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Foreign fund 'not satisfied' after Kyushu Railway refuses proposals

Activist Fir Tree says shareholders are unhappy about undervalued shares

A Kyushu Railway bullet train in Kumamoto Prefecture, western Japan (Photo by Kosaku Mimura)

TOKYO -- New York-based hedge fund Fir Tree Partners says it is "not satisfied" with Kyushu Railway, after it refused the activist fund's shareholder proposals, which included a 10% buyback of company shares.

On Monday the investment firm held a media briefing regarding the proposals in Tokyo, once again explaining their reasoning behind the demands. Back in March, Fir Tree revealed they had increased their stake in Kyushu Railway to 6.1% and planned to submit a shareholder proposal for the company's annual general meeting, which will be held in June.

Managing Director Aaron Stern said: "We took time constructing balanced proposals that would not limit the company's operational and financial flexibility. Although we are happy to see Kyushu Railway moving in the right direction for expressing intentions to change the executive compensation system, that does not mean we are satisfied."

He added, "We stick to our proposals and will continue our dialogue with the company."

There were a total of six proposals, including a share buyback, election of directors and structural changes like shifting to a three committee structure, as well as the revision of compensation for both inside and outside directors.

However, Kyushu Railway announced last week it was rejecting all six proposals in a 21-page document detailing the reasons for its opposition.

The proposal for buybacks demands that the rail operator acquire 16 million of the company's shares for cash up to a total of 72 billion yen ($654 million) within one year from the end of the AGM.

Kyushu Railway cited the rapidly changing business environment, which is forecast to affect the company's operating income negatively during its midterm business plan lasting until 2021. Additionally, the company cited the need for capital to maintain strong performance in its core business as well as investment in growth areas like real estate and hotels.

The company plans a total capital investment of 340 billion yen in the next three years, including 210 billion yen for growth investment and consolidated operating cash flow of 220 billion yen.

"The total payout ratio of 50% in the shareholder proposal to conduct a share buyback is inappropriate for the JR Kyushu Group, which is aiming to realize medium- and long-term growth by exploiting investment opportunities flexibly even during periods of falling operating profit and drawing on debt capacity," the company stated.

"Because Kyushu Railway does not have debt, their capital cost comes across as artificially high compared to its peers, which is hindering the value the company could be offering to its shareholders," Stern explained. He also noted that the company's "ROE is declining while capital cost is not improving, which is not good for shareholder value. Our buyback proposal addresses that issue."

Stern said Fir Tree will continue to engage with the company but declined to comment on whether he has any intentions for a proxy fight or whether the fund plans to further increase its stake. Fir Tree is among the many foreign investors that are shareholders of Kyushu Railway. As of last September, more than 38% of the company's shares were held by foreign investors.

The rail operator, also known as JR Kyushu, is based on the western Japanese island of Kyushu. Aside from its transportation business, the company also engages in real estate, construction and retail.

Fir Tree began investing in Kyushu Railway in 2016, shortly after its initial public offering, and has gradually increased its stake. The investment firm had its eye on the company's high quality real estate portfolio, which includes commercial complexes like JR Hakata City. Previously, in an interview with the Nikkei Asian Review, Stern said the properties were under-evaluated by the market.

Kyushu Railway's stock price stands at around 3,400 yen, having declined 8% this year. Meanwhile, competitors are doing well -- West Japan Railway is up 12% and East Japan Railway is up close to 7% this year.

Stern said, "Since the company released its midterm business plan and their statement on opposing the shareholder proposals, its shares have reacted negatively, which signals that shareholders may be unhappy. We view that the stock value is worth more than twice its current price, so about 7,000 yen."

In the past few years, many other activists have shown an interest in Japan, with some nudging companies for better corporate governance. The trend is rising, as seen in companies ranging from big corporations like Toshiba, Lixil, Sony to smaller enterprises like construction company Hazama Ando.

In 2015, the corporate governance code was implemented with the aim of encouraging Japanese companies to appoint independent directors, become more transparent and raise return on equity. This gave activists easier access to Japanese firms that had been reluctant to talk, and allowed them to demand change.

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