Active Investing in Japan

A longtime shareholding on mine, Internet Initiative Japan (IIJI) (JP: 3774), is having its Annual Shareholder Meeting this Friday in Tokyo. I urge all ADR and Ordinary shareholders to submit their votes as soon as possible, but not later than this Thursday, 10:00 AM Eastern (NY) for ADR holders, or by Thursday, 11:59  PM Japan Standard Time for Ordinary shareholders. Also, please see my previous article detailing my activist work to-date with IIJ.

IIJ hit another 20-month high overnight in Tokyo, up 1.3% to ¥276,900 (ADR equiv. $7.65 at $1/¥90.5), although it traded as high as ¥288,900 in the afternoon session before giving back a good chunk of the gains into the market’s weak close. While IIJ’s stock has had a strong year, I remain convinced that its shares are still undervalued, due in some respects to management’s misuse of capital and the Board of Directors’ failure to unlock value, and in other respects primarily because of overly restrained IT spending in Japan. continue reading…

About 3 ½ months have passed since I sent my first letter and shareowner proposals in late-February to the Board of Directors of Internet Initiative Japan (IIJI) (JP: 3774), a leading ISP and related services (cloud computing, systems integration, etc.) in Japan. As a longtime shareholder (since 2006), my concerns included the company’s level of capital spending, its corresponding levels of depreciation, and its deteriorating returns on assets/equity/etc., the latter being partially suppressed by a large, low-yielding cash position. And my proposals involved items that a Board of Directors typically has more direct influence over (as opposed to my aforementioned concerns) such as stock splits, share repurchases, dividends, and shareholder say in significant non-core business investments. continue reading…

General Electric (GE) held its annual shareholder meeting on April 28th. It comes as no surprise that the same 16 directors up for reelection remain firmly in place. However, it should raise some eyebrows, since the number of shares voted against certain board members (most notably Messrs. Lafley and Penske) fell sharply compared to last year. Yet, in a fantasy land of GE proxy voting, it might not matter so much if shareholder (activist) Evelyn Davis, the “queen of the corporate jungle,” had garnered more votes for her perennial  proposal for cumulative voting, which unfortunately and curiously saw a decline in support versus years prior. Back to reality, regardless of how many additional future votes there might be for cumulative voting, the board will likely not only continue to regard it as a closed matter since it was rejected, but it will also fail to acknowledge the importance of the proposal to a not insignificant number of shareholders. Ironically, even with a majority vote in favor of the proposal, the board is not required by law to do anything at all. continue reading…

Internet Initiative Japan (IIJI) (JP: 3774) is not a household name in the U.S., but it has carved out a niche in Japan in internet connectivity and related system services and outsourcing (essentially it is a high-tech ISP catering to businesses and government with growing potential in cloud computing and mobile access). Overnight in Tokyo it reported better-than-expected full-year earnings, forecast top and bottom-line growth in the current fiscal year ending next March (albeit on the soft/conservative side), hiked its dividend for the fiscal-year ended in March by 11% and is targeting an 11% hike for the current year’s dividend. IIJ surged in the afternoon session in Tokyo following its earnings release, reaching limit-up at ¥259,300 (ADR equivalent of $7.00) and closing at ¥245,000 ($6.61), compared its Nasdaq close $5.68 on Thursday. This is all good news, but it will likely get even better, much better, because IT investments in Japan have been largely held back, and IIJ’s board can take more of an initiative to enhance shareholder value, something for which I hope to be a catalyst. continue reading…

The Carl Icahn v. Lions Gate battle rages on. Unfortunately it features no real suspense; rather, it’s playing out more like a bad dream, in a bad movie. While the Post Office and the related parties’ legal counsel and financial advisers all must be happy to have the work, I’m strictly thinking TiVo: fast-forward past both sides’ rhetoric and “show me the money.” As a long-time Lions Gate shareholder, I of course agree with Lions Gate’s board and its advisor Perella Weinberg, that Mr. Icahn’s $7/share offer is financially “inadequate.” At the same time, I am as perplexed as Mr. Icahn is regarding Lions Gate’s “public relation machine’s” touting of its “horrible share performance as a tale of great success.” continue reading…

