Tales of old and new Japan
Over the past year or so, most major stockmarkets have been much more polarised than usual and Japan was no exception. Only 18.5% of the stocks listed on the Tokyo First section outperformed the index in 1999. The epithet for outperformers, the young entrepreneurs with e-business models and no track record, was new Japan. Underperformers like the steel, petrochemical and construction sectors were labelled old Japan.
This difference in performance continues to exist in all major stockmarkets, although the new sectors, telecommunications, media and technology (TMT) are now underperforming. In Japan, the valuation differential between old and new is particularly extreme, with Oracle Japan, for example, trading at three times the value of the parent company in the US in price/earnings terms.
As some of the excesses in the Japanese stock market ease off, it is worth considering the two causes of the disparity. The first is a mania based on the promise of doing business over the internet and the second is a fundamental shift in the make up of indices reflecting the value creation coming from high levels of IT investment. Growth in IT spending will mean many new economy companies enjoy a following wind, but that does not mean all companies will succeed. The old economy in Japan is battling a strong headwind, but that does not mean they will all fail.
The traditional manufacturers of commodities, or old Japan, were the backbone of Japan’s economy for most of the post war period. The pressures on Japan to open up its markets began a process of deregulation and competition that has wound up the post war economic period. This process is highlighted by a breakdown in the Keiretsu system or business “families”. When the Mitsui and Sumitomo groups proposed a merger between Sakura and Sumitomo Banks, anyone who didn’t believe that Japan was changing had to sit up and take notice.
The breakdown of this system means that old business loyalties, which have kept many companies alive, are disappearing. The hitherto mild pressures on companies who have relied on the system will intensify. Equally, increasing competition from south-east Asia, where labour is cheaper, is also an important factor. Unfortunately for shareholders in these companies, there is a paucity of good management to know how to cope, so no wonder the shares look cheap. Merger and acquisition activity grew strongly last year, but it has not stopped values falling for two reasons. First, free floats in old industry companies are still relatively small, making them difficult to acquire – 39% of the market is estimated still to be cross-held; and secondly, the risk of off balance sheet liabilities or accounting irregularities. The latter should disappear as accounting is reformed, but the former remains an impediment to forcing change.
New Japan is unburdened by such legacy problems of loyalty and over-regulation and it has become synonymous with the new economy, TMT. New Japan should rightly describe any company looking to capitalise on the opportunities exposed by deregulation. It also includes those cutting areas of business dragging on shareholder value in favour of ventures where they have a competitive advantage. This would sound elementary to any US corporate manager but in Japan it is still the exception not the rule. Old Japan can become new Japan, simply by embracing western capitalist principles.
From a top-down point of view, investors will continue to prefer companies benefiting from growth in IT spending, and to avoid areas with a poor medium term outlook, machine tools, for example. However that does not mean from a bottom-up perspective the old economy is a lost cause. The majority of traditional industry companies in Japan will go on producing woefully poor returns for shareholders, but that does not mean they all will. Neither will all new economy stocks reward shareholders for the fancy prices they have been paying. The situation is complicated and the litmus test of stock price performance in Japan will be the improvement of shareholder returns, which could come from any industry. Unfortunately for the old economy, the companies are battling a strong headwind.
Paul Chesson is head of the Japanese investment department at Perpetual in Henley-on-Thames