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Toshiba's ambiguity on M&As leads to showdown with key shareholder

US fund wants battered company to present clear plan for reaching its goals

Reporters raise their hands for a question during a Toshiba news conference.    © Reuters

TOKYO -- Is Toshiba planning to go on an acquisition shopping spree backed by almost $10 billion, a possibility raised by a major shareholder? Or is it all a big misunderstanding, as the Japanese engineering company claims? This brewing dispute will be at the center of an extraordinary shareholders meeting scheduled for March 18.

The larger issue is what is the best path forward for Toshiba, a company that was brought to the brink by its disastrous purchase of the American nuclear plant builder Westinghouse. Farallon Capital Management, which has a large stake in Toshiba through affiliate Chinook Holdings, wants to ensure that the company sticks to improving existing operations to meet its goals.

The dispute centers on the Toshiba Next Plan, a medium-term road map originally released in 2018. Toshiba said in a June 2020 progress report that hundreds of billions of yen would be used to make planned, small-scale "programmatic" mergers and acquisitions.

But in November, another progress report was issued, setting targets for fiscal 2025. Chinook cried foul, saying Toshiba had without good explanation now set aside approximately 1 trillion yen ($9.5 billion) that could be used for such risky bets as opportunistic "major" acquisitions.

Chinook reached this conclusion by reading the operating cash flow figures through fiscal 2025, disclosed in the November report. Toshiba will generate about 1.3 trillion yen that will be equivalent to vaguely defined surplus funds.

Toshiba's November progress report has a key ambiguity that leaves shareholders scratching their heads. It categorizes both M&A deals and stock buybacks under "strategic investment," which appears to amount to roughly 1 trillion yen. Whether this money is allocated toward growth -- by making acquisitions -- or by rewarding investors --- via stock buybacks -- can change on a whim.

Chinook will present a shareholder proposal that would direct Toshiba's board to "formulate a capital policy proposal, including a reasonable explanation of the policy, for strategic investment for growth for the fiscal years ending between April 1, 2021 and March 31, 2026, which shall be presented to a shareholders meeting for its approval."

One mystery is why this dispute is occurring in the first place. Toshiba's board includes Raymond Zage, who has served there since 2019. Zage previously ran Asian operations of Farallon, which manages Chinook assets on contract. Many wonder why this issue wasn't resolved before it was necessary to call an extraordinary shareholders meeting.

It appears that Chinook is mainly concerned about the scale of Toshiba's acquisition strategy. The November progress report calls for reaching sales of 4 trillion yen in fiscal 2025, along with an operating profit of 400 billion yen and 15% return on equity. Looking at the numbers, the pathway to reaching these goals is improvement of existing operations, not acquisitions.

According to the so-called DuPont equation, ROE can be broken down into three factors -- total asset turnover, net profit margin and financial leverage. Under an effective tax rate of 30%, fiscal 2025 would have a net profit of 280 billion yen, or a net profit margin of 7%.

The margin greatly outstrips the 2.3% seen for this fiscal year. And even after adjusting for the impact of the coronavirus pandemic, that figure will need to see a significant improvement to meet that goal.

Toshiba did not include an official target for asset turnover. But an executive said the company "aims for a ratio of 1.0." Based on this figure, which is slightly higher than the 0.9 expected this fiscal year, Toshiba's financial leverage would come to 2.1.

For Toshiba to meet its medium-term goals, it will need to add roughly 1 trillion yen to its sales and raise its net profit ratio to 7% from 2.3% by the fiscal year ending March 2026. Achieving this through acquisitions alone -- which would mean snapping up corporate assets with 1 trillion yen in sales and with net profit ratios of 20% or more -- is not realistic given its budget.

Therefore, bolstering existing businesses will be crucial to its medium-term goals. Toshiba is especially bullish on its infrastructure solutions, given that such facilities as nuclear reactors and water treatment plants require decades of maintenance services.

Toshiba expects an operating profit margin of 9% for infrastructure services this fiscal year. This is higher than at its other two major business fields and is not far from the companywide medium-term target of 10%.

The ultimate goal is to increase sales from infrastructure services by 500 billion yen to about 1.8 trillion yen. Toshiba expects about 230 billion yen of the boost to come from acquisitions, including in offshore wind farms, virtual power plants and other businesses related to renewable energy. Toshiba and GE are discussing a tie-up on core equipment for offshore wind power systems, Nikkei reported Monday.

"We are essentially done reforming our portfolio," such as through exiting unprofitable businesses, Toshiba CEO Nobuaki Kurumatani has said. The company is now expected to focus on such emerging fields as big data and quantum key distribution. But these are still in their early stages and will likely not bear much fruit over the course of the current medium-term plan.

Toshiba is at a crossroads. On the one hand, activist investors seek the right time to recover the 600 billion yen they injected into the company when it increased its capital back in 2017. On the other, there is speculation that long-term investors could flock back to the company after its Jan. 29 return to the first section of the Tokyo Stock Exchange.

But right now, many remain skeptical about Toshiba's prospects.

"It's good that they've set out targets, but I need to see progress before I can believe that they're achievable," said Masahiko Ishino, a senior analyst at the Tokai Tokyo Research Institute, echoing the mainstream view among market watchers.

A QUICK Consensus survey of analysts projects Toshiba's net profit this fiscal year at 82.9 billion yen. That puts the price-earnings ratio at 19, indicating that many investors doubt whether the company can meet its ambitious medium-term goals.

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