The Japanese Money Tree – Investors in Japan Now Face a Day of Reckoning
In his book, Only the Paranoid Survive, former Intel Corp President and CEO Andrew Grove highlights what he calls a ‘strategic inflection point’, or ‘a time in the life of a business when its fundamentals are about to change'. These can either herald future success for the firms who adapt, or the imminent demise of those who do not.
The Japanese markets are in the midst of such a shift, and investors must adopt their strategies accordingly. Many have profited by investing in firms with heavily discounted tangible assets in recent years. With such assets appearing on financial statements, it was relatively easy to spot disparities between firms’ market values and the worth of cash, marketable securities, real estate, plant, inventories and equipment held by them. The spectre of a bank failure by Resona Holdings Inc triggered fears of a deflationary spiral in as late as 2003, and hundreds of companies in Japan were up for sale at large discounts. Many companies on the first and second sections of the Tokyo Stock Exchange could be bought at below book value in early 2003.
Such an opportunity was bound to be short-lived in the world’s second largest economy. Since the government announced it would bail out the nation’s fifth largest bank holding group later that same year, fears of a deflationary meltdown have receded. A recovery in exports has also contributed to optimism, and stock prices have rebounded dramatically.
With tangible assets no longer being discounted by the market, attention is shifting to intangibles. Patents, brands, R&D and copyrights often do not show up on balance sheets unless they are acquired from other firms. Nonetheless, such holdings are expected to account for the bulk of enterprise value for many firms in the future. Many contend that Japan has a competitive advantage in the cultivation of such assets, and is now moving to fiercely protect and profit from such corporate holdings.
Nick Ricciardi, an executive at Citta Capital Management, is convinced that the equity markets undervalue many of these assets in systemic, predictable and scalable ways, arguing that as Japan’s economy normalises, IP-intensive firms should outperform. Ricciardi is a former head of Asian Equity Derivatives at Goldman Sachs. He and his colleagues at Citta Capital are developing detailed databases on intangible asset holdings in various industries, including information such as patent totals, patent references in leading scientific journals, frequency of patent citations and projected licensing revenues.
They are not alone in attaching importance to such variables. Sadao Nagaoka at the Institute of Innovation Research of Hitotsubashi University published a working paper entitled “Patent Quality, Cumulative Innovation and Market Value” in February 2005. He found empirical evidence that suggests that indicators of patent quality, such as number of citations, affect the market value of the Japanese firm holding such intellectual property.
The 2004 battle between Fujitsu Ltd and Samsung SDI Co over plasma display panels (PDPs) reveals a new willingness on the part of Japanese firms to protect their perceived lifeblood. Fujitsu filed suit in April of that year, charging patent infringement on basic PDP technology. Samsung was forced to agree to sign licensing agreements, despite complaints from a South Korean government minister, when the company’s shipments to Japan were blocked by Tokyo Customs.
Moreover, the Japanese government is going far beyond merely cracking down on alleged patent violations. As far back as February 2002, then Prime Minister Junichi Koizumi announced he was aiming to create a ‘nation built on the platform of scientific and technological creativity’ in his policy statement to the Diet. The Basic Law on Intellectual Property went into force in March 2003. The government is calling for, among other measures, cutting the current waiting period for patent examinations in half by 2013. It is hard to imagine Prime Minister Abe back-pedalling on such issues.
Meanwhile, some Japanese scholars have long argued that the Japanese firms have a competitive advantage in cultivation of ‘invisible assets’ due to employment practices. A broader term than the accounting concept of intangibles, Hiroyuki Itami at Hitotsubashi University defines invisibles as information-based assets such as consumer trust, brand image, technology, corporate culture and management skill. Traditional Japanese corporate governance, long criticised by many foreign investors because of its emphasis on worker interests, is well suited for managing such holdings, he provocatively declares. “What is the incentive of workers to accumulate invisible assets if they know the company is run for shareholders?” Itami asks.
Japanese firms have long been thought by some to lack creativity and be mere copiers and improvers of basic technology developed elsewhere. However, Itami argues that the orientation of Japanese firms toward invisible asset accumulation suggests that they will become better at conceptualising new products and generating new ideas. A huge body of experience and knowledge is necessary before creativity is possible, and Japan has been accumulating this little by little, he argues. Corporate Japan now has the experience and knowledge to become much more innovative.
Even if Prime Minister Abe wanted to, he cannot turn back the clock. Ten unsentimental bank holding companies hungry for profits have replaced institutions chained to loss-making firms and riddled with bad debt. A revamped Commercial Code is in place, and a new generation of leadership is rising to positions in power in both the corporate and political arenas. Japan is experiencing nothing less than an economic rebirth. Investors seeking out under-priced firms boasting enviable intellectual property holdings are likely to outperform in the years ahead.
Andrew Shipley is the author of The Japanese Money Tree: How Investors Can Prosper from Japan’s Economic Rebirth. Shipley has worked as an economist in Tokyo for Lehman Brothers Japan Inc, Schroders Japan Ltd, Credit Suisse First Boston Securities (Japan) Ltd and West LB.