TCI learned the hard way via J-Power play

by Tomoko Yamazaki and Shigeru Sato


It was a crisp day in November 2005 when hedge fund manager John Ho entered Electric Power Development Co.’s headquarters in Tokyo, betting Japan’s corporate attitudes were ripe for change.

Ho, then director of Asia-Pacific investments at the Children’s Investment Fund Management UK LLP, also known as TCI, was ushered into a conference room with a worn carpet to meet with Masayoshi Kitamura, then executive vice president of the utility. The visitor told Kitamura he wanted to learn more about the company’s plans for growth.

His London-based fund was on the hunt for global infrastructure assets, and Japan’s No. 1 electricity wholesaler, known to customers as J-Power, looked like an attractive investment. Ho had discussed with his boss, TCI founder Christopher Cooper-Hohn, how J-Power had the cash flow to double its dividends.

TCI, an $8 billion fund that gives a portion of its fees and assets to charity, was looking to invest in airports, shipping facilities and utilities throughout Asia.

“We always make it clear that we’re interested, but we don’t actually make clear our trading intentions,” Ho, 32, says. “I asked a lot of questions.”

Kitamura, 62, says J-Power, as a publicly traded company, welcomed outside investors such as TCI. What J-Power didn’t welcome was a shareholder who made demands at odds with its strategy. Within a year of Ho’s initial approach, TCI bought more than 5 percent of J-Power’s outstanding shares, regulatory records show.

That triggered a three-year battle with J-Power, during which Ho discovered the obstacles that overseas investors face in trying to gain a voice in Japanese companies. The utility blocked TCI’s attempts to gain higher dividends per share, force the disposal of cross-shareholdings and require independent members on its board of directors.

Last October, TCI sold its shares in J-Power at a loss of about $130 million, according to securities filings, excluding dividend payouts, currency fluctuations and hedging gains.

TCI is just the latest foreign investor to confront Japan Inc.’s resistance to outsiders.

“Sadly, Japan has been a value trap for many years,” says James Rosenwald, cofounder of Los Angeles-based Dalton Investments LLC, which controls more than $1 billion in assets, with 40 percent of its holdings invested in Japan. “That means the shares are amazingly cheap for an extended period of time without managements unlocking obvious value, such as companies with huge cash balances and no debt that have no intention of raising dividends or conducting share buybacks.”

Japanese managers are accustomed to investors who are both local and passive. These so-called stable shareholders — financial institutions such as banks and insurance companies that buy stakes for the long term — account for about 30 percent of all holdings in the Japanese equities market, according to the Tokyo Stock Exchange.

Tradition has also helped thwart agitators. Annual general meetings, often the stage for shareholder showdowns in the U.S., are treated as a formality in Japan.

TCI’s bid to shake up Japanese management began with its investment in J-Power, the sole operator of the transmission lines connecting the four main islands. By the end of 2006, TCI was the utility’s biggest shareholder with more than a 9 percent stake.

At J-Power’s 2007 annual shareholders’ meeting, TCI’s proposal to boost dividends was defeated by a margin that J-Power declines to disclose, as Japanese companies aren’t required to reveal details of shareholder votes. In May 2008, the government rejected TCI’s bid to double its stake in J-Power to 20 percent. For the first time, officials invoked a 1949 national security law designed to block foreign investment in vital industries.

In the runup to J-Power’s June 2008 annual meeting, Ho asked the utility to disclose voting arrangements with its corporate shareholders, saying the utility was effectively buying votes to block activist demands. At the time, TCI estimated the value of J-Power’s holdings at ¥68 billion and said the investment program had lost the utility about ¥15 billion.

Ho made a final bid to win over 700 fellow shareholders by making a short speech in rudimentary Japanese asking for their support for higher dividends.

The gambit didn’t work. TCI’s demands were rejected by shareholder vote and the board raised the dividend by just ¥10. Last October, TCI sold its shares back to the company, according to filings. Gains in J-Power’s stock price over three years may have blunted losses. The utility’s shares averaged ¥3,237 in December 2005 when TCI began its investment. The firm sold the stock back to J-Power at ¥3,830, about a 30 percent premium to market price.

Ho says he left TCI earlier this month and plans to set up his own investment firm targeting Asian equities. Rahul Moodgal, TCI’s London-based spokesman, declined comment on Ho, the J-Power investment or the fund’s future strategy for Japan.

Shuhei Abe, president and founder of Sparx Group Co., Asia’s biggest hedge fund company, says Japanese managements will ease their resistance to the activists so they can pull their economy out of a slump.

“There are no good or bad investors per se,” Abe says. “Japan has to study the rules that global players play by through reforms — otherwise, we will be left out of the global competition.”

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