General Electric’s (GE: 16.0206 -0.80%) Annual Meeting of Shareholders is April 28th. All 16 of its directors are up for election, as well as the selection of the company’s independent auditor, and voting on 6 shareholder proposals. Please be sure to vote if you are a GE shareholder. And don’t simply accept the board’s recommendations because every board member will then be re-elected and every shareholder proposal rejected, which will likely happen anyway, but greater evidence of shareholder dissatisfaction could bring meaningful change. continue reading…

Enzio von Pfeil, the author of Trade Myths: Globalization has left trade balances behind, is a Hong Kong-based investment advisor and he also manages his own family of funds using his Economic Clock. He is a regular contributor to Bloomberg TV and CNBC Asia. Enzio earned his Ph.D. in economics at the University of Freiburg in Germany (he studied under renowned “Austrian School” economist Friedrich von Hayek), and subsequently went into banking and garnered invaluable experience in Treasuries, currencies, and macro strategies. He later served as chief regional economist for leading London-based i-banks in Hong Kong.

As someone who has followed Enzio’s work for the past several years, I can confidently say that Trade Myths is as iconoclastic as he intended it to be and with sound reason, not to mention its critical timeliness. While Trade Myths should be required reading for everyone in government (especially in the U.S.), it is also a must-read for those in the capital markets, and it is also readily accessible, and highly suggested to, everyone in the workforce. Trade Myths weighs in at a concise 75 pages, with ten pages of charts that clearly illustrate his trade myth-busting. Below I provide a synopsis of the book and conclude with some Q&A I just had with Enzio. Before starting, I want to thank Enzio for publishing Trade Myths, which has served as a real eye opener, particularly in terms of what headline trade figures mean (or that is, what they miss), how much foreigners are really financing America, and for the various scenarios provided of what could happen if trade goes wrong. continue reading…

Internet Initiative Japan (IIJI) (3774) is a Japanese internet service provider offering a full suite of connectivity and outsourcing services. It is a pioneer among Japanese internet-related companies, having originally listed its shares on the Nasdaq in 1999, before eventually listing in Tokyo (Mothers) in 2005 and later transitioning to Topix 1st Section.

At the end of February, I submitted a letter to the company’s chairman (Mr. Suzuki) and its other directors. While applauding them for their prior decision to repurchase shares, the timing of which coincided with the bottoming of IIJ’s stock, and also for maintaining the dividend, I voiced some concerns and submitted proposals that are either to be actioned or designated for resolution at the Annual Shareholders’ Meeting this June. IIJ’s Investor Relations Officer has been helpful and cordial, and has already forwarded my letter and proposals. Below, I will briefly outline my position.

Unfortunately, despite having listed in the U.S., making it to Topix-1, and having a reasonable level of awareness within commerce and government in Japan, IIJ remains a largely unknown company in the investment community. Since I’ve been a shareholder for a while now I am not pleased about this, but it in fact represents an opportunity.

A cursory review of IIJ’s financials will show that the company met some hard times in 2008 (fiscal year-end March ‘09), as did most companies, but it remained profitable. However, given the weak economy in Japan and lingering deflation, 2009 (FYE 3/2010) is not looking as if it will be significantly better than 2008; that is, as revenues are forecast to be lower, although earnings are expected to rise about 20%, but still be only about a third of what they were between fiscal years 2006-2008. Meantime, IIJ is moving right along with capex, granted some of it is regarded as critical given the upgrade cycle of networking equipment. I have asked IIJ to review its capex/depreciation, while considering the models of Google and Amazon for cloud computing, an area, along with mobile connectivity, that represents great opportunity for the company.

One of my chief concerns relates to the level of capex and correspondingly, the heavy depreciation. Furthermore, the growth in assets, while it had led to top-line growth, it hasn’t brought an increase this year, and has not generated growth on the bottom-line for the past two years. To make matters worse, IIJ is sitting on a sizable pile of cash, nearly ¥8.5 billion ($94M) as of the most recent quarter’s end, compared to total assets of around ¥47 billion, and a market capitalization of around ¥40 billion (keep in mind that its shares are up about 25% in the past month). The company doesn’t have long-term debt, but it does utilize capital leases, which represent a “long-term” liability of ¥3.9 billion. IIJ has no working capital concerns whatsoever, and has access to very cheap bank lending facilities at a cost of capital under 2%.

My specific proposals involve:

I. A stock-split of the ordinary shares of at least 10:1, but preferably 100:1. Correspondingly, in light of the 400:1 ADR-to-Ordinary ratio and IIJ’s subsequent five-dollar per share ADSs, again I suggest a 100:1 ordinary split and a 1:4 ADR split. While stock splits don’t impact the fundamentals, they would most certainly help improve IIJ’s trading liquidity and improve its potential investor base.

