Newsletters

Our first public campaign targeted Tokyo Broadcasting System (TBS), where we have been engaging with the Board/Management for almost three years, conducting 7 meetings, presenting at their AGM and writing 11 letters. It was, therefore, most pleasing that at the start of February TBS announced a 2% buyback following a partial sale of an undisclosed investment (likely Tokyo Electron). While the buyback only scratches the surface of TBS’s balance sheet problem, it is encouraging that they have listened to our suggestions and taken a positive first step to improve balance sheet efficiency.

Tokyo Broadcasting System (TBS) detracted 37bps from returns over
the month, in a month where Japanese equities performed particularly
poorly (TOPIX down -9%). Overall, the share price fell by -14% in May
driven by a -6% decline in the NAV and a widening of the discount from
35% to 40%. TBS’ underlying holdings – Tokyo Electron (20% of NAV)
and Recruit Holdings (21% of NAV) – had mixed months, being down –
16% and up +4% respectively. In addition to the weak background and
poor performance of its holdings, TBS also reported a negative outlook
for next year’s profitability. The headline dividend payout ratio of 23%,
below the stated policy of 30%, also appears to have caused some
consternation despite its decline being solely the result of a distortion
from one-off gains and being previously flagged by the company. While
the recent performance has been underwhelming, it is important not to
lose focus of the fact that TBS’ balance sheet is replete with cash (13%
of NAV), listed securities (54%), and prime Tokyo real estate (29%).
While TBS has to date been distinctly ambiguous about what it plans to
do with these assets, we firmly believe that were it to announce a
definite strategic policy to reduce its massively over-capitalised balance
sheet, the market would reward the company with a much higher share
price. To that end, we remain in constant dialogue with TBS’ Board of
Directors to produce a desirable outcome for all stakeholders.

TBS, with whom we have been engaging publicly, is another company whose actions highlight the changing environment. With 85% of TBS’ market cap covered by listed securities, it offers one of the most egregious examples of balance sheet inefficiency. After repeatedly being asked to do so by AVI and other shareholders, both foreign and domestic, TBS sold a portion of their cross-shareholding portfolio at the start of March. While only a small start, it is a step in the right direction and pleasing to see that TBS have listened to shareholders’ views – despite what many thought of as a hopeless case.

Shortly after month end, Tokyo Broadcasting System (“TBS”)
announced that it had sold a portion of its investment securities
portfolio. This news is most welcome, having engaged with the
company numerous times over our ownership period, and
having submitted a shareholder proposal last June seeking a
reduction in its securities portfolio.

Both announcements by Kanaden and TBS highlight that the
system of cross-shareholding relationships is beginning to
unwind.

Tokyo Broadcasting Systems (TBS) was the third-largest contributor
over the month, adding 36bps to returns as its share price increased
+13%. The returns were driven almost entirely by discount tightening,
moving from 41% to 33%, as the NAV declined by -1%. During the
month, TBS posted third quarter results with sales +3% and operating
profits -4% driven by margin contraction; post month-end, TBS
announced that it had sold part of its securities portfolio to fund capital
expenditure. While the position sold was small relative to the size of
TBS’ portfolio, we view the move as a positive indicator that
management and the Board are beginning to rationalise their balance
sheet and reduce the level of over-capitalisation.

Our investment in Tokyo Broadcasting System (TBS), which sits outside the
basket, experienced the single greatest fall in share price across our
portfolio, down -18% with weak performance at its two largest listed holdings
(Tokyo Electron and Recruit) exacerbated by a widening discount. At a 41%
discount to our estimated NAV and with its market cap covered 1.2x over by
cash and non-core assets, we see the stock’s valuation as compelling
particularly given the potential for improvements in capital allocation at the
company.

