Emerging Markets

Triangulation Reformation

By, 04/30/2007

Economics and free market efficiency are universal. Put any human in a free market and they're likely to behave very similarly to anyone else, no matter the time or place. However, variance can often arise from local government regulation and cultural differences.

To wit, Japan is a bit of an odd duck in the investing world. Most of this week Japanese markets will not be open in observance of a number of holidays:

April 30 - Showa Day: The birthday of former Emperor Showa, who died in the 1989.
May 3 - Constitution Day: On this day in 1947, the new post war constitution was put into effect.
May 4 - Greenery Day: The day is dedicated to the environment and nature, because Emperor Showa loved plants and nature.
May 5 - Children's Day: The Boy's Festival is celebrated on this day. Families pray for the health and future success of their sons by hanging up carp streamers and displaying samurai dolls, both symbolizing strength, power and success in life. (The Girl's Festival is celebrated on March 3.)

This holiday schedule underscores the vastly different cultures throughout the world that sometimes can be difficult to understand for a US-based investor. But a globally diversified stock portfolio must take such things into account, particularly given Japan's large presence in the world as both a market and economy. And anyway, even a US only investor still must pay attention—the world's economy is far too global to ignore the broader picture.

One very important cultural distinction is Japan's aversion to merger and acquisition activity. Generations of Japanese businesses viewed M&A as a kind of failure. The culture's focus was not on greater efficiency or maximizing shareholder value, but on building employment stability and career paths. Thus, if a company were to be acquired, it was considered a breakdown in the operation of the business. It was very rare indeed for hostile bids to emerge in Japan. This is very different from the environment of the US and Europe, where M&A activity is celebrated and often welcomed. Or, at the very least, taken as a normal part of any business cycle.

In fact, mergers are so looked down upon in Japan there are restrictions on foreign investment—a foreign company can only acquire a Japanese company with cash, not with stock.

These cultural and regulatory prohibitions have lead to a great deal of inefficiency over time. When industries are not free to consolidate, inevitably they become disjointed, segmented, and excess capacity pervades.

But all this is about to change. Japanese regulators and businessmen are pushing to increase foreign direct investment in Japan and shift the cultural attitude. Tomorrow, a new law becomes active, allowing foreign companies to purchase Japanese companies through "triangular mergers." This means that a foreign company wishing to purchase a Japanese company must create a subsidiary company in Japan before using its stock to purchase the target company. This may seem unorthodox, but it's an excellent first step for Japan in opening itself to foreign investment.

We're not likely to see a huge wave of activity right away. Again, cultural shifts take time, and even big corporations will probably be a bit reticent to be the first to get their feet wet. But it will happen eventually…because economics are universal.

For some time now, we've highlighted the game of using cheap borrowing costs to purchase companies with high relative earnings yields. (See our past commentary "if CEOs don't, investors will do it for them") Japan's aggregate corporate earnings yields are among the cheapest in the world—very attractive acquisition targets. Eventually the world will catch on. Here's proof:

Citigroup inks Japan's Largest Foreign Buyout
By the Associated Press via MSNBC

The cultural shift is on in Japan, likely paving the way for Japanese corporations to participate in the M&A boom that's taking the investing world by storm today.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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