firms are taking action to review their corporate structures and either buy out or sell off listed subsidiaries. These transactions accounted for the lion’s share of tender offers in 2019.
COVID-19 is likely to be an additional spur for companies to review their capital structures. With the business environment likely to deteriorate further due to the pandemic, we expect more announcements of large-scale tender offers as parents look to shore up subsidiaries and improve their earnings by making them wholly owned or consolidated entities. As the total market capitalization of listed subsidiaries has fallen 8% this year through July 8, it is also cheaper for parents to execute these offers.
What about hostile takeovers? Haven’t they traditionally been taboo in Japan?
Hiromi Suzuki: It is true that unsolicited tender offers have been rare in Japan—and that successful bids are even more unusual. But the situation is changing dramatically. On the corporate side, the renewed focus on shareholder value means that companies themselves may be more willing to at least consider bids—unsolicited or otherwise—if a subsidiary’s sale would increase their capital efficiency. As a first step we are already seeing companies begin reviewing their capital ties with listed subsidiaries with an urgency unimaginable in previous years.
In line with the government’s corporate governance reforms, domestic institutional investors have also become more keenly aware of their fiduciary duties to use their voting rights to encourage enterprise value growth. In other words, they are less likely to resist unsolicited tender offers if they deem the transaction value-accretive. This awareness has also made it more difficult for companies to maintain takeover defense strategies—or so-called “poison pills.” Popular in Japan, these mechanisms allow companies to issue new shares, often at a discount, to existing and “loyal” shareholders, diluting the stake of a potential acquirer. However, 2019 marked the first year where the number of companies abandoning takeover defense measures exceeded the number with them. This year, more than forty companies have said that they will give up such measures, reflecting the growing risk that they will not receive shareholder approval at annual general meetings. As a result, the potential for unsolicited bids to succeed has increased.
What’s the bottom line for investors?
Hiromi Suzuki: The progress of corporate governance in Japan, coupled with increasing numbers of activist investors operating in the market, is driving a wider discourse around the independence of Japanese companies and their accountability to shareholders. Given an ongoing focus on corporate reorganization to increase capital efficiency, and the fading resistance to hostile takeovers, we expect to see more tender offers, which could create interesting opportunities for investors going forward.