Activist Nihon Global offers ideas to create value for Toyo Suisan shareholders

Business: Toyo Suisan Kaisha and its subsidiaries produce and sell food products in Japan and internationally. The Company operates through the following segments: Seafood, Overseas Instant Noodles, Domestic Instant Noodles, Frozen and Chilled Foods, Processed Foods and Cold Storage. It purchases, processes and sells seafood, and manufactures and sells a variety of products, including cup and bag instant noodles, soup and processed foods.

Stock market value: Approximately 1,000 billion Japanese yen (10,070.00 yen per share)

Ownership percentage: 3.8%

Average cost: n / A

Comment from an activist: Nihon Global Growth Partners Management is a long-term investor in Japanese-listed companies experiencing rapid growth in markets outside of Japan. Before founding Nihon Global in 2018, the company’s principals helped manage a private equity program in Japan beginning in 2004. As private equity investors, the principals completed nine buyouts, including three companies listed in Japan. All of the executives’ previous private equity investments involved Japanese companies with a substantial portion of their growth in markets outside Japan.

In late April, Nihon Global issued a press release and presentation detailing its investment in Toyo Suisan and four shareholder proposals that it put to a vote at the company’s next general meeting of shareholders in 2024: (i) increase the dividend payout ratio to 40%; (ii) repurchase 20 billion yen of shares in the company; (iii) implement a share-based compensation program for directors; and (iv) disclose the company’s cost of capital.

Toyo Suisan is an international conglomerate with several business segments in seafood, processed foods and refrigeration, but its crown jewel is its overseas instant noodle business. The company is a global leader in the field, particularly in North America, which contributed 65% of consolidated earnings before interest and taxes in 2023 and is expected to exceed 70% in the coming years. Toyo Suisan’s brand of packaged instant noodles under the Maruchan brand can be found in more than just student dorms, dominating 70% market share by volume and 45% by value of sales in the United States, and more than 75%. in Mexico. The segment recorded compound annual growth rates of approximately 10.9% in revenue and EBIT of 12.8% between 2012 and 2024, as well as continued healthy EBIT margins in the mid-teens .

Despite this stunning performance and its status as a global leader in instant noodles in the United States, Mexico and Japan, the company appears deeply undervalued in its intrinsic value. Nihon Global attributes this to (i) lack of strategic focus on its core assets; (ii) poor capital allocation, devoting far too much investment to historical activities with low ROA and being considerably overcapitalized; and (iii) a lack of focus on total shareholder return, which has underperformed its peers in terms of total return, as well as a lack of formal shareholder return policy.

The ideal plan for Toyo Suisan would be to divest its legacy, non-core businesses and focus its capital and resources on growing its core noodle business. Traditional businesses generated only 17% of the company’s 10-year cumulative earnings before interest, taxes, depreciation and amortization, but they received 51% of investments despite a return on assets of less than 5%. Assets such as its valuable cold warehouse segment, a highly attractive business, would be better suited as a Japanese real estate investment trust or sold to a strategic buyer. The same goes for its processed food and seafood trading businesses, which would benefit from the scale and synergies offered by a strategic acquirer, but which continue to languish in Toyo Suisan, hampering valuations and diverting capital. attention to the company’s key growth areas, while producing mediocre results. ROA.

Nissin Foods (2897.T) is one of the largest and most respected instant noodle companies in the world. Toyo Suisan has consistently outperformed Nissin Foods in North America, one of the most profitable and fastest growing markets in the world. Still, Nissin trades at a higher price-to-earnings multiple because it is a pure play focused on the instant noodle market. Nissin also has a clear dividend payout ratio of 40% and is carrying out share buybacks. Toyo Suisan, on the other hand, is the last company among its peers without a shareholder return policy and stated targets for return on equity, equity dividend, dividend payout ratio and total shareholder return. shareholders, according to the Nihon Global presentation. It has also not carried out a share buyback in 17 years.

