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Regarding our Shareholder Proposal

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(Additional announcement, 24 March 2019)

  On 20th March 2019, we have submitted to Sanyo Shokai our intent to withdraw one of our two shareholder proposals – adoption of stock compensation plan (Item #8). After numerous valuable discussions with various corporate governance professionals, capital markets professionals, and other shareholders, we have received many feedback stating that the fundamental difference between our proposal and company’s own proposal is minimal and that it is confusing to see them as competing proposals. While we re-affirm our view that share-based compensation and dividend increase are in essence a paired proposal aiming to align interest between the management and shareholders in a forward looking manner, we came to appreciate the management’s proactive judgment to introduce this plan. Due to limited time left to the AGM, company has decided to not accept our withdrawal in order to avoid further confusion from shareholders so it will continue to be on the proxy.

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(below are originally published statement dated 6th March)

Dear all,

We have submitted a shareholder proposal to one of our portfolio companies, Sanyo Shokai, on January 28th 2019 for the Annual General Meeting scheduled on March 28th 2019 and we would like to inform our clients, other investee companies and fellow shareholders our intention for the proposal as Proxy statement has now been dispatched by the company. below is the explanation. We cordially seek for your understanding and support.

The proposal consists of the following two points:-

Proposal
(1) The Adoption of Stock Compensation Plan for Directors with 3 – 20 years vesting period (Item #8)
(2) The dividend per share for fiscal year ended December 2018 shall be 80 yen (Item #9)

We have had numerous constructive discussions with the management team and the executives of Sanyo Shokai Ltd. (hereinafter referred to as “the company”) in the last two and a half years since we started investing in the company. This proposal in fact stands as a reflection to the discussions to date. As can be inferred from its contents, this proposal is not intended to create conflicts but to support the management team and to share values. We hope that these contents will easily resonate with all other shareholders. It is important to note, however, that on February 14th 2019, board of directors of Sanyo Shokai also announced to propose its own stock compensation plan to the AGM. This means that there are two competing plans for stock compensation which may potentially increase the risk of both agenda being denied by not reaching the 50% threshold. We believe the fundamental direction of our proposal and board proposal is similar. We would like to expand on this later.

As a leading fashion company in Japan acclaimed for its excellent tailorship, Sanyo Syokai Ltd. was a licensee of Burberry in Japan since year 1970. Nonetheless, after the contract with Burberry was cancelled in year 2015, the company has undergone a difficult period and is likely to report deficits for three consecutive years from year 2016 to 2018. In our view, president Mr. Iwata, was promptly elected as the current representative director in January 2017 to revive from a catastrophic condition. It has not been an easy mandate, and we thank him for going through such tough times with decisiveness.

It is a major setback for the company to suffer deficits for three consecutive years. However, our evaluations revealed that the reasons behind the deficits in year 2016 and 2017 were somehow different from the reasons behind the deficits in year 2018. In the first two years, the company had taken a more conservative approach and had focused on company restructuring as a measure to re-emerge from the sudden downfall of its business but from year 2018, even with the embracement of the company’s bitter decision to ask for early retirement, it started to take a more aggressive approach and has begun to invest and advertise, with the aim to revive as Japan’s premium fashion company. A surplus in year 2019 is definitely a “must achieve” goal and the management has also announced its plan to invest more than 10 billion yen in M&A by year 2020, indicating that returning to profit is just a starting step for a much bigger ambition.

10 billion yen investment is an extremely big decision and challenge for a company that suffers deficits, with less than 50 billion yen shareholders’ equity and also with less than 60 billion yen revenue. As one of its shareholders, we do feel a tinge of uneasiness but we would like to give our support to this challenge with our hope that management will balance out its speed, risks and values (to not make expensive purchases). The success or failure of this challenge may significantly change the company’s brand value and corporate value.

In our opinion, the most important thing in achieving success in this challenge is that the company’s directors and executives have same visions, work together and put their heart and soul in sharing both “risks” and “future results” with the shareholders. Through interviews, we are convinced that the management team has deep feelings for the company’s brands and a sense of responsibility unbeatable by other companies. It is further encouraging to us to see new executives who have joined the company in the last few years are also striving to develop the company with strong enthusiasm, exercising a vital impact to its new growth plans. Amid these circumstances, if we link the “personal success” of the directors and executives with stock compensation, we believe that the chances of success will increase.

On the other hand, some people may opine that it is wrong to adopt the stock compensation plan now because the management responsibility with respect to the three consecutive years deficits has yet to be ascertained. While we are cognizant of this point, it is our opinion that “now” is the best timing to adopt the plan. The company has gone through a bitter restructuring process by reducing its employees more than half in the last five years and is now trying vigorously to make a major comeback. Stock remuneration will arouse the fundamental instinct of human being “to want to make a fortune” and can be a driving force that assimilates altruism and self-benefits, and maximizes the power to create a V-shaped recovery.

This time, as mentioned earlier, board has also decided to propose its own stock compensation plan on February 14th 2019 (Item #4). We are happy to see risk taking appetite aroused from the board itself whether it has or has not been influenced by our proposal. However, it comes with a consequence that raise some confusion around the difference of the two proposals, as well as the elevated risk of both proposals being denied by achieving less than 50% approval rate in the AGM. Then many may ask “why Hibiki is not taking back its proposal after seeing a similar proposal from the board”. We would like to explain.

