Tokyo-Japan-Picture
By Markus Leupold-Löwenthal

ValueWalk is pleased to present our interview Steven Towns, the author of a new book titled, Investing in Japan. Steven was kind enough to sit down and talk about his experience, his book, and views on value investing in Japan. His full bio is at the bottom of this article.

VW: Can you tell us a bit about your background?

ST: Sure, I’ve spent about 12 years or so in Japan in total. I’ve been stateside for a while now but I visit as much as possible. My background is primarily in research involving equities and capital markets, M&A, business development, and what’s known as prospect research for university advancement.

VW: You fought a pretty successful proxy battle against General Electric Company (NYSE:GE). Can you discuss that. And as a segue can you tell us why you state corporate governance in Japan is not nearly as bad as people think?

ST: I did get very close to having a critical shareowner proposal appear on General Electric Company’s (NYSE:GE) proxy statement this year. It was really unprecedented because it involved dividends, which is generally a disallowed topic believe it or not, and the SEC initially ruled in my favor adding a strong message that dividends are important to shareowners. To try and keep this short, first, I believe getting a proposal onto a proxy is difficult by design. There are numerous limitations enforced by the SEC that really handcuff shareholders, and then companies do anything and everything to thwart proposals. It’s a real ugly process. I could go on and on with personal experiences and ones my partners have suffered.

My proposal called out General Electric Company’s (NYSE:GE)’s wasteful buybacks to the tune of tens of billions of dollars over the past decade, the subsequent raising of equity capital at a much lower price, and the slashing of its dividend by two-thirds. Thereafter, General Electric Company (NYSE:GE) has very slowly increased its dividend, while it hoards cash, and continues to overspend on buybacks (which happens because its buybacks struggle to reduce share count due to equity-based compensation). So stock repurchases are not value enhancing at General Electric Company (NYSE:GE)and the market knows that. My proposal asked the Board to reconsider dividend policy, including paying a special dividend.

Although the SEC initially agreed with me, as always happens companies appeal and re-appeal the SEC, and General Electric Company (NYSE:GE) was ultimately granted “no-action” approval by the SEC since it claimed “substantial implementation,” that is, to have held a board meeting (while it was in opposition of my proposal!) and discussed my proposal and decided that nothing needed to be changed.

So this answer has really been a rambling on about General Electric Company (NYSE:GE), but I think the message is very important. We need more investors submitting proposals and being their own agents, not relying upon directors. That more value investors aren’t in the proxy activism business is unfortunate and a shame.

Now, about Japan, I argue that Japan’s corporate governance is no worse than CG in the U.S. because it’s really the same difference. We claim to have independent directors, while the Japanese can have as few as one independent director, but the outcome is essentially the same: management is in control, especially the CEO, who is often times also the board chairman. Now, since Japanese management and directors tend to view the company has having “stakeholders” (employees, customers, shareholders, and communities they impact) decisions often reflect the difficult task of trying to please all. In the U.S., companies claim to make shareholders their highest priority, but in many cases the result is an enriching of management with a complicit board, putting their interests ahead of outside minority shareholders. I have some great data in my book about compensation. Japanese executives are comparatively way underpaid. Another matter is my experience with activism in Japan shows that ironically boards will listen and can be responsive to value-enhancing proposals.

VW: You lived part of your life in Japan and speak fluent Japanese, what advice can you offer to people less familiar with the culture?

ST: I obviously have an advantage, however, as I mention in the preface to my book, Japanese stocks on average are so widely undervalued that I don’t even really discuss value investment strategies because (1) value investors tend to already have an approach(es) they prefer and (2) any strategy or approach ought to pay off over time. For instance, Nate Tobik of the blog Oddball Stocks doesn’t understand the language at all, but he seems to be doing quite well in the universe of Japanese net-nets. I also mention the case of the late “superinvestor” Walter Schloss.What a fascinating story, which shows you need not really know much beside reported financials. Otherwise, another approach is one like Warren Buffett’s as he has managed Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B). One may not find companies earning as high ROE in Japan (a fascinating topic which I explain in my book), but there are household names that trade at very little to no market premium.

