What Warren Buffett sees in Japan Inc
TWHERE TO UNDERSTAND WHY it was a shock last month when Berkshire Hathaway invested $ 6.5 billion in five Japanese trading houses that have been around much longer than its 90-year-old president, let’s go back to a talk Warren Buffett gave to business students in Florida in 1998. As a spirited sixty-something with his sleeves rolled up, the Sage of Omaha was at his witty and wicked best.
The first question he asked was about investing in Japan. He replied that the country’s 1% interest rates made it attractive. Nonetheless, he viewed Japanese companies as bad bets due to their poor performance. Low-profit companies might be worth buying based on what he called the “cigar butt” approach. “You are walking down the street and looking for a cigar butt somewhere. Finally you see one and it’s soggy and a bit repulsive, but it’s still a puff in it. So you pick it up and the puff is free. But even that theory wouldn’t draw him to Japan Inc, the pride of the country’s post-war renaissance, he explained. It’s hard to think of a more distasteful analogy in a country as posh as Japan.
Some 22 years of low interest rates later, Mr. Buffett has finally overcome his phobia of obscenity. Berkshire’s investment in 5% each of Itochu, Marubeni, Mitsubishi, Mitsui and Sumitomo, while small compared to its investment firm’s $ 140 billion in cash, was largest outside the United States . He said his holdings could grow as much as 9.9% over time. But the acquisitions were a headache. What, if anything, had changed over the past decades to make business houses suddenly attractive? Or had Mr. Buffett simply succumbed to the temptation of a few cheap puffs because the money burned a hole in his pocket?
At first glance, the acquisitions give the impression that he has lost the plot. Trading houses, or sogo shosha, makes fun of many of the investment principles he has held fast to all his life. He says he likes easy-to-understand companies like Coca-Cola and Apple. He argues that businesses should not only be cheap, but have reliable returns and, ideally, “ditches” to keep competitors at a safe distance. On every account, the trading houses fail miserably.
Start with simplicity. In the eyes of the West, no Japanese company is a model of Anglo-American shareholder capitalism. But few seem as far removed from it as the trading houses. They are shaped by history, which dates back to the 19th century zaibatsu and post-war keiretsu system of corporate loyalties and cross-shareholdings. In the modern age, their business models have twisted and transformed. From the 1950s to the 1980s, they acted as middlemen, scouring the world in search of energy, metals, and minerals, helping to support Japan’s economic miracle. Then they invested in mining and hydrocarbons to fuel the commodities boom led by China before moving “downstream”, buying everything from convenience stores to cable companies. In the process, they accumulated assets faster than they sold them. The results are heavy. Mitsubishi sells everything from coking coal to Kentucky Fried Chicken. The most profitable Itochu calls its consumer division the 8th company, implying that it has no more names after seven other units.
What about returns and value? Undoubtedly, trading companies are inexpensive. Of the five, only Itochu trades at a market price above the carrying amount of the net assets on its balance sheet. That’s not to say they’re a good deal, however. Kikkawa Tatsuya of JPMorgan Chase, a bank, says their low-yielding legacy assets, which sometimes experience significant write-downs, increase investors’ perceptions of risk. Their complexity increases their cost of equity, which is higher than for more targeted commodity producers, such as ExxonMobil or Rio Tinto.
And then there is the competitive position of traders. Perhaps Mr. Buffett is betting that as a revered corporate species in Japan, the sogo shoshasurvival is certain. But as individual businesses, their returns suggest they have nothing to do with the moats of other Berkshire mainstays. Rather, they are each other’s most bitter rivals.
Look beneath the surface, however, and there may be a method in Mr. Buffett’s madness. As he admitted in 1998, his view of Japan could change if leaders become “more responsive to shareholders.” In recent years, they have done so, even in trading houses, which once viewed corporate governance with contempt. Zuhair Khan of Union Bancaire Privée, a Swiss bank, said opinions started to change following shareholder-friendly reforms promoted from around 2014 by Abe Shinzo, who resigned as prime minister in the Beginning of the month. In some trading houses, executives have bought large amounts of shares to align their interests with those of other shareholders. Compensation has become more performance-based. The focus has shifted from investing to generating cash and increasing dividends. The pandemic is expected to slow down but not derail the trend. Suga Yoshihide, Mr Abe’s successor, appears keen to take further steps to hold shareholders accountable, Mr Khan said.
Mr. Buffett can see other attractions. He likes energy companies, and all the trading houses, especially Mitsui and Mitsubishi, have big energy companies. They are expected to benefit from a post-pandemic economic rebound that stimulates demand for electricity. Companies are also sources of talent. Jeremy White of Baker McKenzie, a law firm, says they maintain a tradition of recruiting from top Japanese universities and rival investment banks and tech firms as the most prestigious companies to work for. And if anyone can navigate confusing organizational charts and balance sheets, it must be the people behind Berkshire Hathaway, America’s largest financial conglomerate.
Stogy? Or just gruff?
It is not a safe bet. History is littered with fortunes lost because of the belief that Japanese companies can become more Anglo-Saxon. If so, Berkshire shareholders will miss Mr. Buffett’s nonagenarian adventure. If, on the other hand, his investments reinforce the idea taking root in Japan that shareholders, domestic and foreign, are a constituency worth fighting for, he will deserve a big Cohiba. ■
This article appeared in the Business section of the print edition under the title “Lighting up Japan Inc”