We wrote extensively on Tokyo Broadcasting System (TBS) in last month’s
newsletter in the wake of the company’s AGM at which our proposal for an inspecie
distribution was (expectedly) defeated. TBS’s share price was then
weak over July, falling -6.9% in local currency. We estimate that 70% of this
decline was due to discount widening and, in the absence of other news,
would attribute this move to continued disappointment in the level of support
for our proposal. As we explained in last month’s newsletter, we do not
intend to walk away quietly, and continue to engage with management. TBS’
valuation is still compelling, with the shares trading at a 30% discount to our
estimated NAV (54% in listed securities; 25% in real estate; 7% in net cash;
14% in core broadcasting business), and we believe Japanese institutional
shareholders will find themselves under increasing pressure to justify
supporting the company’s intransigence regarding its egregiously
overcapitalised balance sheet.

Tokyo Broadcasting System Holdings (TBS) was our strongest contributor
with a share price increase of +8% driven mainly by discount narrowing in
the run-up to the company’s end-June AGM. At the meeting, shareholders
voted on our proposal that the company distribute 40% of its stake in Tokyo
Electron (equivalent to a distribution yield on share price of 14%). We
understand that our proposal was the first – and we believe is unlikely to be
the last – time a Japanese company has been asked to make an in-kind
distribution. This approach strikes at the heart of Corporate Japan’s
problems, directed as it is specifically at cross-shareholdings.

Considerable effort was put into our campaign. We launched a dedicated
website, www.improvingtbs.com; received endorsement for our proposal
from ISS; held two press conferences; hosted an information session
attended by 70 domestic representatives from banks, insurance companies,
asset managers and corporations; met with regulators; and had over 150
press articles mentioning the campaign. With that in mind, we were
disappointed that our proposal was only supported by 11% of those voting,
but will continue to engage with TBS to explore ways in which to improve its
corporate value for the benefit of all shareholders. We believe the facts
clearly show that TBS’ excessive “strategic” shareholdings: (1) impair TBS’
corporate value, as reflected in the ¥200 billion gap between TBS’ asset
value and market value; (2) have nothing to do with TBS’ core broadcasting
business; (3) reduce the accountability and discipline of TBS management;
and (4) conflict with the principles of the Corporate Governance Code. We
are encouraged that TBS management has acknowledged that its policies
on strategic holdings need to be reconsidered in light of recent changes in
the Code.

While unsuccessful this year, we always saw the proposal as the start of a
process rather than an end in itself, and – given the high profile nature of the
company – our campaign in TBS has the potential to become an annual
barometer on the extent to which Corporate Japan is willing to embrace the
Corporate Governance and Stewardship Codes. More broadly in Japan, our
now-elevated public profile and the experience gained in this campaign has
built the foundations for us to engage successfully with companies be it in
public or private.

A trip in June to Tokyo and Osaka, during which we met with management
of many of our investee companies as well as potential new investments,
confirmed to us that there is genuine change afoot and that managements
of almost all companies are now acknowledging their duties to reduce
cross-shareholdings and improve the efficiency of balance sheets.
Meetings with regulators and officials were encouraging and it is clear that
top-down pressure on corporate governance reform will far more likely be
ratcheted up than eased off (witness the recent revisions to the Corporate
Governance Code). It is apparent to us from such meetings that there is a
deliberate yet unspoken policy of empowering (particularly foreign)
shareholders to pressurise companies to more stringently apply the various
corporate governance provisions. The pace of change has been and will
likely continue to be slower than we would like, but the prize in the form of
latent value trapped on corporate balance sheets is so great that one can
afford to be patient, particularly given our focus on companies with solid and
growing operating businesses.

AVI’s campaign in Tokyo Broadcasting System (TBS) stepped up a notch in
May with the launch of our website, www.improvingtbs.com. The site sets out
our proposal calling for a distribution-in-kind of 40% of the company’s stake in
listed semi-conductor business Tokyo Electron (the value of the entire stake
equates to over 25% of TBS’ market cap). A revision to the Japanese
Corporate Governance Code announced last week adds weight to our
arguments, calling as it does for companies to now disclose polices for
reducing their cross-shareholdings rather than simply explaining why they are
held. Our proposal will be voted on at TBS’s AGM in late-June, and we do not
think it overly dramatic to label the vote as the first major test of how far
corporate Japan has travelled. We believe any institution voting against our
proposal is implicitly voting against both the Stewardship Code and the
Corporate Governance Code.