Among listed ADRs in the U.S., we have Sony Corporation (ADR)(NYSE:SNE), for example, which is certainly a much more complex case, but is trading at distressed prices; and did you know that Toyota Motor Corporation (ADR) (NYSE:TM) trades at reported book value? In many cases, back out a portion of excess cash, not to mention a potential cornucopia of other short and long-term assets, and one can easily take that path without needing to know the language. Finally, in my book I tried to be as meticulous as possible with citations, which in some cases allows investors to really take advantage of sites the Japanese themselves use.

VW: Many value investors have been killed investing in Japan for 20 years, and many famous investors like Kyle Bass are shorting JGBs or buying CDSs on Japanese sovereign debt. Is it any different now than over the past two decades?

ST: Good question. It’s been those that try and bet against JGBs that have been killed, the so-called “widow-maker” trade. I think value investors have simply given up after results have not been as good as would be expected. First, debt-to-GDP has continued to climb, which suggests more dire straits, but as I outline in my book, it is not nearly as dire as it’s made out to be and there are a combination of low hanging and more structural (reform) solutions. Also, Kyle Bass’ bet is really just a bet (and it’s not the farm), he’s leveraged several million dollars to control a much larger amount and he’s also reportedly used a yen-denominated mortgage for his home in Texas. I wish him the best, but don’t think he’ll make out like he did with subprime. Now, what’s different for value investors in Japan today? Undervaluation is underlined by higher-quality assets and simplicity. Cash is king. Net-cash or high ratios of cash with little or no debt are far more prevalent than in years past because the “balance sheet recession” Japan faced (past-tense) is essentially over. Many forget that despite record high yen and now in spite of last year’s triple-disaster and flooding in Thailand, companies for the most part have remained profitable. Beyond that, there are numerous points I make in my book that show the positives far outweigh headline bearishness.

VW: Japan faces huge demographic problems, any ideas on how to solve this?

ST: Demographics is a favorite of Japan bears. It makes me laugh, actually. Yes, Japan has a problem; it has a problem that other countries are beginning to face, too, just it’s the first. I have some great data points in my book. A solution? Have more babies. You can only imagine what the lost decades have done in terms of bad news becoming the norm and discouraging couples from having children or more children and also even causing people to put off marriage. That said, we’re seeing more companies adopt flex-time arrangements, there is a known issue of there needing to be more childcare centers to allow more women access or reentry to the workforce, and there’s also a matter of younger employees not being paid so well, which inhibits the ability or desire to have children. The fix is easy for the latter in terms of companies needing to compensate younger employees better. The cash hoarding allows for that in fact. Meanwhile, the longtime seniority based system of Japan is helping ease operating costs as these older employees retire and companies witness cost-savings to come and theoretically could and

should channel more pay to younger staff. I’m not overly worried about demographics. I’m happy to move back and +4 the population.

VW: What do you think about investing in ADRs versus stocks on the Tokyo exchange? What do you think of some of the ETFs?

ST: Exchange-listed ADRs (Nasdaq or NYSE) are always good options if the valuation makes sense. The only matter is that there are fewer and fewer such ADRs. The large majority are Pink Sheets or OTCBB. I discuss this at some length in the book. Let me say here to just be careful with those outside of the Nasdaq or NYSE. Investors need to ensure an ADR is fairly actively traded to (1) get in at a good enough price with enough shares and (2) have enough daily bids to eventually sell. Also, the ADRs with tickers ending in ‘F’ are the most inferior in terms of sponsorship and disclosure, and could result in $75 or so brokerage settlement fees. Thus, to answer your question I’d say if you have enough investment capital to manage the commissions of trading in Japan, you really want to be able to invest directly in Ordinary shares in Tokyo or Osaka. In this case, to praise my own book, it really is a must read to learn the various idiosyncrasies for starters and better equip oneself to take advantage of the universe of stocks in Japan.

