Activist Investors in Japan

The following famous quote was made by James Carville, a lead strategist for Bill Clinton’s 1992 presidential campaign, in 1993:

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

Given the subsequent decline in bond yields - and the near-zero yields seen a few years ago - the quote no longer feels as apt. A more relevant modern version would be about activist investors.

Fundamental investing is structurally challenged. You can buy a cheap stock only to see it get cheaper over extended periods. I think it’s been superseded by what I refer to as “catalyst investing”. This involves taking a position in a stock ahead of a catalyst, such as an earnings report.

The great thing about being a well-known activist investor is that you can create your own catalyst: the mere act of buying a stock generates publicity and triggers a meaningful spike in the share price.

By contrast, I can take a large position and explain how fundamentally cheap a stock is, and no one cares. I would like to be reincarnated as an activist investor.

Before launching our Japan strategy, I wrote that the increased influence of activist investors was a positive development. I believed they would target fundamentally cheap stocks in our long portfolio and “shorten the time required to close the gap between market and fundamental values, making it more compatible with our investment horizon”. I was wrong.

Numerous Japanese stocks targeted by activist investors have been in our short portfolio. The latest example is Daikin (6367 JP). As reported by CNBC:

“Shares of Daikin Industries surged as much as 13.9% on Thursday [April 16] after activist investor Elliott Investment Management said it would work with the company to improve performance and narrow its valuation gap with peers”.

Based on our quant analysis, Daikin looks like a strong sell. It’s expensive and has extremely poor earnings momentum. And unlike numerous Japanese stocks it doesn’t have any massively undervalued assets on its balance sheet.

Elliott Investment Management proposed a share buyback, but unlike many Japanese companies, Daikin Industries doesn’t have significant net cash. And buybacks are becoming somewhat passé in Japan - almost every second day it seems a Japanese company is announcing one.

Elliott Investment Management also proposed that it works with management to improve its profit margin by making the company more efficient and consolidating its production and development facilities.

I’m sure the team at Daikin will be thrilled to hear they could be doing a better job - and that a U.S. hedge fund knows better than they do how to run their business. Because, of course, Japanese companies just love being told what to do by foreigners. /s

It will be interesting to see how this plays out. I’m obviously sceptical and have been adding to the fund’s short position.

It feels like Elliott Investment Management could randomly pick almost any stock and it would pop 10%. Borrowing from James Carville’s famous quote, they can “intimidate everybody.”