Oasis launches a campaign at Kao. This battle may be difficult

Business: Kao Corp, based in Japan, manufactures and sells consumer products and chemicals. It operates in five business segments. The Hygiene and Life Care segment provides fabric, kitchen, home, sanitary and pet care products. The Health and Beauty Care segment offers face, body, hair, oral care, hair styling and coloring products, as well as salon and retail health care and warming products. bathroom. The life care company offers health drinks and hygiene products for commercial use. The cosmetic activity offers advice and self-selection of cosmetic products. Finally, the chemical business segment includes oleochemicals, fat and oil derivatives, surfactants, fragrances and other specialty chemicals.

Stock market value: 2.92 trillion Japanese yen (6,273 yen per share)

Comment from an activist: Oasis Management is a global hedge fund management company headquartered in Hong Kong with additional offices in Tokyo, Austin and the Cayman Islands. Oasis was founded in 2002 by Seth Fischer, who leads the company as chief investment officer. Oasis is a genuine international activist investor, campaigning primarily in Asia (and occasionally Europe). The firm has an impressive track record of prolific and successful international activism. He has as many arrows in his quiver as any activist and has successfully won board seats, opposed strategic deals, advocated for strategic actions, improved governance company and to hold management accountable.

On April 8, Oasis Management announced that it owns more than 3% of Kao Corp. A few days earlier, the company launched its “A Better Kao” presentation, proposing an overhaul of the company.

Kao Corp is a rapidly evolving global consumer goods company with a diverse portfolio of products ranging from hair and skin care to cosmetics and chemicals. The company operates in five segments, but hygiene and life care (33%), health and beauty (25%), cosmetics (15%), and chemicals (23%) are their four key segments generating almost all of Kao’s 1.53 trillion yen in 2017 revenue in 2023. The company has a range of brands (including Curél, freeplus, Jergens, Bioré, Oribe and Molton Brown) which have significantly underperformed its peers. Upon the release of its campaign presentation, Oasis highlighted that Kao’s shares were down 22.9% since 2021 while its peers were up between 1.7% and 100.4% during the same period. Additionally, while its competitors have recovered their consumer product sales, Kao has failed to return to pre-pandemic levels and has one of the worst operating profit margins in the industry. Despite pressure from the Tokyo Stock Exchange for companies to improve return on equity, Kao’s ROE has seen a steady decline, falling to less than 5% in 2023, from around 20% in 2017. Operating margins also follow a similar trajectory, falling to 4% in 2023 from 14% in 2019.

Oasis details what it believes are the company’s problems in its presentation of the ‘A Better Kao’ campaign. Oasis believes that the company: (i) is too dependent on Japan, generating 65% of its turnover in its domestic market and 35% in the rest of the world, an almost inverse distribution to that of its peers, ( ii) is not in optimal distribution channels, (iii) does not focus enough on marketing – while its peers spend between 20% and 35% of its revenue on marketing and advertising, Kao has consistently failed to paid only 10 to 11% of their income on consumer goods. Oasis also said Kao had a bloated brand portfolio with too many national subscale brands; the company has nearly 80 brands, but generates the same revenue as its peers who have between 10 and 30.

Oasis offers several solutions to the company to revive its growth, such as: (i) reversing its opposition to international expansion and distribution to unlock the potential of its stable of globally loved brands, which have been artificially limited to national and regional markets; (ii) review its brand portfolio, prioritizing concentration and investments in high-growth areas, increase gross margins through product premiumization, rationalize its bloated brand and SKU portfolio and focus particularly on the rationalization of its cosmetics and health and beauty segments; and (iii) embrace marketing by integrating a CMO with global experience and updating the board with equally experienced directors. These are comprehensive changes to Kao’s business, geographic footprint, distribution channels and product mix that would typically require an in-depth analysis of costs, demand, competitive landscape and likelihood of success. Oasis provides none of this.

Oasis cites Beiersdorf’s turnaround as an example of what is possible in Kao. Suffering from the same problems, Beiersdorf had lower performance than its peers, poorly allocated marketing spend and lagging behind in premiumization. Investors had also lost confidence in management. The company refreshed its CEO, overhauled its corporate culture and growth strategy, and refocused on key brands and gross margin expansion. Since then, Beiersdorf’s share price has outperformed its European peers in the consumer goods sector. However, Oasis had absolutely nothing to do with this turnaround and is not recommending any of the Beiersdorf executives for positions at Kao. It’s hard to see what significance Beiersdorf has here beyond just being a peer.

Oasis says the board does not have any directors with expertise in international consumer goods marketing or branding, and the company makes good arguments regarding the gender and demographics of the board. Oasis has proven to be a value-creating activist in many situations and would likely be a valuable board member here, but this is not a typical Oasis activist campaign. First, until 2023, the company had never hired a cosmetics company. Since then, this is Oasis’ third engagement with a Japanese company in the cosmetics, health and consumer goods category. The other two didn’t go very well. Kusuri No Aoki and Tsuruha are both operators of pharmacies specializing in the sale of pharmaceuticals, cosmetics and other consumer goods. In both companies, Oasis fought proxy fights and was defeated by management. Second, if Oasis is even remotely right about Kao’s problems, resolving them would require a total reconstitution of the board and replacement of management. This is not something that is usually done in Japanese companies and in which Oasis has a lot of experience. In Japan, Oasis and other activists have managed to create shareholder value simply by engaging companies without implementing their activist agenda. This is something that can happen in Japan, but usually when the recommendations are minor, such as capital allocation, cross-shareholding sales, and improving corporate governance. In this case, Oasis should implement its activist agenda and do a lot of work to create value in a company with the problems it claims to have.

This doesn’t seem to be part of Oasis’ plan here. Oasis CIO Seth Fischer hasn’t ruled out submitting shareholder proposals to Kao, but even that sounds like using a fly swatter on an elephant. Furthermore, a settlement here is very unlikely. Oasis had been meeting privately with management since 2021, so if management was inclined to work with them, this would have happened by now and Oasis would not have had to go public with their campaign. On the contrary, the day after Oasis’ campaign launch, Kao said the company lacked understanding of its portfolio management and restructuring plans.

On the date of its presentation, Oasis expected between 76% and 97% increase for the stock, or nearly 10,000 yen per share if their proposals were adopted. However, the investor has also been engaging privately with the company since June 2021, during which time growth has slowed, margins have declined, ROE has fallen and the stock has fallen. So I would take the company’s forecasts and chances of success with a grain of salt.

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.