The Problem

Teikoku is a high-quality business, providing essential disaster prevention equipment through an impressive distribution network. It is the market leader and experienced manufacturer of fire hoses in Japan, commanding a 45% market share. Building on this strong base, Teikoku has developed a diverse product mix of disaster prevention equipment. Its low CAPEX requirements and high margins underpin a business that, with a more efficient balance sheet, could generate a ROE in excess of 20%.

However, Teikoku’s quality business is hidden under a mountain of non-core assets. 70% of balance sheet assets are allocated to low returning net cash and investment securities. These have a return on equity to Teikoku of less than 1%.

Teikoku has given no quantitative justification for its ¥23bn investment in Hulic. It has blindly allowed its stake in Hulic to grow in value such that it now accounts for over 30% of total assets. Principle 1.4 of the Corporate Governance Code states that “when companies hold shares of other listed companies as cross-shareholdings, they should disclose their policy with respect to doing so, including their policies regarding the reduction of cross-shareholdings” (emphasis added)

Non-core assets trapped in Teikoku are valued by the market at a discount to their real value. Teikoku’s 2.6% in Hulic accounts for 25% of Teikoku’s market cap (after capital gains tax), and cash accounts for 34% of Teikoku’s market cap, resulting in a very low implied valuation for Teikoku’s high-quality business. Inefficient structure depresses Teikoku’s valuation and creates a “sum of the parts discounts”