And as for ETFs in the U.S., I’m not a big fan. iShares MSCI Japan Index (ETF) (NYSEARCA:EWJ) is great for traders or those who really don’t want to do any work but have exposure to Japan, but I’d say that any value investor can do much, much better. I explain in detail in my book the sad situation and management of U.S.-based Japan mutual and exchange traded funds. Caveat emptor!

VW: What is the best way to find cheap stocks in Japan?

ST: It really depends what tools or services you already have or what kind of budget you have. For the sake of individual investors, for starters, I mention a number of undervalued stocks throughout the book and again have links that allow you do some investigating and coattails investing. Otherwise, in terms of free sources for screening, the WSJ online has a global markets data page with a list of the more actively traded stocks in Japan. The FT online has a global market screener that you can restrict to Japan and use a variety of screen parameters. Another option is purchasing the Japan Company Handbook, which costs over $100, but is probably well worth itconsidering that every public company is listed in the book in something like a Value Line format, all in English. The quarterly stock handbooks in Japan are practically bibles for investors.

VW: What stocks do you like?

ST: Among Japanese stocks with listed or actively-traded ADRs, my favorites are Internet Initiative Japan Inc. (ADR) (NASDAQ:IIJI) and Nintendo (NTDOY.PK). I’ve held Initiative Japan Inc. (ADR) (NASDAQ:IIJI) shares and been accumulating opportunistically for several years. During the 2008/09 crash, IIJ traded at around cash value, maybe not net-cash, but we’re talking about a cutting-edge company in cloud-computing and wireless connectivity (that also has a great recurring revenue business from fixed broadband) that would easily trade at a multiple of 30 or more in the U.S., but trades at less than 20-times trailing earnings at a year-to-date high. It trades for less than sales and only 2-times book.

Again, I’ve written extensively about Initiative Japan Inc. (ADR) (NASDAQ:IIJI)on my site, and do periodic updates. I can’t imagine selling Initiative Japan Inc. (ADR) (NASDAQ:IIJI) unless some sort of euphoria takes over the broader market or net-related stocks. We’re talking a world-class company at very, very reasonable valuations and great buying opportunities from time-to-time. Nintendo, meantime, is also obviously world-class, but somehow it’s become this ugly cyclical stock like it’s in the steel business. Beside record yen, which has pushed it into the red for this past fiscal year (for the first time ever), you have a company whose market cap is comprised of more than 50% cash, it has no debt, tremendous earning power which is not recognized at current prices, and is led by great management that has true pay-for-performance and a very transparent dividend policy for shareholders. This only scratches the surface of positives, and I don’t think the negatives are as bad in reality nor represent the demise of the company. Nintendo today resembles the same situation pre-Wii launch several years ago. The rest is history, with the challenge being knowing when to take profits. What an amazing opportunity the market is basically ignoring.

VW: Thank you for your time!

 BIO: Steven Towns is the author of Investing in Japan (2012). A value investor and shareowner rights proponent, he wrote the book from a value investor’s perspective and doubly tried to give readers a fresh, alternative look at Japan. One that shows the country is not on its last leg and rather is a country that has been mistakenly dismissed for too long — to the benefit of fellow value investors. He edits Active Investing, a website where he shares some of his activist work and investments; and offers custom research services for investing in Japan. Steven achieved unprecedented success working with cross-listed (Tokyo and Nasdaq) Internet Initiative Japan’s board to witness four dividend hikes in one year. Steven is a member of the nonprofit, United States Proxy Exchange, which advocates for shareowner rights. With a number of successes to-date, the USPX is poised to further empower shareowners. Steven can be reached via his website, hyperlinked above. Steven has level-1 proficiency in Japanese, the highest, per Japanese government certification.