Tuesday, July 8, 2008


Japan is notorious for cross-shareholdings. Today cross-shareholdings stand at 12.2% of the Japanese stock market's market cap for last financial year, according to Nomura. What seems to be getting the attention is that this is the first rise in cross-shareholdings by Nomura's measurement in more than a decade and presumably prompted by some management teams embracing these structures to thwart attempts by activist shareholders to force them to sharpen up their acts. But what most people gloss over is that cross-shareholdings have been on a downtrend for some time, having peaked in 1987, again according to Nomura.

Anyway, regardless of this, these set-ups can actually be quite an appealing investment in some cases. Japan has numerous situations where small companies sit atop of substantial equity stakes in much bigger corporate brethren.

(Apparently, this is also the case with Italy, according to a former colleague who used to work in Milan. If anyone knows of a list of interesting cross-shareholding investment opportunities I would love to see a copy).

With these kind of investments headline ROE, PER etc are likely to be misleading metrics as they tend to be asset plays. So how to play these?

One can buy one of the shares in the cross-shareholding arrangement, short out the cross-shareholding to back out the underlying business of the one of the companies, which may be trading at very cheap stand alone valuations.

While I'm not sure whether Orbis did this with Fuji Electric back in 1999 the investment at the time certainly lent itself to this and Orbis shareholder letters show that the fund was interested in how the cross-shareholding discounted the underlying business. Asatsu-DK and its capital tie-up with WPP also looks like a possible candidate for shorting out the WPP holding to gain exposure to a cheap ad business.

One can also use the smaller company as a cheap back-door entry into its larger cousin, particularly, when the larger company is trading at cheap valuations. A good example of this is Third Avenue's investment in Toyota Industries, which has a substantial holding in Toyota Motor and Denso.

In some instances the stock may even be trading marginally above or below the value of its cross-shareholdings giving an even greater margin of safety. Southeastern recognized this in its investment in Nippon Broadcasting and its holding in Fuji TV. Value here was eventually realized with Livedoor's hostile bid for Nippon Broadcasting.

Nippon Broadcasting touches on another factor to consider - corporate restructuring. Many of these cross-shareholdings tend to be legacies of keiretsus (group company structures). A buy-out by the head company of the smaller firm is a quick way to realize value - assuming the head company pays a decent price - and is also EPS accretive to the acquirer as theoretically they can retire the shares held by the target thus boosting returns for existing shareholders.

Anyway, I am going to try and draft up a list over time of interesting cross-shareholding plays. This is no doubt going to take a very long time (and right now is less than embryonic) as I don't have access to a Bloomberg, and my list will definitely not be exhaustive but I will be posting sporadically on these at this Google spreadsheet .

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