Fundamentally, the only major difference between the two are the “restriction” period where the individual board member who received the stock is not allowed to monetize by selling them. Hibiki’s proposal is between 3 – 20 years (of which Board has the sole right to determine the period) and board proposal mentioned it as 3 – 5 years (of which, again, board has the sole right of determining the period). In apple-to-apple comparison, Hibiki’s proposal is more generous as it gives more flexibility to the board which imply also potentially utilizing this stock compensation as retirement bonus. Board can blend the mid-term incentives (3-5 years) with long-term incentives (as long as 20 years) and if it is used as retirement bonus, such board should be able to save a lot of tax obligation due to tax breaks given to retirement related benefits in Japan. While we view our proposal to be superior as it is inclusive of the board proposed 3-5 years, we also view that 3 – 5 year mid-term based incentive stock compensation is a plausible measure as it will incentivize those recipients of stock compensation to create value in shorter time pressure. In such circumstance, we are in the position to recommend to you that each shareholder should decide based on their own time frame (in both life and in business).

Our second proposal is in regards to increase in dividend per share. We view this as pair to our first proposal and such is another reason why we are not pulling our stock compensation proposal. Dividend per share (disposition of surplus) was maintained at 80 yen until year 2015 but since the company reported a deficit in year 2016, it was cut down to 40 yen (figure is uniformly stated adjusting the reverse stock split). The fact that the company was still able to payout dividend even though it suffered deficits proves that the company has a strong financial base. As of the third quarter of year 2018, 18.9 billion yen (approximately 25% of the 76.7 billion yen total assets) is cash and deposits with only 9.1 billion yen in interest-bearing debt. If we divide this 18.9 billion yen by the number of outstanding shares, it is worth 1,497 yen. The 80 yen per share that we propose for dividend is equivalent to approximately 5% of this 1,497 yen, which we think is a reasonable level for a stable annual dividends. In fact, 80 yen per share is approximately 2% based on the Dividend-on-Equity (DOE) ratio, which is the level increasingly adopted by companies in terms of dividend payout computation. As a reference, the simple average of DOE calculated with this year’s dividend estimate of four similar companies (Adastria, Onward Holdings, TSI Holdings and United Arrows) is 3.7%, a much higher figure than this 2%. Our proposed dividend level is thus still lower than the average level for companies in the same industry. We think that this proposal is a realistic one even considering their need for capex or future investments and is the first step to continuously increase dividends along with business recovery.

Those who has tirelessly supported the company going through trying times in the last three years includes the company’s management team, employees, banks, all stakeholders, and of course, stakeholders should also include the shareholders. Needless to say, public shares can be bought and sold at any time. There are probably shareholders who have sold their shares because they have run out of patience and there are shareholders who still keep the shares like us. We believe many shareholders have owned the shares and supported the company since long before the Burberry Shock in year 2015. This year (2019) is an important turning point for the company. While turning back into black ink is a “must-achieve-mission” for the board, company is also making a 10 billion yen investment to secure future growth. We believe that it is an important gesture to start giving back some more to the shareholders who have gone through the hard times together with the company. Company and the board must create a forward-looking win-win relationship with shareholders in order to win a longer-term support.

Last but not least, we do need to clarify one important thing to all. This proposal is made with the intention to be presented as an antithesis of the relationship between shareholders and companies which has often been viewed as antagonistic due to the stereo-type image of “activist investors” as well as due to somewhat naive board governance in Japanese companies. The proposal may not be straight forward as it is unusual for shareholders to propose for stock compensation for directors. Nonetheless, the fastest way to overcome the misconception that shareholders and management team are in a forever conflicting position is for the management team to become shareholders and manage the company from the perspective of a shareholder (It is difficult for various shareholders to become a part of the management team – too many captains will wreck the ship). Dividend policy (such as DOE) can then be a powerful tool to obtain a forward-looking endorsement from shareholders and to strengthen management confidence in future strategies of the company. The management team, with strong support from shareholders, will get to enjoy more management freedom and will have more confidence when implementing their management strategies. The enhancement of managerial judgment through such confidence and experience are the ideal forms of a listed company. The importance of independent directors who strictly check if such “confidence” has become “over-confidence” will only increase going forward. Additionally, the quality of judgment with regards to important management decision such as M&As whether it will maximize long-term shareholder values will naturally be sharper if the management team owns more shares, of course, with longer restricted periods. From this perspective, these two proposals should be viewed as a set of proposal to enhance management commitment and strengthen its skills; we hope it to be a wake-up call. In a sense, small start-ups and venture capitalists are in such reciprocal relationship and we view that it can easily be expanded to public companies.

Building a capital market ecosystem based on such progressive and reciprocal relationships between management, investors and shareholders, even if sometimes have conflicting views on a few small things, are the essences of an ideal form of corporate governance and stewardship in our view. We run mandates for endowments and pensions around the world. We have a fiduciary duty to maximize those clients return over the long term and it is an unquestioned priority for us. However, due to the long-term nature of our investment philosophy, it should harmonize with the notion to “make things better”. We are here to make things better co-working with people in different positions to make good things happen; in this specific case it may be shareholders and management team. We duly hope the management and other shareholders to sympathize our view and forget about small differences. We continuously hope and support Sanyo Shokai to prosper over the long-term, and this proposal is only a small stepping stone for that.

Sincerely,

March 6th 2019

Yuya Shimizu
Chief Investment Officer
Hibiki Path Advisors