We visited Japan again during March to meet with the management and
boards of investee companies including Tokyo Broadcasting System and
holdings within our Japan Special Situations Basket. While the pace of
corporate governance change is not as fast as some may have hoped, we
are cognisant that changing a decades-old corporate culture will not happen
overnight. With each visit, we are encouraged by the increasing awareness
of shareholder rights. Companies now recognise that their default
justification for cross-shareholdings – that they are “required for business
relations” – is no longer acceptable, and there is increasing pressure on
companies to sell unrelated businesses. A potential water-shed moment
occurred this month with the announcement by Japanese Exchange Group
(JPX) that it would sell its stake in Singapore Exchange (SGX), publically
stating that “Following a review of the requirements under the [Corporate
Governance] Code, JPX reached the conclusion that the existing cooperative
relationship with SGX would continue even without holding the
shares of SGX”. Such a statement would have been unheard of not too long
ago. We remain excited about Japan, and continue to engage with our
portfolio companies in the country to unlock trapped value. Our position in
TBS was added to on weakness during the month.

We wrote last month on Tokyo Broadcasting System (TBS) and our public
campaign to encourage the company to reduce its stock portfolio. TBS’
share price rose +20% over November on the back of publicity surrounding
our actions and strong operating profit growth (+38% for H1-17) in the
underlying operating business. Despite the share price increase, non-core
assets (listed equities, investment properties, and net cash) more than cover
the market cap with the high quality operating business being implicitly
assigned a negative value by the market. We continue to engage with the
board and management.

Tokyo Broadcasting System (TBS) accounted for 4.3% of BTEM’s NAV
at the end of the month. The company’s core TV production business
is masked by its bloated balance sheet which includes a stock portfolio
that covers 95% of its market cap and investment properties
accounting for another 32%. In October we began a public campaign
to encourage TBS to reduce its stock portfolio. The thrust of our
argument is that TBS’ management are taking an outsized and
unjustifiable risk by having 62% of this stock portfolio in two stocks,
Tokyo Electron and Recruit Holdings, and that a partial reduction will
not have a detrimental impact on business relations. Amidst a
background of improving corporate governance in Japan, TBS stands
out and we believe management’s continued complacency is
untenable. At TBS’ AGM in June 2017, the CEO registered an approval
rating of just 79% (down from 84% in 2016), the 20th lowest rating among the 450 Japanese companies for which we had such data after
the AGM. We were encouraged that the media picked up on our
engagement with TBS with articles being written in the Wall Street
Journal, the Nikkei and on Bloomberg. We hope that management will
take steps to rectify this problem for the benefit of all stakeholders and
we will continue to engage with management in a constructive manner.

We initiated a new holding in Japan, Tokyo Broadcasting System (TBS). TBS’s core business makes it a top five TV and newspaper distributor in Japan, but it also has an equity portfolio worth ¥300bln, a real estate business valued in excess of ¥220bln, and net cash of ¥7.5bln. These different lines value the company at c. ¥625bln versus a market cap of just ¥362bln, a discount of 43%. The implied stub value is also near an all-time low (i.e., the implied value of the real estate assets and the TV production business are barely reflected in the current share price). While such discounts are not unique in Japan, there are very few that are as prominent in the public eye or that are as large and liquid as TBS. Many Japanese companies have equity holdings, but it is rare to find one where the liquid equity portfolio is worth such a big proportion of the market capitalisation. Growing pressure across corporate Japan to boost ROEs could conceivably see TBS management look to sell all or parts of its equity portfolio and/or real estate.