Becoming a pure-play noodle company with improved capital allocation practices would almost immediately close out the ~8x P/E multiple discount that Toyo Suisan trades at relative to Nissin Foods. After that, as a dominant player in the North American market, Toyo Suisan would be in a prime position to become a global consolidator in the instant noodle market, a market ripe for consolidation with two or three players dominating the industry . With this plan, Nihon Global estimates the company’s intrinsic value to be 17,300 yen per share or more, as opposed to the low-end range of 10,000.

However, while this type of ambitious activist plan would be common in the United States, activism in Japan is more of a foot race than a sprint. This usually begins with shareholder proposals which, under regulation, can only address specific issues, such as capital allocation and dividends. As a result, Nihon Global presented four shareholder proposals that will be voted on at the company’s annual meeting in June 2024: (i) increase the dividend payout rate to 40%; (ii) repurchase 20 billion yen of shares in the company; (iii) implement a share-based remuneration program for directors in which 40% of the total remuneration would be linked to performance and half of which would be in shares; and (iv) disclose the company’s cost of capital. These are incredibly reasonable proposals. The dividend increase represents an incremental increase of just 1.9% in December 2023 cash flow. The buyback represents only 4.6% of December 2023 equity. The compensation package is equal to market standards and the Disclosure of the cost of capital is consistent with existing recommendations of the Tokyo Stock Exchange.

A word about shareholder proposals in Japan for those unfamiliar with them: It’s like appearing before Judge Chamberlain Haller in the 1992 film “My Cousin Vinny.” “This is a lucid, intelligent and well-considered objection. Rejected.” In other words, they rarely succeed. Last year, 3% of corporate governance shareholder proposals were adopted and 4% of balance sheet-based shareholder proposals were adopted. This is part of an increasing trend. But there is a lot of good news here. First, if adopted, they are binding – unlike in the United States. Second, and more importantly, they don’t need to be adopted to get management’s attention. Japanese corporate culture takes shareholder concerns seriously: if a proposal gets at least 20% of the vote, management will often act in a way that is consistent with it. Last year, 107 shareholder proposals received more than 20% shareholder approval, and 49 received more than 30%, according to a study by law firm White & Case.

In this case, Nihon Global could potentially win here or get more than 40% of the vote, which is almost equivalent to a mandate in Japan. Last year at Toyo Suisan, a less experienced activist shareholder with a negligible shareholding who did no marketing or canvassing to support his more questionable proposal to amend the bylaws received 19.8% of the vote. Additionally, the shareholder base here is 41% foreign and more likely to support a shareholder proposal. There is no large “white knight” shareholder or cross-holdings supporting management. Nihon Global’s first three proposals are more likely to pass than the fourth, as the first three require a majority of the votes cast and the fourth proposal would require two-thirds of the votes cast. A final possibility that often happens in Japan is that Nihon Global withdraws its proposals after meeting with management, who would agree to implement some of the recommendations. Senior management has so far refused to meet with Nihon Global, but the company has only requested a meeting since September 2023, which is quite common in Japan. Now that Nihon Global has referred the issue to shareholder proposals, senior management may decide to meet with the company, especially since it is a next-generation senior management team, some of which are trained in UNITED STATES.

This activist campaign highlights three important themes in Japanese activist investing. First, it shows the opportunities available to activists in Japan, where reasonable shareholder proposals could lead to significant shareholder value creation. Second, it shows the limits of activism in Japan, where ambitious plans, even if convincing and logical, such as divesting non-core activities and focusing on the core business, cannot start in the early stages of a campaign in Japan. Third, there is a trend in Asia where private equity investors are turning to shareholder activism in state-owned companies. While shareholder engagement in Japan is relatively new for public investors, private equity investors have been doing it for decades. As a result, it is private equity investors who have experience dealing with the management teams of Japanese public companies. This is inviting many former private equity investors into the space. Brian Doyle of Nihon Global and his team are a good example of this. Hiroyuki Otsuka, former deputy head of Carlyle Group’s Japanese operations, recently raised around $1 billion to launch Newton Investment Management, a Japan engagement fund.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments.