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This time is different – The mysterious case of Japan’s capital market reforms

In a high-context culture like Japan, often the real message is left unspoken.  

But when it comes to capital market reforms – or reforms of any nature in fact – ideally there should not be room for ambiguity.  

And that is probably one of the main frustrations among foreign investors – especially activist fund managers – about Japan’s stock market, which has printed barely USD 1.9bn worth of new stock so far this year, trailing behind China, Indonesia, Hong Kong and even India. The year-to-date showing may still beat 2022’s full-year USD 2.43bn, but lags well behind 2021’s USD 6.8bn, according to Dealogic data.  

What is particularly ironic is that while the country’s Nikkei 225 Index keeps marching to test record highs, many stocks are still trading below 1x book value, as reported by this news service earlier this month.

“You know what, literally five minutes before you arrived, we decided to go short on Japan,” a Hong-Kong based manager of a global hedge fund told the Explorer in late May. “Reforms in Japan…take forever.” 

The fund manager is clearly not alone in thinking so. But there are reasons to make the case for investors to spare another thought about Japan Inc. this time.  

First and foremost, the Tokyo Stock Exchange (TSE) has called on companies since late January to review non-core, underperforming businesses, especially companies trading below 1x book value, so as to improve capital efficiency, increase profitability and enhance investor returns.  

Another asset manager told this news service in April that TSE’s move had put companies trading below 1x book “under tremendous pressure… it’s a game changer.” 

There is also evidence that Japanese corporates are starting to heed and act – as TSE’s efforts have triggered a wave of apologies and capital return initiatives in recent months. Japan Post Holdings [TYO: 6178] said it is “ashamed” of its 0.35x book value while JFE Holdings [TYO:5411] said it takes its low P/B of 0.51x “very seriously”.  

To incentivize reforms, the government will grant tax breaks to companies that apply between 1 April this year and 31 March next year to spin off a wholly-owned subsidiary, retaining an ownership below 20%.  

Thirdly, activist investors are pushing harder than ever, calling companies to carve out non-core, unprofitable businesses to extract shareholder value. 

Japanese listco carve-outs have historically been dominated by trade sales. Carve-out listings (Spin-off IPOs) are rare but that is likely to change.

As Softbank Group Corp [TYO:9984] filed for a US listing in April for chipmaker subsidiary ARM looking to fetch an USD 80bn valuation, there is a growing enthusiasm about carve-out listings among Japanese corporates. Softbank, which bought Arm for USD 32bn in 2016, failed to sell the business to Nvidia [NYSE:NVDA] for USD 40bn in 2020 due to a veto by regulators in 2022. 

The idea of equity carve-outs and spin-offs is not new. But it is just not yet rooted in the Japanese corporate playbook.   

According to Dealogic data, there have only been 38 equity carve-outs and five spin-offs in Japan since 2003. This compares to a combined 174 carved out IPOs and spin-offs in Australia, 105 in Hong Kong and 127 in South Korea during the same period.   

Spin-off IPO are mostly done by larger Japanese corporates. Among the top 10 largest IPOs in Japan since 2003, six came out of listed Japanese corporates.  

The largest carve-out in Japanese history is SoftBank Group’s spin-off of its telecom unit SoftBank Corp [TYO:9434] in December 2018, raising JPY 2.4trn (USD 21.3bn) with a market cap of JPY 7.3trn (USD 63.8bn). The telecom unit’s shares dropped 14.5% upon listing while Softbank Group shares were up 2.8% one-month after the spin-off was announced.  

In April 2023, Rakuten Group [TYO:4755] floated its internet banking business Rakuten Bank [TYO:5838] raising JPY 83.3bn (USD 674m), Rakuten Bank has surged 39.1% since listing, while the parent has dropped 27.5%.   

With tax incentives and shareholder activism driving the agenda again, one can reasonably expect a pick-up in Japan’s carve-out via IPO activity at least over the near- to mid-term, especially when a record-high benchmark index makes it easier for conglomerates to spin off their units at more desirable valuations.  

Less than three years after Sony [TYO:6758] took private its financial subsidiary arm Sony Financial Holdings in 2020, Sony said in mid-May that it is considering a partial spin-off of the financial division so that the group can focus and scale up investment in its image sensors and entertainment business.  

This is the second time Sony takes its financial arm public. In 2007, Sony floated the unit raising JPY 348bn (USD 3bn). The FT
reported that Sony would make use of the government tax break initiative to hive off the unit, aiming to retain around 20% of the business with a targeted timeframe of two to three years for the listing. Prior to the take-private in 2019, US activist Third Point has urged Sony to consider divesting their stakes in Sony Financial, while spinning off the semiconductor business.  

Under pressure by ValueAct, Seven & i Holdings [TYO:3382] said in early April that the company has established a strategy committee to evaluate alternatives, including an IPO or spin-off. In January, the US activist called upon the retail giant to conduct a tax-free separation of 7-Eleven stores via IPO within a year to unlock up to 80% in shareholder value.  

With foreign investors pouring in record amounts of money into the country, money managers will surely demand a bigger say in reshaping the Japan Inc.