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Advancing the cause of shareholders' rights

Abe De Ramos documents the rise of shareholder activism in Asia and the incremental progress being made

The victory was very emotional for Scott Callon. For three months, the Tokyo-based chief executive of Ichigo Asset Management had been campaigning against the planned sale of steelmaker Tokyo Kohtetsu to a larger domestic rival, trying to convince management that the company was worth at least 30% more than it had been offered. Callon knew his cause was a shot in the dark. Management of both companies had already agreed on the acquisition, and in Japan, this meant the deal was as good as done.

Nonetheless, the former Morgan Stanley investment banker rallied other shareholders against the merger in the run-up to the shareholder vote. In February 2007, the campaign made proxy-voting history in Japan when investors overwhelmingly rejected the deal. “It was very moving, receiving the calls and emails of support from the other shareholders, many of them elderly,” says Callon.

In the past couple of years, shareholder activism has reached a scale— whether measured in number of cases, amount of money involved, or level of media coverage—that suggests recent activity has been more than just a random, anecdotal burst of dissent. To be sure, the amount of active engagement by minority shareholders in Asia might seem unremarkable when compared with the history of activism in developed markets such as the US and Australia. But the momentum can only grow, thanks to a couple of trends:

Increasingly shareholder-friendly behaviour among regulators and lawmakers; and


The influx of foreign investors, whose methods of boardroom campaigning are influencing local players.

If these trends are sustained, the result could be a major shift for investor culture in a region where the Confucian ethic of deference to figures of authority still predominates.

Structural issues also explain the lack of activism in Asia, where a tight-knit group of individuals or businesses often own big blocks of voting shares. From India to Indonesia, a typical listed company is majority-owned by its founder, who appoints himself and family members to management and board positions. In China, which is in transition from a state planned to a free-market economy, companies are still majority owned by the government. In Japan, where many business groups were destroyed during the Second World War, companies were rebuilt with the view of protecting themselves from foreign takeovers, creating patterns of cross-shareholding nearly impenetrable to outside influence.

Yet, remarkably, much of the recent activism has been happening in Japan. A series of legal changes has eased foreign-led acquisitions. As a result, a number of hedge funds and asset managers are now looking for profitable companies with poor management that they can either shake up or possibly acquire. During Japan’s proxy season in June, shareholder advisory firm Glass Lewis recorded 85 investor motions at 21 companies, compared with 47 motions at nine companies last year. These motions ranged from proposals for raising dividends to challenges against poison pills introduced by some companies in an effort to thwart foreign takeovers.

In south-east Asia, activism will get a push from Railpen Investments in the UK, which, through shareholder advisory firms Governance for Owners in London and HIM Governance in Singapore, has undertaken a pilot on voting and engagement at the companies in which it invests.

Tan Lye-Huat, CEO of HIM Governance, says the firm’s approach, involving up to 60 companies in Thailand, Indonesia, Malaysia, and Singapore, will be focused on pragmatic engagement rather than vocal and public confrontation. “We don’t perceive ourselves to be a replacement of management or the board,” he says, “but we are supposed to be a change agent.” Tan’s role will be similar to that of Jang Ha-Sung, South Korea’s most prominent business activist, who was tapped last year by New York-based Lazard Asset Management to advise its US$210 million Korea Corporate Governance Fund, which invests in small- to medium-sized companies.

Peter Butler, CEO of Governance for Owners, which is expanding to Japan, says Asian managers can learn from European companies such as Deutsche Börse and Netherlands’ Stork, the M&A strategies of which are being challenged by an increasingly foreign investor base. “Ignoring international investors and behaving as they had always done with domestic investors is a recipe for confrontation,” Butler says. “Asian directors need to learn new skills and communicate sensibly with investors to bring about reasoned changes. Most international investors are not hostile activists.”

Since the 1997 Asian crisis, corporate restructuring, both voluntary and under pressure from lenders, has put businesses back on track with a new management mantra: cash is king. In 2004, Merrill Lynch observed that most Asian companies had drastically reduced their debts, and thanks to the succeeding economic boom and a more conservative investment approach, these companies also had become cash rich. Their ability to generate free cash flow, however, has not always translated into higher dividends - or even a clear plan to reinvest them to boost return on equity (ROE). This state of affairs has made Asian companies the targets of activist investors such as Hugh Young, Singapore-based managing director at Aberdeen Asset Management, which manages a US$35bn Asian portfolio (part of the British firm’s total assets under management of US$137bn).

“That’s probably our most basic issue with classic, conservative family businesses in Asia that have built up cash over the years,” says Young, one of the handful of institutional fund managers in the region to have consistently stood up against shareholder abuses or neglect through letters, dialogues with management, and proxy voting.

“Of course,” continues Young, “cash is part of the investment attraction, but what are you going to do with it? If you need the money to grow, use it well; but if you haven’t got a need for it, give it back.”

That has been the recurrent theme of shareholder uprisings in the region. Last April, for example, shareholders of Hong Kong-listed CNOOC stopped the Chinese oil explorer from depositing US$450m of its cash with the financing arm of its Beijing-owned parent (with no guarantee that the funds would have been returned). In South Korea, US investor Carl Icahn and New York-based Steel Partners teamed up last year to force tobacco giant KT&G to raise its dividends and buy back US$2.9bn in shares. In Japan, investors are urging companies to revalue property still accounted for at historical value, sell off the assets, and use the proceeds for other investments, according to Yasuhiro Oshima, vice president of the CFA Society of Japan. “This,” says Oshima, “has raised awareness among shareholders that they can increase shareholder value by engaging with management.”

