Was "Horiemon" the Spark?: Problems Surfacing in the M&A Battle Between Livedoor and Fuji TV

TSURU Kotaro
Senior Fellow, RIETI

The takeover battle for Nippon Broadcasting System Inc. (NBS) between livedoor Co., Ltd. (Livedoor) and Fuji Television Network Inc., a high profile case that has attracted massive media attention, finally came to an end on April 18 with Livedoor and Fuji TV agreeing to enter a capital and business tie-up. If last year's takeover battle for UFJ Holdings, Inc. marked the beginning of the era of "theatrical" mergers and acquisitions (M&As), then the latest tussle initiated by Internet portal Livedoor could be called an "out-of-the-ring, professional wrestling style of M&A," one which attracted far greater public attention and packed more drama than the UFJ fight in many respects. There is no denying, however, that the debate this time around was somewhat fuzzy with too much attention given to the words, deeds and personality of Livedoor President Takafumi Horie, also known as "Horiemon." In this article, rather than discussing the rights and wrongs of the case or the future of Livedoor-Fuji TV tie-up, I examine the problems in Japanese corporate governance and government regulators that have surfaced in wake of the takeover struggle.

Buyout as the "ultimate weapon" in corporate governance

I have had an opportunity to discuss this issue with a renowned M&A expert and hear his views about the Livedoor case. He pointed out that no hostile takeover bid will succeed unless the acquiring company has the three key factors of shin (spirit), gi (technique), and tai (strength). Livedoor was not clear about its motives and goals in its takeover bid and failed to show sufficient consideration to the target company. It thus lacked "spirit." The company was unable to secure prior confirmation concerning the procedural legality of its block purchase of NBS shares during off-hours trading after the closing of the regular trading session at the Tokyo Stock Exchange (TSE). It thus showed a lack of "technique." Finally, Livedoor could and should have launched a counter takeover bid but failed to do so because it was unable to mobilize sufficient financial resources, thus betraying insufficient "strength." Most of the criticisms leveled against Livedoor have centered on one of these three points. That is, by taking such an unclear approach, Livedoor ended up prompting various debates and emotional arguments over the issue.

However, the fuss over the NBS takeover has been meaningful in the sense that it illuminated various problems plaguing companies, shareholders and government regulators in Japan. First, it was revealed that there are some companies, even among those listed on the First Section of the TSE, that do not understand the principles of capitalism. In the case of public joint-stock companies, inefficiencies in the management of a company undermine its market value, thus resulting in a lower valuation of the company relative to its breakup value. Arbitrage practices - in which an arbitrager buys an undervalued company and tries to boost its market value by implementing more efficient management - are a natural outcome based on market mechanisms. This is why corporate managers who want to protect their company from the threat of a takeover strive to maximize corporate value. In this regard, a takeover is the quintessential mechanism or the "ultimate weapon" for imposing corporate governance.

Of course, there are cases in which a hostile takeover results in the loss of various assets based on implicit contract, which seriously impairs the competitiveness of the acquired company. There is no denying the possibility that the imposition of discipline by means of a corporate buyout may turn out to be a deadly poison. However, in light of the principles of capitalism, the blame in such cases should be placed on the management of the target company, not on the acquirer. Amid the accelerated unwinding of cross-shareholdings in recent years, the percentage of so-called stable shareholders - those who hold shares for the sake of long-term relationships and who are thus unlikely sell to a hostile raider - has steadily fallen. Meanwhile, potential buyers in Japan continue to enjoy a surplus of funds. Under these circumstances, buyouts have become far easier than they used to be. Corporate managers must clearly recognize that leaving the price/book value ratio (PBR) at a level close to 1 - as has been the case with Fuji TV and NBS (PBR is around 1.2 for both) - is tantamount to advertising a company as a willing target for a buyout. Few lessons seem to have been learned from the hostile takeover bids against two Japanese companies, Yushiro Chemical Industry Co. and Sotoh Co., mounted in late 2003 by a U.S. investment fund. Yushiro's PBR was 0.7 while Sotoh's was 0.5 at the time.

The continuing instability of the financial system since the 1990s has given rise to the idea that debt-free companies with ample retained earnings and current assets are risk-resilient and therefore "excellent" companies. The same characteristics, however, also mean that these companies are making only modest investments in the physical and human resources that offer high earning potential. As a result, the PBR of these companies is kept at a relatively low level, which makes them an easy target for takeovers. This is like a family keeping a large amount of cash in the house. Having the cash at home would help in times of emergency, but it also increases the risk of burglary. Some companies might argue that their low PBR is the result of market participants' failure to assess the true value of the goods and services they provide to their customers. If that is the case, the company should have its stock de-listed and become a private company. Indeed, many American companies opted for management buyouts (MBOs) when a wave of hostile takeovers swept the U.S. In the case of NBS, however, the critical question is whether it was really necessary for the company to go public in 1996 when the value of Fuji TV, a subsidiary, had far exceeded that of its parent, NBS. The wisdom of that management decision is now being questioned.

Many Japanese listed companies do not understand the "manners" of capitalism

Second, there are quite a few listed companies whose managers do not understand the "manners of capitalism." This means providing shareholders with rational explanations for management decisions. Thus, the management should be scrutinized as to whether they have consciously taken appropriate steps to provide such explanations at each point in the decision-making process. The crucial question here is whether managers have fulfilled their accountability to shareholders, not whether they have always given top priority to shareholders' interests in their decisions.

