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HenryTo
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Joined: 06 Aug 2004
Posts: 7177
Location: Houston, Texas & Los Angeles, California
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 Posted: Thu Jun 19, 2008 11:15 am Post subject: Matthews Funds |
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Matthews Funds - the Asian specialist - on Japan:
http://www.matthewsfunds.com/about_asia/asia_insight.cfm
| Quote: | What You Wished For
Virgil Adams
Senior Research Analyst
Matthews International Capital Management, LLC
To many investors, Japan is an enigma. The Japanese market has been stuck in a rut for nearly two decades, and it seems that every time we find encouragement in a single step forward, the country ends up taking two steps back. I was in Japan for most of these two "lost decades" and can empathize with investor frustrations over the behavior of both Japan's market and companies. However, I also believe there are some very positive changes that are occurring which may generate opportunities for investors in Japan over the coming years.
The headlines of nearly every investment periodical reference the problems of the U.S. housing market, challenges created by skyrocketing oil and commodity prices, and the threat of inflation. Another dominating story is the risk of a worldwide recession, given how "coupled" markets abroad relate to the American economy.
In Japan, not only do these problems exist, but there are the added difficulties of lame-duck political leadership, forecasts of declining profits for the new fiscal year, and fears of protectionism preventing needed M&A. Beyond the headlines, however, we are seeing the emergence of some important trends in Japan—trends that rarely make headlines because they represent structural (and thus, gradual) changes, rather than events that make for daily news. Perhaps the most significant, and yet also the most misunderstood of these trends is the return of inflation.
"Inflation" is a word that strikes fear in countries like the U.S., but in Japan— which has been suffering from the opposite condition for the last 20 years—it is a welcome change. The sales and profit growth of Japanese companies as a whole over the last 10 years shows that—in aggregate—Japanese companies have been able to grow profits consistently (and considerably) in a zero-growth sales environment. "Sales" for any company are simply a function of "volume" and "prices"; While Japan has seen healthy growth in sales volumes during its long recession, the average selling price of goods and services fell enough each year to keep overall sales flat-lined. In an inflationary environment, that is likely to change, and the result on corporate profits could be significant.
It was only a couple of years ago that Japan-watchers considered the deflation that was plaguing the country to be the largest hurdle to sustainable economic recovery. They wished for some inflation and their wish is now being granted. But many are now too preoccupied with the potential damage inflation can inflict on a country like the U.S. (with a negative net savings rate) to appreciate the positives it can have on a very different country like Japan. In this case, the old saying, "Be careful what you wish for, because you just might get it" is not applicable; the inflation Japan has been wishing for is finally starting to materialize, and its impact, we believe, will lead to strong corporate profit growth, increased bank lending, and more consumer spending.
Japan is still very much a manufacturing economy, with high fixed-cost bases and dependence on imported raw materials. If a semiconductor manufacturer increases sales volume, the increase would amortize the fixed-cost base and, in general, lead to higher profits. But much of that positive "volume impact" has been wiped out by erosion in selling prices (deflation). If manufacturers could increase the selling price of their products, all of the increase would flow to the bottom line—there is no new cost associated with simply charging more for the same product.
Japan hasn't been able to do that in the past, but we are seeing signs that pricing power is beginning to return, at least to certain companies and segments of the economy. Japanese companies have spent the last 15 to 20 years cutting costs and reducing debt; at this point, the survivors of the post-bubble period are, for the most part, lean companies that have no more fat to cut. When input prices such as copper, oil, steel and electricity rise, companies either have to pass this increase on to end users or absorb it themselves. Of course, simply passing on material cost increases does not raise profits, but it is beginning to change the mindset of corporate entities and consumers. People are beginning to expect persistent increases in the general price level—the very definition of "inflation"—and this expectation will lead to changes in behavior that will benefit the broader economy.
This expectation of inflation can be a powerful force. As the expectation spreads and real inflation returns to the Japanese market (we are seeing it now, not only in the price of energy and food, but increasingly in labor costs and a range of other goods) overall savings should increasingly be converted to consumption, interest rates will rise, loan growth will accelerate, and the value of long-term assets will increase.
Inflation will also help propagate Darwinism in a country in which nearly every industry is fragmented and populated with small, inefficient enterprises. In fact, the dichotomy alluded to above—one group of companies that can pass on higher costs and another group that cannot—is becoming increasingly pronounced. Companies that can't pass on the higher costs will be forced to merge with other companies in order to "get scale".
Slimming, Trimming and Consolidating
In nearly every Japanese industry, there are too many companies: Japan's three largest pharmaceutical companies combined are less than half the size of Johnson & Johnson. The largest retailer in Japan, the world's second-largest economy, is about one-tenth— yes, one-tenth—the size of the largest retailer in the U.S. Japan's largest chemical company doesn't even break into the top ten worldwide. How many fiber optic cable manufacturers can you name? In Japan, there are four. Think of that: there are more fiber optic companies in Japan than there are in the rest of the world. The fragmentation that exists in Japanese industries hasn't changed. What has changed recently is the need for scale amongst these small but increasingly globally focused players.
