Table Speech

“New Trend of M & A”

January 31, 2007

Mr. Ikuo Yasuda,
Chairman and CEO,
Pinnacle Inc.
Kyushu University

Since the Livedoor incident two years ago, there are a lot of discussions concerning M&A. M&A, which includes hostile buy-outs, has increased substantially.

There are three reasons why M&A has increased lately.
Firstly, [Selling of Companies] increased. The image of [Selling] used to be [Desperate selling of a bad company], like selling a company because the company was losing money and management became very difficult, or because one could not find a proper successor to management. These are the cases of selling the company because you could not find a better way. On the contrary, these days, we see the cases [Selling because the company is good.] If you can sell a profitable company, you can sell the company at good price and make a profit. We see many of such cases recently.

Secondly, large corporations, with the motto of [Selection and Concentration], started company re-organization and review the activities of each divisions and subsidiaries, and started selling subsidiaries which had little synergy effect. The company will utilize the fund they make by selling their subsidiary to buy another company in order to increase the value of the company.

The last reason is the increase of cases of [Movements to buy a company, even though the company does not want to sell.]. This is what is called a hostile take over. These are the cases where overseas funds, so called [Activist Fund] operate actively. Usually the fund will buy more than 30% of the shares at the first stage and make a take over bid at the final stage. At this stage, the targeted company has to be saved by a White Knight, but the fund will usually make a large profit in such a case. I am concerned that such cases will occur from now on.

All of such overseas funds have tremendous amount of cash, therefore the case of Myojo Shokuhin last year is just a tip of an iceberg. It is expected that M&A by such funds will increase more hereafter.

There are funds such as activist funds which give threat to the management, but the number of funds which will only do friendly buy-outs are also increasing. All of such funds are operating with huge amount of money and they are operating in Japan in earnest. The number of Japanese Funds is also increasing. The existence of such funds is contributing to the increase of M&As.

The function of a friendly fund is called [Warehouse] function. In the process of company A to be bought out by company B eventually, the fund buys the company A once, then the fund will improve efficiency of the management of company A, thereafter will arrange to be sold to company B. The fund acts as an intermediary.

In the 1980s, when the competitiveness of large American companies declined, they aggressively utilized the function of M&A and accomplished [re-organization] and recovered competitiveness of the companies. In this process, Buy-Out funds performed such warehouse function.

One other recent trend to be noted is the problem of [Pains of Listing]. Listing at the Stock Exchange used to bring all kinds of good things. By listing, all kinds of measures of financing become available, the status of the company improved, able people will come to work for you, and so on. These days, however, shortcomings of listing at the stock exchange are noted. I call them as [Three large demerits of listing]. They are threat of hostile TOB, observance of compliance, and burden of investor relations. These are heavy burden financially as well as mentally.

In order to avoid such a burden, if the company has no debt and does not need to raise cash, there is a trend to change to delist. These are the cases of MBO (Management Buy Out). MBO has the merit of bringing substantial cash to shareholders who owns certain number of shares of the company. Also, in some cases, a division manager or a plant manager may wish to do an MBO by themselves, rather than being spinned off by the parent company. Buy out money will be provided by a fund which operates in a friendly buy out and stock option will be given to the management as an incentive.

The matter to be noted this year is the change of the Company Act. Merger by the exchange of shares of foreign companies will become possible. But this does not mean the arrival of KUROFUNE, causing immediate threat. The procedures are not so simple. But it is a fact that it will become easier for the foreign capital to do M&A in Japan.

In Japan, a hostile take-over has yet to succeed. Because of this past record, some people think there is no threat, but this is a misunderstanding. In most of the cases, the party which tried a take-over made a substantial profit. This is because defendants try to defend by spending money. After the amendment of the Company Act, I am sure that foreign investors and Activist Funds will increase their activities. In order to defend against a hostile buy out, you can use defensive measures to be made before and/or after the take over bid occurs, but usually you will need a large amount of money, if you try to solve the problem after the action of take-over was taken.

In order to avoid such a situation, you should take measures before hand to defend against take-overs.

There are many defensive measures, such as changing the articles of incorporation, and changing the terms of directors of corporation. You should prepare in ordinary times while there is no emergency. We are currently receiving a lot of request of advice regarding such matters.

One incident to be noted as a case of hostile TOB is the TOB by Oji Paper Company to Hokuetsu Paper Company last year. In Japan, hostile take over used to be considered as a taboo. People used to have a feeling that hostile take-over is only exercised by a minority such as Activist Funds and that a traditional company with history and an honorable tradition will not dare to do TOB. By the TOB by Oji Paper to Hokuetsu Paper, however, the situation has changed drastically.

I received a strong impression by the statement of the president of Oji Paper in TV, “The first hostile TOB by a well established company to a well established company.” A well-established and honorable company tried hostile TBO overcoming the taboo. Public opinion, which some thought may act against this, was not against Oji. This was a historical moment when the taboo was lifted. I think once the taboo is lifted, some of the management of the large companies may think they can take similar actions.

On the other hand, middle class companies, third or forth in the industry, have started to fear of being taken over by a larger company, not due to the traditional reason that their share prices are low, but because they are good companies.

Around the same time last year, AOKI of men’s apparel proposed a TOB to FUTATA of Fukuoka. FUTATA was eventually saved by KONAKA. Similar to the case of Oji, this is the case where the company expanding throughout the country wishes to take over a company which is very strong in a certain local market.

Companies that are strong in a certain local market may fear that they may become the next target of TOB.

I have been using a word hostile take over often in my speech. Now we have to study what is “Hostile Take Over”.

The word “Hostile” is used to express an attack on the management of a company. Therefore the word “Unsolicited Offer” is more commonly used in the United States. In the United States, the judgment of either friendly or hostile depends upon “The decision of the board of directors of the target company, either accepting or rejecting the offer.”

I believe the board of directors of the target company will judge the unsolicited offer on whether the proposed buy-out will increase the share value of the company or not. The judgment of a director should be made as a director and not as an executive of the company, who wishes to stay as an executive of the company. Therefore, even in the case where the TOB started as a hostile take-over, it may end up as a friendly take over by persuading the board of directors on the basis of the increase in the value of the shares. This often happens in the United States.

After the revision of the Company Act, international enterprises which are well acquainted with such maneuvering will come into the Japanese market. Even though at the beginning, the offer looks like an “uninvited TOB””, eventually the offer may be changed to a “friendly buy-out”. Therefore the defensive side has to become more sophisticated.

Even Matsushita Electric, or Shin Nippon Steel, such huge companies, has their guidelines to defend themselves against a hostile TOB. This means they are preparing for the defense against the coming of foreign investors with billions and billions of dollars into Japan.

It will not cost much money, to prepare against TOB in ordinary times. Please prepare yourself beforehand, while there is no sign of an unsolicited TOB to your company.

I talked mostly about hostile TOB, but most of the M&A are friendly and it is becoming one of the important business strategies. I recommend to you to study M&A, aggressively but in a friendly manner, in order to expand your business and increase the value of the shares of the company.