II. Switch to a quarterly dividend payout schedule instead of biannually. I suggest this given it is common practice in the U.S. and the appreciation most shareholders will have for a more frequent payout.

II. Announce another stock buyback. I have already summarized IIJ’s cash position above. I regard IIJ as undervalued both based on a valuation of its assets and a return to at least the levels of profitability it achieved in the recent past. Use of cash for share repurchases is ideal considering IIJ’s recent low ROA (and ROE) and its foray into a non-core business (see below).

III. Allow shareholders to vote on any investment or acquisition in excess of ¥1 billion that does not involve IIJ’s core business related to internet connectivity and services. This proposal is prompted by its new ATM business. It has a majority stake in a business that places ATM’s in pachinko parlors (similar to how ATMs are placed in casinos). While this business may someday become profitable (I have asked for revenues/earnings guidance), it has accumulated losses to-date of over ¥1 billion, and it will need even more capital before all the thousands of ATMs are deployed.

One-year stock chart of IIJI:

Disclosure: The author owns shares of IIJ. Note this article does not constitute investment advice.

Reuters (article in Japanese) reports that Goldman Sachs issued a report earlier this week that argues M&A will be the major theme for Japanese equities in 2010. Having a ‘macro’ investment theme for the start of each new year is a ritual for brokerages in Japan, although it seems no one ever has the resolve to action or follow through; and the M&A theme itself is not a new one. So Goldman repeats known information that Japan (equities) was overly victimized in the financial crisis and remains largely defenseless to external shocks. With ROE so low, domestic demand remaining sluggish, and overseas competition ever-intensifying, the best bet for Japanese companies is to merge and restructure. M&A/restructuring should boost top-line growth, says Goldman, which also should help margins, and therefore drive stock prices higher.

However, the longstanding problem with inward M&A is that reorganization is easier said than done (as heads, and tails in the form of non-core subsidiaries, tend not to roll in Japan), the volume of M&A has often disappointed, and the size of deals has been on the small side.  Nevertheless, all of that means there is still great opportunity in Japan. The best opportunities appear to continue to be in smaller-sized deals, where there are plenty of gems, and in listed subsidiaries. Goldman is said to favor retail, machinery, services, land transport, non-bank financials, warehousing, and real estate — the underlying idea is that these industries are the most fragmented.

Bottoms-up then, as 2009 is winding down and 2010 is poised to be the year of M&A (at least thematically or in a macro sense).

No doubt David Einhorn (Greenlight Capital) is an astute investor. Recently he declared his bearish view on JGBs, which subsequently has generated heavy interest among financial and political circles. Hats off to Gwen Robinson of FT Alphaville for solid ongoing coverage of the latest JGB tale (see JGBs and the ‘end’ of the short-squeeze fest). My take is as follows:

Regardless of whether Einhorn still has his short trade on or not, the chips are stacked against him and any copycats. It’s a fat chance for opportunistic hedge funds, since JGBs, even with their paltry yields (and circumstantial concerns), have both sizable and perpetual domestic demand. As I said in my last post on this topic, in spite of subdued individual investor demand, there is always an obliged patron of JGBs (the domestic institutional investor), which in the collective can fend off any offensive.

On the surface, Japanese investors sure seem confounded, largely (and in the author’s opinion, mistakenly) shunning their own depressed equities, while settling for skeletal JGBs and feeling compelled to chase overseas trends.  I used to think they were unpatriotic, in a sense, for not being buyers of domestic stocks. However, it turns out they are exceedingly patriotic given that even if they’ve lost their appetite for JGBs (in the case of individual investors), they’ll be silent holders one way or another via proxy, thanks to institutional money managers.

The Einhorn-JGB story is a reminder to Japan bears that no matter how shaky the shoji rice paper sliding doors and tatami floors appear, the pillars are quite strong and have reinforcements. As I discovered last October (‘08) when the Nikkei tumbled to 1982-levels, the seemingly disastrous cross-shareholding system in Japan actually turned out to be one solid floor for equities. With the addition of timely pension fund-buying, the two effectively stopped the hemorrhaging.

So it is, Japan remains an enigma to outsiders. JGB shorts with a prerequisite nine lives. And value investors stuck in, or already having pried themselves out of, the most elusive value trap.