Addition by Subtraction in Tokyo

Kopin Tan | Barron’s | 08.25.2012

Japan has about 3,500 publicly listed companies, but David Baran thinks there really should be fewer than 2,500. A third of Japan’s public companies, he says, would be better off privately owned and run.

Baran, Tokyo-based co-CEO of the hedge fund Symphony Financial Partners, isn’t the only one who believes that. Perennially slumping prices of public shares, cheap bank financing, and changing attitudes have spurred an increase in Japanese management-led buyouts, or MBOs, where investors team up with executives to take public companies private. Last year, the total value of Japanese MBOs doubled to reach $4.08 billion, the highest level since a burst of activity just prior to the financial crisis in 2008, according to Dealogic.

This is good news for Japan’s long-suffering value investors. Finding cheap stocks in Tokyo hasn’t been the problem in recent years; it’s getting them to go up that’s the challenge. Baran suggests browsing for undervalued stocks that are also potential MBO targets, an added catalyst.

Public valuations are especially depressed among overlooked small companies with market caps of less than 100 billion yen (US$1.27 billion). One in every five such companies has an enterprise value less than three times its cash flow. A whopping 183 companies–or roughly 6% of the small-cap sector–recently sported market values below even their cash holdings.

“These companies are obvious MBO targets, but management usually has limited interest in taking action, as they view the cash as their retirement allowance and safety net,” says James Rosenwald, managing partner of Dalton Investments. For example, Dalton teamed up with private-equity investors to take Sun Telephone private in 2007 and has since slashed debt leverage from 90% to zero, freeing up cash flow to pay dividends amounting to 30% of their initial investments. Rosenwald expects these payouts to continue “until the markets turn more positive and we can re-list Sun Telephone on the Tokyo Stock Exchange.”

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