Moxie with a proxy

Brian Heywood

Last April heads turned when Japan’s GPIF announced that it had named activist investor Taiyo Pacific Partners to help manage the world’s largest ¥126 trillion pension fund. Even Taiyo Chief Executive Brian Heywood was taken aback. He never thought the proposal from his small, Seattle based hedge fund would be seriously considered by the uber-conservative GPIF.

That did not stop him from trying. As a missionary in Osaka during the 1980s on a two-year break from Harvard, Heywood learned that fortune favors those who knock on enough doors. In 2003 good fortune smiled again when, with little more than an idea and some moxie, he and two partners successfully pitched the US pension fund CalPERS to launch a $200 million Japan corporate governance fund. Today, Taiyo manages assets of ¥270 billion (about $2.3 billion) in Japan.

CEOs do more than listen to Heywood not only because Taiyo is their second or third largest shareholder. That he secures by buying 3% – 10% of a firm’s listed shares. Rather, CEOs are influenced by his researched based advice which gains him access to almost every level of management.

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Taiyo collects and analyses data to find undervalued companies in Japan. It employs a staff of 40 that includes 20 Japanese investment professionals. The firm has visited roughly half of Japan’s 3,400 listed companies at least once, some as many as 30 times. Heywood uses what is gleaned from over 7,000 company visitations to help Taiyo’s 40 portfolio companies protect, create and unlock value.

Each year the firm holds benkyō-kai (study group) and shachō-kai (CEO group) events that most portfolio firms and their CEOs attend. Each benkyō-kai involves an interactive case study where participants pretend to represent a mythical firm with a problem often faced by Japanese companies. Topics range from managing the cost of capital to handling investor relations.

In the November before the 3/11 earthquake, Taiyo held a benkyō-kai on emergency response. A shy woman from Taiyo posing as a reporter timidly asks an investor relations (IR) representative from a portfolio firm about a recent ‘incident’. The mythical firm made windshield wiper blades. Heywood recounts, “She starts out being nice and then turns into a piranha. ‘One flew off causing the truck to hit a bus and some kids were killed, and you don’t know anything about it?’ Everyone was caught off guard.” Five months after the benkyō-kai Heywood says all portfolio companies handled Japan’s triple disaster with extreme professionalism.

The shachō-kai is no less entertaining as it is educational. Four years ago Heywood treated CEOs to a practical history lesson in Japanese sword making. A master sword smith demonstrated traditional sword making techniques using special clay only found in Okayama that produces razor-sharp blades. The smith fired up his furnace, giving each of the CEOs their hand at forging a blade from red-hot steel.

According to Heywood, sword making techniques have evolved over the millennia always in response to outside threats. “The sword got stronger and then it became hollow; It got longer, then shorter,” he says, making parallel reference to the need for Japanese firms to evolve in the face of increasing competition from Korea, Taiwan and China. His aim is not to shame CEOs by their lack of history knowledge, but rather to see their own culture in a different way. “CEOs can learn from a foreign fund,” he says, but adds that he could not affect positive change without there being good management in portfolio companies to begin with.

Addressing the nuts and bolts of finance, Heywood believes that most Japanese firms don’t understand the importance of return on invested capital. “Japanese often ignore it,” he says “because banks just give them the money they need.” Firms focus on doing what they are good at – making great products – but at the expense of capital discipline.

If Heywood had asked Japanese management 10 years ago, “What’s your cost of capital?” he might have received several responses including, “I have no debt, so I have no cost of capital.” Most CFOs, he explains, come from dominant Japanese banks that are inefficiently run. They are seconded to client firms through a kind of ‘amakudari’, the process by which retiring bureaucrats who have not been promoted to board level ‘descend from heaven’ into cushy private-sector jobs. “These CFOs are big shots who think they know everything about finance,” says Heywood. That and the proclivity of Japanese investors to hold a firm’s shares regardless of financial performance, leads to the lack of capital discipline.

To address any lack of understanding, at CEO roundtable events Heywood asks CEOs to prominently display on their desks a color-coded scorecard which highlights key performance indicators. The scorecard shows where each firm’s strengths and weaknesses are. A blue dot represents their company. A green dot is the foreign competition. And a red dot refers to the Japanese competition. “We simplify financial performance so the CEO can digest it,” says Heywood.

Taiyo helps portfolio firms market themselves to prospective investors. As foreign investors started coming into the market in 2001, the new job of IR was created. CEOs would appoint a person solely because of that individual’s ability to speak English. Without training the newly appointed IR representative had to answer questions like, “Why do you have so much cash on the books?” Heywood says, “They couldn’t tell a convincing story about why anyone would want to invest in their company.”

One former portfolio company made plastic pipe fittings. Pipes are usually low margin products. However, this firm made specialized angled pipes with multiple feeds that attracted a high margin. As a result, this small $250 million mid-cap firm had $200 million sitting idle on their books and was kicking off cash. That perked Heywood’s interest. He went to tour the factory and found a 30-foot wall lined with approval stamps issued by each of Japan’s many municipalities. To sell across Japan, products have to bear the stamp of each local municipality. “It must have taken 50 years to collect those stamps,” Heywood surmised.

Taiyo prepares a presentation containing suggestions as to how Taiyo itself might go about communicating a firm’s unique selling points to potential investors. In the case of the pipe fittings company, that story was about how a barrier to entry preserved high margins in what might otherwise appear to be a commodity business. IR representatives are invited to incorporate those suggestions into their own sales pitch. Many do.

Through such ‘friendly engagement’ Heywood hopes portfolio share prices will rise. With a little help from above, perhaps they might.

Tiayo Pacific Partners

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