FREE KIC - NO. 19 APRIL 07

  INVEST IN JAPAN  (IT’S A STEEL!)

For a number of years I have been confused about the Japanese stock market and I have written two opinion pieces explaining why this was the case. (Opinion piece 1 Oct 05 and 7 April 06).

I have recently made a very small investment in the Japanese stock market and I thought it might be useful to explain why.

In my first opinion piece I explained the conflict that existed between traditional Japan and an aggressive group of activist fund managers led by Steel Partners. I said that the activist fund managers had failed in their attempts to acquire companies by means of hostile takeovers. I felt that traditional Japan was attempting to repel this bunch of upstarts and therefore I was not prepared to risk investing.

So what has changed you might ask? Well I think a few things have moved on to the point where a small exposure to the Japanese market is justified.

First of all the activist fund managers have not gone away. Steel Partners, TCI and Dalton continue to accumulate stakes in a large number of Japanese companies. Recently Steel Partners had a stake of over 5% in more than 30 companies. (5% is the limit for disclosure of stakes) They probably have a lot more stakes below the 5% declaration limit.

The second thing to point out is that these activist shareholders appear to be getting more aggressive. Steel Partners have attempted to buy Myojo Food and Sapporo Breweries. Dalton has suggested that Fujitec and NFC go private through management buyouts. They are getting more aggressive because generally they make significant returns on their investments. As they make more money from each attempted takeover it gives them a bigger war chest for their next battle. Even if they do not succeed in the takeover battle (which has been the case up until now) it doesn’t really matter that much because of the profits they are making.

In the case of Steel Partners trying to buy Myojo Foods I would imagine that they were very happy with the money they made. They were quite happy that Nissin Foods came along and bought them out at a significant profit.

The third thing to point out is that there are plenty of opportunities in the Japanese market. There are many companies that have loss making divisions that could and should be sold or closed down. There are other companies sitting on excessive cash or real estate assets. In the case of Fujitec, Dalton has proposed that they dispose of unprofitable operations. With all of these opportunities it would be amazing if nobody attempted to unlock the value. In my last opinion piece on Japan I gave the example of Asahi Chemical as a company that had potential. One day it might be the target of the activists.

This leads me on to my fourth point. In the last year activist / private equity funds around the world have raised ever larger funds. This has led to an explosion of deals. In recent weeks we have seen ABNAmro being the target of activist fund manager TCI. This explosion in activity will ultimately exhaust many of the most obvious cases in western markets. I think that this will ultimately lead more funds to look at the value available in Japan and ultimately I believe that Japan will not be able to fend off these activists for much longer.

Finally there are some legal changes taking place in Japan that will allow foreigners to buy local companies with shares rather than cash. I am not sure if this will make a significant difference because I have not seen cash rich foreign companies attempting hostile takeovers even though they are not constrained by an inability to use shares. Even if this is not a significant change it at least creates another option.

In conclusion my decision to invest in Japan has been based on this idea that there are asset rich companies that are cheap. I now believe that there is a real chance that those cheap companies will be forced to look after their shareholders. This is not a view on the short term direction of the economy. It is not a view on a specific company. It is a long term investment based on value being realised in the broad Japanese stock market.

In order to implement the decision I have bought a Japanese exchange traded fund (ETF). This gives broad exposure to the overall market.

I have invested in Japan. It might not quite be a steal but Steel Partners will help to unlock the cheapness!!!

• ANALOG DEVICES AND LINEAR TECHNOLOGY.

In January (opinion piece 16) I wrote about a technology sector for long term investors. I mentioned that I had bought shares in Analog Devices and Linear Technology and I said that I would keep readers in touch with my progress. When I said that, I thought that I might talk about it in a year or twos time. Little did I think that by April I would have seen a significant increase in the share price of both companies. Analog hit $40 this week and Linear was over $38. Demand appears to be picking up but more importantly Linear announced that they are going to buy back $3bn worth of shares. I said that I trusted their Chief Financial Officer, Paul Coghlan but little did I think that this would happen so soon. As far as I am concerned, this is just the start of things so I am not selling yet.

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