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Entertaining change: Sony to look at activist's spin-off idea

Daniel S. Loeb, founder of Third Point LLC, participates in a panel discussion during the Skybridge Alternatives (SALT) Conference in Las Ve
Daniel S. Loeb, founder of Third Point LLC, participates in a panel discussion during the Skybridge Alternatives (SALT) Conference in Las Ve

By Tim Kelly

TOKYO (Reuters) - Few foreign activist investors have made much headway in forcing change in Japan, where a conservative corporate culture favors long-standing ties with banks, business partners and workers rather than shareholders seeking value.

Struggling electronics giant Sony Corp, though, with more foreign and fewer bank shareholders, may prove something of an exception. That's the hope, at least, of Californian billionaire Daniel Loeb, whose Third Point hedge fund has built up a more than 6 percent stake in Sony, making it the group's biggest stockholder.

Loeb wants CEO Kazuo Hirai to sell as much as a fifth of the group's money-making entertainment arm - movies, TV and music - to free up cash to revive an electronics business battered by competition from Apple Inc and Samsung Electronics. He reckons the shake-up, which Hirai said on Wednesday would be considered by the board, could increase Sony's market value by 60 percent.

The target and timing of Loeb's polite hand-delivered overture are not accidental.

Sony earns two-thirds of its revenue overseas and, for corporate Japan, appears more westernized. Hirai, who spent most of his childhood in the United States, was picked by former CEO Howard Stringer, a Welshman, in part for his ability to be both a Japanese boss in Sony's domestic electronics hub and a western CEO in the U.S.-centered entertainment business.

Also, investors are clamoring to get back into the world's third-biggest economy where Prime Minister Shinzo Abe's promise of deflation-busting policies has triggered a share bonanza.

"He (Hirai) is very accessible to a western person," Loeb told Reuters in Tokyo the day after announcing that his hedge fund had built up a $1.1 billion stake in Sony. "And we wouldn't be here if we didn't think there was a tailwind from the economic policies in Japan."

Third Point's proposal is "one that affects a core part of Sony's business and the direction of our management, so the Sony board will give it thorough consideration," Hirai told reporters. Sony shares earlier closed up 5.9 percent as investors bet that Sony would at least look at the proposal. The stock has gained 22 percent since Third Point arrived.

Highlighting the challenge Hirai faces in reviving consumer electronics as a profit centre, Sony scaled down its sales targets for digital cameras and smartphones for the year to end-March 2015 by 13-17 percent, and chopped its operating profit margin goal for its PlayStation gaming business to 2 percent from 8 percent. [ID:nL3N0E31DG] Hirai last year identified those three units as core to a revitalized Sony.

DIFFERENT MIX

Sony's share registry could work in Loeb's favor.

The $21.2 billion electronics group has a large pool of foreign shareholders, who could be more easily tempted by the lure of a near-term valuation gain. Before Third Point amassed its stake, 35 percent of Sony stock was held overseas, compared with 22 percent at rival Panasonic Corp.

Sony's foreign ownership peaked at 53 percent six years ago, but has been whittled down as the group's losses ballooned and investors exited deflation-snarled Japan.

Sony also stands out among its Japanese peers by having less of its stock held by conservative banks and insurance companies. Prior to Third Point's arrival, Sony's top 20 shareholders held around 13 percent of its shares, with Japan's big banks accounting for about half of that. At Panasonic, with an ownership structure similar to most Japanese blue chips, banks and insurers hold more than half of the 22 percent owned by the top 20 investors.

RARE SUCCESS

While driving change in Japan can be tough - foreign activist investors are often stigmatized as asset stripping sharks - Loeb may be in the vanguard of a new wave of activism attracted by 'Abenomics'.

"Westernized companies are in the minority among large caps, for sure. Boards tend to focus on stakeholder management at the expense of shareholder value," said Oscar Veldhuijzen, a London-based fund manager at The Children's Investment Fund Management (UK) LLP. "The background of activism is very negative as it used to be a sort of Mafioso involved with a very different type of activism involving a lot of violence."

A preoccupation by Japanese companies in the 1980s and 1990s to keep shareholder meetings benign created a niche for sokaiya - gangsters who extorted money by threatening to disrupt carefully orchestrated annual meetings.

Veldhuijzen can boast a rare success for foreign activist shareholders. Rebuffed in a 2007 bid to raise dividend payouts at Japan's Electrical Power Development Co, or J-Power, The Children's Investment Fund Management bought a stake in former state-run monopoly Japan Tobacco in 2011, and called for higher dividends, management changes and a share buyback.

At the time, the government was looking for cash to help the reconstruction effort after the devastation of the March 2011 earthquake and tsunami. It agreed to increased dividends and this year sold a third of its stake in Japan Tobacco for more than $10 billion. At the same time, Japan Tobacco bought back stock worth more than $2 billion.

"They needed the money and the popularity of the government was very low. It was a very unique activist situation in that respect," said Veldhuijzen, who says his fund's return on its Japan Tobacco stake is "close to half a billion dollars."

ABE MAGNET

Veldhuijzen said 'Abenomics' could spur foreign activists to seek out Japanese targets, though he warned there are few big-name companies where their attentions would be welcome.

"When I look at Japan, I struggle to find large caps with attractive business models," he said, though he noted that Central Japan Railway Co, which operates the country's most lucrative bullet train lines, could be a "phenomenal" company if management could be persuaded to raise prices and ditch plans to spend $50 billion on a high-speed magnetic levitation rail line from Tokyo to Osaka in western Japan.

To tap into the 'Abenomics' effect, Veldhuijzen said his fund recently raised its stake in Japan Tobacco - which now accounts for 15 percent of the fund - hoping a return to inflation will push up cigarette prices, which at around $4 a pack are far cheaper than in other developed markets.

Josh Schechter is another investor who has succeeded where others have failed in Japan. Schechter is a partner at activist fund Steel Partners Holdings, which forced the removal in 2008 of management at Japanese wig maker Aderans Co. A year later Steel Partners wrested control of the board, and still owns 28 percent of the company.

"It's important you have a credible plan," said Schechter, who sits on the Aderans board. He said his fund aligned itself with local shareholders unhappy with the board and with managers wary of where the company was heading. The fund, though, could not repeat its success in 2010, failing to place its candidates on the board of brewer Sapporo Holdings. It later sold its 18 percent stake in the company.

Schechter declined to say whether his fund would chase new Japanese targets in the current climate, but noted Japan could spur investors if it tweaked its tax code to let companies turn business units into separate entities and offer their shares to existing stockholders free of a capital gains levy - the type of corporate rejigging at the core of Loeb's proposal for Sony.

Loeb needs to convince other Sony shareholders that selling part of the entertainment business would both generate cash to help the struggling maker of Bravia TVs and Vaio laptops and improve profitability at Sony Entertainment, which would remain under Sony's control.

"I think the proposal will be welcomed by foreign shareholders, but won't be 100 percent acceptable to Japanese ones," said Yuuki Sakurai, CEO at Fukoku Capital Management, the investment arm of Fukoku Mutual Life Insurance, which owns Sony stock. Although Sony looks westernized, its "culture is heavily rooted in Japan."

(Additional reporting by Emi Emoto and Chikafumi Hodo; Editing by Ian Geoghegan)

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