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The "shadow activist fund" SKAGEN Insight seeks the most undervalued companies. At the time of writing, the fund has around one third of its portfolio invested in Japanese companies, including Kyushu Railways (pictured here). Photo: Bloomberg.

Around one third of SKAGEN Insight’s portfolio now consists of Japanese companies.

“What all our Japanese investments have in common is that they are rather extraordinary positions that you wouldn’t find elsewhere in the world. In many cases, there is a substantial disconnect between what the value of these companies should be and the value that the market places on the companies,” says Tomas Johansson.

Many of the companies that the shadow activist fund SKAGEN Insight is currently considering have a market value that is lower than their own financial investments, in other words, a negative enterprise value.

Tomas Johansson explains that, seen through western eyes, it is absurd that the market assigns a negative value to companies. An important reason why this is the case is that historically speaking there has been a weak corporate governance framework in Japan. This has partly been due to a lack of understanding of fundamental concepts such as return on capital, and partly to the large cash holdings that many companies have accumulated on their balance sheets.

Signs of improvement

“When a company trades at a P/B figure of less than 1, in Europe or the US, the market often prices in the need to write down the book, assuming that something is wrong. But when you see Japanese companies trading at a low P/B figure, this often means that the book is far too big, i.e. that they have far too much cash,” explains Tomas.

“At the same time, management and boards have traditionally had little incentive to push up the share price, since they rarely have much exposure to companies’ share prices,” he adds.

However, Tomas Johansson believes that there are now clear signs that corporate governance in Japan is about to improve. Amongst other things, the Japanese state has announced new clear corporate governance guidelines.

“Japanese companies are waking up to the fact that they are not sufficiently profitable. The easiest way to raise profitability of capital is by addressing the over-capitalised balance sheets. Or to put it simply, doing something about the considerable cash pile,” says Tomas.

Overweight Japan

SKAGEN Insight is overweight Japan, where it invests around one third of its portfolio versus only eight percent for the benchmark index. Why does the fund currently have such high conviction in Japan?

“It is clear to me that the issues above are in the process of being addressed. We have recently returned from a trip to Japan and based on what local investors are saying and how some of the companies are behaving, we see strong indications that the external pressure for change is much higher than it has been previously,” says Tomas.

“I would say that international investors are structurally underweight Japan, and many won’t believe in change until they see it. We are not quite there yet, but the fund has allocated capital to Japan because we believe that we are well prepared for the reforms that are underway and that will accelerate.”

Has it been more common to see activist investors in Japan in recent years?

“It has. They see what activists have managed to achieve in other parts of the world, while at the same time observing enormous inflated values and improvement potential in Japanese companies. We have heard about a couple of new activist funds about to be launched and are excited that activity is increasing on that front,” says Tomas.

Undervalued companies attract

Given its overweight in Japan, and also in Europe, the fund has a clear underweight in the US. Aren’t activist investors known for their aptitude at pushing for change in the US?

“First, we don’t take index weightings into consideration. However, it is true that we are underweight the US, and there are two reasons for this. US companies are generally better managed, which means that there is less potential for improvement. This is due to the fact that over the past few decades, shareholders in the US have been better at pressuring companies to improve. But the main reason for our underweight is that US companies are priced higher than the situations we are looking at in Europe and Japan. We strive to invest our money in the most undervalued parts of the world.”

How do you look for investment ideas? Do you have a screener which tells you which companies activists are involved in?

“In terms of process, we have an information portal that keeps track of flagging messages, press releases and other channels where activists report on their investments. Since activists are minority shareholders in various companies, they are dependent on the support of other minority shareholders to be able to push forward their case. They are therefore very eager to inform people about their investments. In order to have more weight in discussions with companies, activists often go out publicly to explain what measures they would like to see implemented.”

Seeking potential for change

Around half of the fund is invested in industrials, versus 11 percent for the index. Why is such a large proportion of the fund invested in this sector?

“The industrial sector is well suited to activists, since the companies have good control over how much money they can earn. There are numerous ways to run an industrial company, and it is logical that owners of these types of companies sit down with management and discuss how things can be done differently. It is more difficult to tell a biotech company, for example, how they should go about inventing new drugs. Industrial companies also have cyclical risks of course. But they often have good control of what structurally determines how much money the company should earn. That is why activist investors often have a natural inclination towards industrial and also consumer companies, which have control over their own destiny.”

Can you describe which types of change process can push up shareholder value in an activist situation?

“We look for five types of change: structural, strategic, operational, financial and managerial. Structural change often involves making complex companies simpler; both simpler to understand from the outside, but also easier for management to run in the best possible way.

“One example of strategic change is altering the business model to earn more money or take less risk. Operational improvements consist of continuing to do the same things, but more efficiently and with fewer resources. Financial change is about ensuring that the financial capital on the balance sheet is used in the best possible way. When it comes to managerial improvement, this involves amongst other things establishing a strong connection between shareholders, boards and management and getting good incentive structures in place.”

Thyssenkrupp, Ericsson and Pasona

Tomas Johansson illustrates the above by describing structural change at ThyssenKrupp, operational change at Ericsson, and financial change at Japanese Pasona. The latter has a market value of around USD 600 million, while holding half of a listed subsidiary whose market value is USD 3.4 billion, according to Tomas.

Do you have a favourite activist investor?

“I don’t prefer any one single activist; it is rather a matter of specific situations, and the right activist being in the right place at the right time. It is important to assess how much experience an activist has of similar change work and whether it is likely that the fund in question will succeed in achieving its goal with the situation. SKAGEN Insight currently invests alongside 20-25 activists, and we generally prefer that the activist is based in the same market as the company,” says Tomas.

Turbulence can drive change

Economic data has come in weak in recent months. How does a potentially weaker economy affect the activists’ situations?

“In times of economic turbulence and stock market uncertainty, this part of the market tends to deteriorate initially, and we saw this in the autumn when stock prices fell sharply in many activist situations. However, it creates an environment that opens up for faster change in the companies, and it is often during such times that activists manage to achieve a great deal. I tend to say that uncertainty is negative in the short term but the best thing that can happen in the medium term, as it accelerates the change programmes of the companies which can generate a lot of value over time.”

Was this something you noticed during the stock market turbulence this autumn; that the change processes took off in some portfolio companies?

“Undoubtedly. Things that have happened in these companies over the past six months were almost unthinkable a year ago. One example is the industrial conglomerate Thyssenkrupp, which is the fund's second largest holding. Not long ago, it was considered unlikely that this structure would change, but now the company has announced that it will be divided into three parts. They are spinning off the traditionally volatile steel business, and splitting the industrial company in two. This is the first step in a journey to make Thyssenkrupp less complex, and a typical example of something that would not have happened if the share price had not done so badly,” explains Tomas Johansson.

This article first appeared in the Swedish publication, Fonder Direkt

In het verleden behaalde resultaten zijn geen garantie voor toekomstige resultaten. Toekomstige resultaten zullen, onder andere, afhangen van marktontwikkelingen, de competenties van de fondsbeheerder, het risicoprofiel van het fonds en de beheervergoeding. Het resultaat kan negatief worden als gevolg van negatieve prijsontwikkelingen.