Japanese companies need M&A and consolidation to have the scale necessary to negotiate pricing contracts with both suppliers and end-users. There have been barriers to M&A that have existed in the past, such as cross-shareholding or the reactionary move to create poison pills. These have shielded Japanese industry from consolidation in the past, but the increase in input costs for lean organizations that don't have the ability (or scale) to pass on those costs is an undeniable force that will tear these barriers down.
But how can there be consolidation when companies such as Jpower seem to be violating the core principles of publicly traded companies? Many Japanese companies have been reactionary about being acquired by investment companies, which means being presented with nothing more than a demand for higher dividend payments and the potential of being chopped up and sold off piecemeal. However, they are not as averse to being acquired by strategic investors that can help grow their business. We expect to see more M&A between foreign and domestic strategic partners and their Japanese targets, and these marriages will likely result in larger, stronger (and we believe more profitable) enterprises. Of course, financial investors can still play a role in changing the landscape of the market, as Steel Partners' recent victory over Aderans shows.
Of course, there are many challenges remaining for Japan. But with each door closing, another seems to open. Asia is shifting from being merely a place for low-cost production to a market in and of itself, and the growth in business and consumer spending in the region could more than outweigh declines in exports to the U.S. Japan should also quickly transform from being a mass producer of commodity products (where deflation is felt most) such as laptops and mobile phones to being the world's source for new technologies such as earthquake-resistant construction materials, low-emissions diesel particle filters and ultra-energy efficient appliances. This shift to unique, value-added and highdemand products is in itself a powerful shield against deflationary pressures that might persist.
Finally, Japan is regaining some of its "attractiveness" relative to other large equity markets. Japan has been through the fire of a housing bubble. It has gone from being over-levered to underlevered, and it has spent the last 20 years becoming adept at cutting costs and not relying on growth to solve its problems. Japan, in other words, has been through the fire that the U.S. is in currently. Not having a financial industry that is tied together with CDOs (collateralized debt obligations) and other derivative instruments that cannot be valued or untangled is an added benefit.
As any Japan watcher knows, the tide changes slowly in the land of the rising sun, but when a critical mass is reached, the spillover is rapid and dramatic. Positive change is building in Japan, and sometimes—as with inflation—it comes in forms that might not at first be recognized as beneficial. When the "tipping point" comes is anyone's guess, but the upside will be surprising, and we are encouraged by the signs of change.
May 31, 2008 |
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HenryTo
Site Admin
Joined: 06 Aug 2004
Posts: 7177
Location: Houston, Texas & Los Angeles, California
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| Posted: Wed Jul 23, 2008 11:28 pm Post subject: |
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Matthews Funds on South Korea:
http://www.matthewsfunds.com/about_asia/asia_insight.cfm
| Quote: | Wisdom in Crowds
Michael B. Han, CFA
Portfolio Manager
Matthews International Capital Management, LLC
Last month, South Korea’s decision to resume U.S. beef imports triggered massive protests in Seoul. For more than 40 days the city was moved by rallies that escalated into an outpouring of tens of thousands who took to the streets to oppose a trade deal they feared could expose the public to mad cow disease. The issue has posed a political crisis for South Korean President Lee Myung Bak, who took office following a landslide victory just four months ago.
Until about five years ago when a case of mad cow disease was detected in the U.S., South Korea had been among the top importers of American beef. Though many U.S. officials maintained that there were no statistically significant safety risks to U.S. meat exports, Korea, along with Japan and the European Union, imposed a blanket ban, later resuming conditional imports. Then in April, public outcry ensued when President Lee, a former chairman of Hyundai with a reputation for action that has earned him the nickname "The Bulldozer" agreed to lift the U.S. beef ban. The move was seen as one expected to help clear the way for a broader U.S.–South Korea free trade agreement that has been stalled. But by June, growing public uproar over the issue led Lee’s presidential aides to resign over the flap.
In and of itself, the reopening of the domestic Korean market to U.S. beef may not seem to justify the widespread furor that it unleashed. But what the public backlash really represents is Korea’s fear that its government is not acting in its best interest. The mostly peaceful protests have not been demonstrations against the U.S., or against free trade. Rather, the frustrations have been directed at the leadership’s lack of sensitivity to concerns over health risks, and highlight fears that the government prioritizes business over public safety.
President Lee has since publicly apologized over the situation and modified his earlier trade deal to limit U.S. beef imports to younger cattle, believed to be at less risk of mad cow disease. Despite the moves, however, the beef protests have given rise to sharp criticisms of the administration’s other plans for economic reform, including possible plans to privatize the public health care system and plans to build a grand canal. There have also been criticisms over Lee’s cabinet member selections.
