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Stocks

Investors prodding cash-rich Japan Inc. to spend smarter

Buyout of ad agency Asatsu-DK shows pressure for better capital efficiency

TOKYO -- Investment houses are turning up the heat on Japan's stubbornly undervalued companies to make better use of capital, creating a new wave of pressure on top of government-led corporate reform.

Showcasing the trend is Japan's No. 3 advertising agency, Asatsu-DK, which made news Monday by deciding to delist via a tender offer from U.S. private equity firm Bain Capital, apparently frustrated with the lack of improvement in its return on equity.

"Bain beat us to the punch" with the buyout, lamented one investment manager at another U.S.-based asset management firm. ADK shares were lifted by a buying frenzy as the market opened Tuesday, rocketing past the tender offer price of 3,660 yen ($32.46) to touch a high of 3,820 yen.

The manager's firm had been making strategic bets in hopes of taking on a more activist role at companies and pressing them to improve their use of capital. ADK's stock was on their list, as was convenience store chain Ministop.

Chronic undervaluation

ADK is among the foremost examples of undervalued Japanese stocks, owing to a glut of idle financial assets. The ad agency's market cap was just over 130 billion yen before Bain's tender offer, though the U.S. firm will pay a premium to buy it for about 150 billion yen.

But ADK's books show it with about 17 billion yen in cash and deposits, and effectively zero debt. Its investments in securities total about 88 billion yen -- largely in shares in its U.K. partner agency WPP Group, which it is divorcing through the Bain buyout, and in Japanese business partners. Were it to sell off those securities, the proceeds plus its cash would top 100 billion yen. A back-of-the-envelope calculation therefore shows Bain spending less than 50 billion yen on the company.

ADK's ROE is also low, leaving it chronically undervalued and drawing investors' ire, to the point that the president was reappointed with only 59.5% of the vote at this year's general shareholders meeting.

Bain probably smelled a bargain with ADK. A key measure for acquisitions showed the Tokyo ad agency earning back its purchase price quicker than Japanese market leader Dentsu, or American broadcast media companies, for instance.

ADK's enterprise multiple -- its enterprise value divided by earnings before interest, taxes, depreciation and amortization, EBITDA for short -- is around five, or just shy of eight at the roughly 20% premium Bain is paying. Dentsu and the like would have less-appealing ratios in the nine range.

Widespread inefficiency

Government-backed corporate governance reform efforts, which kicked off with Prime Minister Shinzo Abe's signature Abenomics policy in late 2012, have made some businesses more attentive to ROE. Yet ADK is hardly alone in staying persistently undervalued. Even with the Nikkei Stock Average hitting two-year highs, a full 30% of Tokyo Stock Exchange first-section components have a market value below their book value.

Market pressures are knocking harder and harder on management's door, with activist investors and major institutional investors even teaming up, a rare display. Nikko Asset Management recently endorsed a proposal by investment fund Strategic Capital urging Tosho Printing, a listed unit of Toppan Printing, to increase dividends.

British equity management firm Silchester International Investors, which owns a 17% stake in ADK, appears to be nudging the likes of drugmaker Suzuken to improve ROE as well. Should the market press another company into following ADK's example, it could improve the undervaluation plaguing Japanese stocks and lead to higher prices overall.

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