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16/Jun/2024 – ISS Recommends Support for Hibiki’s Shareholder Proposals

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Hibiki Path Value Fund (hereinafter referred to as “HPVF”), which has a discretionary investment contract with Hibiki Path Advisors (hereinafter referred to as “we” or “Hibiki”), submitted shareholder proposals to three companies holding their annual general meetings this June. Although the boards of directors of all three companies expressed opposition to these proposals, Institutional Shareholder Services (hereinafter referred to as “ISS”), a major proxy advisory firm, has publicly recommended to vote “FOR” all four of our proposals to these three companies. We would like to report this development to other shareholders and once again provide a brief explanation and philosophy behind our proposals. We hope to encourage shareholders to carefully consider what is most appropriate for maximizing corporate value.

First, the companies to which we have submitted shareholder proposals are Kinden Corporation (hereinafter referred to as “Kinden”), Tokyo Broadcasting System Holdings, Inc. (hereinafter referred to as “TBS”), and Japan Pure Chemical Corporation (hereinafter referred to as “JPC”). Although these three companies belong to completely different industries, we, as shareholders, are confident in the fundamental strengths of their businesses and are excited about their potential for further growth in their respective fields. However, unfortunately, all three companies face the same issue from a financial perspective. Despite favorable business performance and increasing profits, their current capital policies make it difficult to improve their ROE and PBR.

Kindly refer to the figure below.

(Source: March 2024 Kessan Tanshin publication of three companies, compiled by Hibiki)

One immediately noticeable point is that cash and marketable securities constitute 40% of total assets for Kinden, and a staggering 72% and 87% for TBS and JPC, respectively. This situation presents several issues; 1. For shareholders who have purchased the company’s stock, holding large amounts of marketable securities unrelated to the company’s core business exposes them to external business risks. 2. This results in bloated balance sheets with extremely high equity ratios ranging from 70% to 84%. 3. Consequently, all three companies suffer from very low ROE, ranging from approximately 4% to 6%. As outlined in our six recommendation letters published last, while the historical practice of cross-shareholding—a byproduct of Japan’s development of capitalism—cannot be entirely dismissed, from the point of view of corporate governance, they unfortunately hinder the revitalization of Japanese companies and their global presence. Notably, the two major proxy advisory firms have already stated their opposition to the reappointment of top executives at companies with significant cross-shareholdings.

Therefore, our shareholder proposals for all three companies advocate for managing equity (synonymous with net assets) to achieve sustained ROE improvement. Naturally, this implies the sale of such marketable securities. The following diagram illustrates our proposal (clickable links are at the bottom of the table).

(Source: Compiled by Hibiki)

Fundamentally, our stance towards these three companies stems from these simple questions:

  • With abundant internal reserves inherited from your predecessors’ past profits, can you improve ROE solely through profit growth without addressing the overly stabilized balance sheet?
  • For example, if the ROE is 6% and the payout ratio is 50%, equity, the denominator of ROE, increases by 3% each year. Would you increase net income by more than 3% annually on a compound basis?
  • Incidentally, increasing 3% compound over 10 years totals 34%. Therefore, even if net income increases by 34% in 10 years, the denominator also increases similarly, keeping the ROE the same as now. To make ROE 1.5 times the current level, net income must double (1.34 x 1.5). Notwithstanding that this is a rough calculation, would you be able to achieve such profit growth? If so could you show us your plan? We would prefer to see commitment from those likely to be involved in management 10 years from now.
  • This is a simplified case, but would you present a plan to current investors for improving ROE, based on doubling profits in 10 years?

These straightforward example questions form the basis of our shareholder proposal. While we, as shareholders, currently fully entrust the board of directors and employees with profit growth and efforts, we earnestly wish that the board will decide on the usage of equity, the denominator of ROE, after constructive dialogue with shareholders.

Although the boards of directors of all three companies opposed our proposals we would like to ask them: “Do you have a reasonable, executable plan for sustainable ROE improvement?” We posit that ISS may have found the issuer’s explanation insufficient in this regard.

Once again, we urge shareholders to carefully consider what is appropriate for maximizing corporate value. We believe the future of Japan’s corporate activities and the revitalization of its capital markets relies on your vote as a shareholder. Thank you!

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