AVI’s response to Teikoku’s rejection of proposals

We have reviewed Teikoku Sen-i’s Board of Directors’ opinion issued February 14 concerning our shareholder proposals.

We are disappointed that the board has rejected our moderate proposals for a share buyback and increased dividend. Our proposals were intentionally modest against the background of the company’s abnormal and value destructive overcapitalization.  We had thought that, by making our proposals so modest, it would make it easier for the board to take an initial small step in the right direction.

We are also seriously concerned that the board is retaining shareholder capital without adequate quantification and financial analysis.  The board’s opinion casually mentions rough figures for needed working capital and projected capital expenditures under the company’s mid-term management plan.  But the published mid-term plan contains no hard numbers.  The projected capital expenditures are nowhere analyzed in relation to hurdle rates or expected return on investment. 

If the board of directors believes that the company needs to retain capital, as opposed to returning it to shareholders, it has an affirmative duty to explain in concrete detail how the retained capital will be invested to produce a superior rate of return on investment.  The lack of detail and vague generalizations, both in the opinion and the company’s mid-term plan, reflect badly on the diligence and the board’s sense of responsibility to shareholders. Without much more detailed justification and analysis for retaining capital, the board is failing its obligations under the Corporate Governance.

In what follows we will demonstrate how modest our proposals in fact are, taking into account the company’s balance sheet, current profits and actual capital needs.

The FY2019 balance sheet shows net assets of ¥55 billion, an increase of ¥8 billion over the previous year, of which ¥38 billion consists of cash and securities net of tax, including a stake in Hulic worth ¥16 billion¹.

Our proposed share buyback of ¥2 billion, amounting to 3% of outstanding shares, can be funded by selling just 10% of the company’s interest in Hulic. 

In our view the board cannot justify having one company, Hulic, with which there is no meaningful business synergy or relationship, constitute 32% of total assets.  If the board were properly sensitive to the objectives of capital efficiency and corporate value, it would promptly divest the entire stake in Hulic and return the proceeds to shareholders. Nonetheless, in order to induce the board to take a small initial step in the right direction, we proposed a much smaller disposition of the Hulic stake.

With the rejection of our proposal the board has openly declared that it has no intention of addressing the company’s massive and unproductive overcapitalization in general or reducing its outsized stake in Hulic. It has ignored Principle 1.4 of the Corporate Governance Code, and the absence of cost of capital in Teikoku’s arguments and focus on vague business ties with Hulic, shows a worrying lack of consideration towards shareholders and returns on equity.

Our other modest proposal was to pay a dividend of ¥76 per share, or roughly ¥2 billion in aggregate, as against ¥4.3 billion in net profit for FY2019—a payout ratio of approximately 50%.

In rejecting our proposed dividend, the board’s opinion once again refers to vague and unspecified capital expenditure plans and needs.

We have stressed repeatedly that we support meaningful and necessary capital expenditures.  However, Teikoku Sen-i’s overcapitalization is extreme and obvious.  Cash earning no return and low yielding securities have continued to accumulate and grow, destroying potential corporate value.

We believe that the board’s opinion rejecting our proposals without adequate quantitative justification in terms of capital efficiency and return on investment bespeak a larger failure of corporate governance and dereliction of duty.

The “group shareholders” of the company that have sided with and protected management at the expense of general shareholders over the years must acknowledge their share of responsibility for this failure of corporate governance. 

Anyone who objectively analyses the company’s balance sheet in relation to its actual business and capital needs will immediately recognize that something is wrong and abnormal.

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In the coming weeks leading to the annual shareholders meeting in March, we will be communicating with our fellow shareholders, including “group shareholders”, to encourage them to support our proposals and send a message about their dissatisfaction with the company’s corporate governance and basic direction under current management.

Underneath Teikoku’s inefficient balance sheet hides an excellent business that deserves to trade at a significantly higher share price. Through our modest proposals we hope to improve Teikoku’s long-term capital efficiency for the benefit of all shareholders.

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¹ After capital gains tax of 31%, assuming zero-cost base
² Assuming 31% capital gains tax, funded by the sale of ¥3bn Hulic shares, such that the net proceeds are ¥2bn