How does a president’s landslide election victory plummet to record low approval ratings just a few months later? To begin with, South Korean voter turnout has been quite low, and many voters in the last election generally felt they were choosing between the “lesser of two evils.” Many protesters also regard President Lee’s beef deal as a rash and reckless act that stood to realize merely $1 billion in beef imports.
It is still unclear what will become of any free trade agreements between the U.S. and South Korea but the wider issue is that of Korea’s distrust of government. That Koreans feel inclined to take to the streets en masse may also indicate the lack of effective legal and political systems for public disputes. Compared to the U.S., Korea’s legal system is less approachable for the average person and the society is generally less litigious. When class-action lawsuits are not an option for protection, it is easier to understand why many may be moved to protest publicly. The danger, however, is that the political distrust is breeding voter apathy and diminishing turnouts at election time.
What is remarkable to note, however, is the ability of protesters to affect public policy. Following public backlash to the beef issue, the U.S. has reportedly looked further into establishing a system to verify the age of its livestock. The U.S. media has also begun to urge tighter regulation on the food inspection system. It seems that the aggregate wisdom of crowds and their voices have carried across the Pacific.
Evolution of Democracy
There are significant differences between the culture of demonstration in Korea now, compared to that of 20 years ago. Pro-democracy movements in South Korea in the 1980s were largely driven by college student leaders and frequently turned violent. Though recently there have been increasingly violent clashes between protesters and police, demonstrations over the beef issue began calmly when the majority of ordinary citizens participated. They have included young parents with children, executives in suits, middle school students, Roman Catholic nuns and Buddhist monks. Another important difference is that unlike the pro-democracy movements of two decades ago, the recent beef protests have involved no single, specific ideology, political leaning or special interest group. The protests involved passionate debate among participants, who remained respectful to each other. Commentators have credited Koreans for protesting peacefully, noting the high level of public participation as evidence of a maturing democracy. South Korea’s high Internet penetration rate, and its use of the Internet to mobilize the public over social issues, are also seen as signs of a highly educated society.
Indeed, Korea places great emphasis on education. It ranks fifth out of 35 developed nations in terms of its percentage of graduates under age 35 with four-year college degrees or higher, according to the Organization for Economic Co-operation and Development. The country also ranks third behind only India and China in terms of the number of students it sends to the U.S. each year to pursue higher education degrees. (In 2007, more than 62,000 Korean students came to the U.S. for school.)
The evolution of democracy in Korea is also evident in the decreasing signs of corruption where business and politics overlap. In the 1980s, two former presidents, Chun Doo Whan and Roh Tae Woo, had received illegal contributions of $1 billion and $500 million, respectively, from businesses. Both former presidents were convicted, and subsequent leaders have been accused of taking far less in kickbacks from business. The most recent offense—involving $10 million in controversial campaign contributions—by former President Roh Moo Hyun indicated there is a large decline in the size of dubious financial contributions to politicians.
Economic Democracy, the Next Evolution
Just as political democracy benefits grassroots movements, economic democracy benefits minority shareholders. Following the 1997 Asian financial crisis, Korean officials improved government transparency by adopting accounting standards similar to those of the U.S. The next step is to improve corporate governance.
In Korea, public participation, not activist hedge funds, paved the way to economic democracy. Non-government organizations (NGOs), which comprise professors and lawyers, have been involved in shareholder activism over the past decade. NGOs such as the People’s Solidarity for Participatory Democracy and Solidarity for Economic Reform, backed by minority shareholders’ voting rights, initiated a proxy battle against majority shareholders of what is known as chaebol, or large family-controlled conglomerates. Chaebols have played a significant role in the exportoriented growth of Korea’s economy. Though many chaebol affiliates have grown to become top-tier players in their fields, many could still benefit from improvements to corporate governance.
Armed with professional volunteers, NGOs have uncovered tax evasion cases or revealed other questionable corporate transactions that have benefited chaebol families at the expense of minority shareholders. NGOs are developing the skill of using litigation and proxy battles to enhance public awareness over complicated corporate governance practices. The organizations have also rallied against bad policy proposals regarding the adoption of poison pills.
Shareholder activism initiated by NGOs has also begun to move institutional shareholders. The National Pension Service (NPS), the country's leading institutional investor and the only national pension fund, voted against two business tycoons (both formerly convicted of fraud) who were seeking re-election to the boards of their respective corporate subsidiaries. The NPS’ first attempt to remove the two board members failed because the two tycoons had large holdings. The fund currently has $220 billion in assets under management, and its asset allocation in the domestic equity market has been growing rapidly, which indicates that NPS may play a significant role in the future. There also appears to be a stronger likelihood that, going forward, people will be more concerned with corporate governance, which is critical to the performance of their retirement savings. Corporate governance and political transparency deserve more public attention than they currently receive. Fortunately, we continue to see signs of positive change—even if it’s in the form of surprisingly massive beef rallies. We see an evolving sense of democracy among those who are mobilizing to shape public policy. As these trends continue we hope minority shareholder value will be enhanced and a more vibrant sense of entrepreneurship will evolve.
June 30, 2008 |
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