Various recent campaigns have met with mixed results. Last May, Sparx Asset Management successfully influenced both the management reshuffle at camera-maker Pentax and its merger with Hoya, an optical lens maker. In June, Steel Partners forced wig-maker Aderans to reconsider its takeover-bid policy. Instead of launching a poison-pill provision, the company appointed outside directors to a committee tasked with analysing unsolicited takeovers.

Likewise, Brandes Investment Partners managed to change the dividend policy of Ono Pharmaceutical. After the fund demanded a sevenfold increase in dividends, Ono revealed a new payout policy linked to its level of free cash flow. In Korea, Sindoricoh, a manufacturer of copiers and other office automation products, agreed to Lazard’s demand to appoint new auditors and outside directors.

Defeats also have been common, especially with cases involving takeover bids in Japan. As the Japanese government eased takeover rules in 2005 and again in early 2007, listed companies have been responding with poison pills (since 2005, at least 350 companies have introduced such devices). Steel Partners in particular suffered some high-profile setbacks. Last spring, when the fund made takeover bids for Bulldog Sauce and beer maker Sapporo, shareholders for both companies approved poison pill provisions, scuttling the respective bids. A similar proxy battle waged by New York-based Harbinger Capital against Doutor Coffee was also crushed when minority shareholders sided with management.

So far, activism has paid off for the most tenacious investors. Barring the fall of MAC Asset Management - the Japanese activist fund whose founder, Yoshiaki Murakami, was arrested last year for insider trading - the rest have shown stellar performance. Tracking six funds that have taken companies to court, launched takeover bids, or claimed to actively engage with management, Nikko Citigroup’s Activist Index outperformed the benchmark Topix Index by 225% from 2002 to 2006. Meanwhile, a study of two activist firms, published in February 2007 by Goldman Sachs Japan, shows that the firms also outperformed the Topix by 300% from 2000 to 2006. “This is the kind of success that feeds on success,” says Nikko’s Patrick Mohr, who launched the index last May. “If the funds generate more returns, you will see more people trying activist approaches in the future. Right now, it’s not very broad based, but we see that changing in the future.”

Indeed, choosing the right approach may prove to be the trickiest part for activist investors in culturally sensitive Asia. Callon of Ichigo indicates that in his campaign against the merger of Tokyo Kohtetsu and Osaka Steel, “there was a struggle between going back to the old passive form and accepting a more aggressive form of activism.” The answer, in the end, was neither. “We felt there was a third way where you could be respectful of Japanese values and other stakeholders while carrying out your responsibilities as an active shareholder,” says Callon, whose fund then owned 14% of Tokyo Kohtetsu. That meant avoiding arrogance and respecting management’s competence. In his talks with Tokyo Kohtetsu, Callon, who speaks fluent Japanese, told management he invested in the company because he believed in their ability to deliver value. “So,” he says, “it was purely about, ‘Is this the right price for us to give up our ownership in the company?’”

“That was a positive argument,” Callon adds. “What we were telling them was ‘We think that you’re far better as a company than the price that Osaka Steel has offered.’” That was the same message Ichigo stressed to other shareholders when it sought their support in a proxy solicitation - a first in Japan. And it did so with a human touch. “We didn’t hire an outside firm; we directly communicated with shareholders,” Callon says. “We sent emails, licked envelopes, and set up a special phone number for them to call if they had questions.” The outcome was unprecedented - three-quarters of the retail vote sided with Ichigo. “No shareholders in Japanese history had ever turned back a merger agreed by management,” says Callon. “In our case, I think investors were pretty motivated. They saw far more value in Tokyo Kohtetsu and didn’t want to lose their shares.”

Meanwhile, in a recent case in Singapore, minority investors of department-store operator Isetan started out their campaign amicably- only to turn confrontational in the end. Since 2004, they had been asking management at general meetings to indicate how the company planned to use a S$60 million tax credit to which it was entitled until 2007. Having received no satisfactory reply, a group of 43 minority shareholders called for an extraordinary meeting in January, with a resolution to replace three independent directors with the group’s nominees. Their goal: to pressure management to distribute the funds to minority shareholders before the tax credits expired. As Isetan’s Tokyo-based parent holds a 61% ownership stake, the minority investors’ proposal was voted down. Management of the Singapore entity, however, promised to address the tax-credit issue and announced a special and final dividend in February.

To Tan of HIM Governance, one of the three independent directors nominated in the Isetan case, the saga provided a lesson in activism for Asia. Neither he nor the shareholders who called for the general meeting expected the resolution to pass. The goal was to drive home a point: that shareholders are willing to do everything within their means to force change. “More often than not, threat of a high-level action is enough to force a certain course of action,” he says. “If it works and they act on the threat, then we don’t have to go through a lot of unpleasantness.” Adds Young: “Management generally becomes more responsive over time; although it doesn’t come naturally to patriarchs who set up the company, their managers understand what they should be doing for shareholders.”

Going forward, all eyes are on the future of takeover battles in Japan. Following a defeat in its proxy fight against Bulldog Sauce, Steel Partners took the company to court, seeking an injunction against its poison-pill provision - the first time the legality of takeover defences was challenged in Japan - and calling it a violation of the principle of equal treatment of shareholders. On 28 June, a Tokyo court ruled in favour of Bulldog Sauce. Steel Partners filed an appeal to the Supreme Court on 10 July.

While some viewed the lower court’s decision as a setback for activism, others predicted it would only motivate activist funds to further challenge such defences.

For the rest of Asia, activism is likely to gain institutional support over time. More North American and European pension funds have been engaged recently in “relational investing,” helping to create a new breed of talent and corporate governance activists who will pursue shareholder value.

“Knowing how to exercise shareholder rights and being able to build alliances with other shareholders present opportunities for shareholder engagement,” says Peter Taylor. He concludes: “Know which battles you can win and which ones you can’t.”

Abe De Ramos is a policy analyst with the CFA Institute Centre for Financial Market Integrity

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