In this context, the management of NBS, particularly the outside directors, should have requested Fuji TV to raise the takeover bid price when Livedoor emerged as a rival bidder and NBS shares began to rise. From the viewpoint of providing rational explanations to shareholders, it is also problematic that some corporate shareholders readily accepted Fuji TV's takeover bid, agreeing to sell NBS shares to Fuji TV at a price roughly 10% lower than their market value. In fact, derivative lawsuits were filed against some of these companies immediately after their acceptance of the bid by Fuji TV. Apparently, the management of these companies cannot fulfill their accountability simply by saying they want to give priority to their long-term relationships with Fuji TV. As it turned out, major corporate shareholders of NBS were not unanimous in their responses to Fuji TV's takeover bid: Some companies accepted the bid, while others decided to continue holding NBS shares, and still others sold NBS shares in the market. Livedoor's takeover bid thus served to draw a line between companies that resort to old-fashioned "crony management" based on an insider theory and those that are mindful of accountability to outsiders including shareholders.

Third, investors, stock exchanges and government regulators have failed to close a legal loophole so obvious that it is mentioned in an M&A management textbook (see note), although they could and should have done so by drawing up proper guidelines. Many people, including legal experts and M&A specialists, initially emphasized the illegality of M&A Livedoor's block purchase of NBS shares in off-hours trading. I believed at the time such reactions were unreasonable. Livedoor's move is apparently not in line with the objective of takeover bid regulations, which call for ensuring equality among shareholders. But I believe the ruling by the Tokyo High Court, which confirmed the legality of the block purchase based on a faithful interpretation of the relevant provisions of law, was both appropriate and reasonable. It is no good to quibble over legal interpretations. What we should be concerned with instead is the fact that there have been growing indications that Japan may be returning to the era of "discretionary administration," in which the government requires private-sector companies inquire about legal gray areas on a case-by-case basis, rather than creating clear-cut rules. Such gray areas, though they provide great opportunities for profit, entail a high risk of illegality; this motivates companies to seek prior approval in private from the relevant government authorities whenever they plan to step into the gray zone. In the meantime, the government remains passive, doing nothing to change the situation until a problem grows into a major issue both among the public and politically. The Livedoor case shed a harsh light on the opportunism of the private sector, as well as on the government's inaction.

Maximization of corporate value is the only defense against hostile takeovers

Finally, the Livedoor case, in which the threat of a hostile takeover became a reality, has prompted many Japanese companies to consider measures to protect themselves from such takeovers. Based on the aforementioned principles of capitalism, however, the best defense against hostile takeovers is the maximization of corporate value, and there are no gimmicks or tricks to it. Reinforcing cross-shareholdings due to excessive fear of a takeover by a foreign company would deservedly be labeled an attempt by management to save its own neck. Meanwhile, "poison pills" have drawn much attention as a means of avoiding hostile takeovers. Under this scheme, a target company typically issues stock options that are automatically exercised when the percentage of shares acquired by a bidder reaches a designated level so as to reduce the stake held by the bidder. However, in implementing such a takeover prevention scheme, it is important to ensure that a reasonable mechanism for removing the poison pill is also in place so as not to prevent takeovers that are likely to increase the value of the company. Since last year, a study group on corporate value, operating under the auspices of the Ministry of Economy, Trade and Industry, has been discussing measures and rules for defending Japanese companies from hostile takeovers. In the main points of discussion released in March, the study group recommended that third parties such as independent outside directors be involved in decision-making and that objective criteria for the removal of a poison pill be established. However, given the fact that the presence of outside directors remains small and has yet to become a norm in Japanese companies, it is uncertain whether the proposed mechanism for canceling anti-takeover measures would actually function properly. Companies prone to become a takeover target tend to neglect the principles and manners of capitalism. It may therefore be difficult to expect any rational decision on the removal of anti-takeover measures from the boards of such companies. In this respect, as emphasized by the study group, it is important to ensure that shareholders have the final say, or that they be given an opportunity to vote through a proxy contest.

Japan is not yet ready for direct restrictions on hostile takeovers

Those brandishing the threat of foreign hostile takeovers often insist that Japan should introduce, on top of protective measures discussed above, direct restrictions on hostile takeovers equivalent to those in the United States, namely, state laws known as business combination laws or "freeze-out" laws. This argument stems from a perception that Japan should not lag behind other countries in implementing takeover defenses. However, we must not forget that these defenses have been introduced in the U.S. and other countries based on the premise that various supporting mechanisms and norms are already in place. In the U.S., the threat of a takeover is constant and functions as a governance mechanism. Thus, the ideas of maximizing corporate value and protecting shareholders' interests are very much a part of the mindset of corporate managers. It is based on this foundation that outside directors have come to play an important role in the U.S. Therefore, simply introducing institutions equivalent to those of the U.S. would be nothing more than emulation in form without the substance. Worse, these institutions might end up helping inefficient corporate managers save their necks. The introduction of direct restrictions on takeovers is definitely an issue that can be considered only after the function of corporate governance, including the substantive role of outside directors, takes root and comes into full play in Japan. Excessive takeover defense mechanisms, the introduction of which is politically tempting, pose a high risk of hampering the reorganization and revitalization of Japanese companies. Thus, it is premature for Japan to implement such restrictions.

Problems surrounding hostile takeovers should be examined in the light of the enormous changes taking place in Japan's economy. The historical path of institutional development, or the process by which a certain institutional system has developed, matters a great deal. Furthermore, it is not necessary for Japan's institutional systems to converge with those of the U.S.; nor would it necessarily be possible for Japan to fully emulate U.S. systems even if tried to do so. The process of change in institutional systems should be an evolutionary one in which a country progresses, through trial and error, based on its own institutional foundations. Key players in this trial and error and experimentation are called "mutational mavericks." I hope that the recent thrust by Horiemon, the modern-day Don Quixote of Japan, will provide a small but important spark in the evolution of the Japanese social and economic system.

April 20, 2005

Nobumichi Hattori (2004), "Jissen M&A Manejimento (Practical M&A Management)," Toyo Keizai Inc. (p93)

April 20, 2005