Tokyo-based hedge fund run by SFP exploits market inefficiencies by investing in undervalued Japanese companies and implementing changes leading to share price appreciation over a two to four-year period.
Investors may think they have heard every reason why they should be invested in Japan. If they have not talked with Symphony Financial Partners (SFP), they may be missing a unique opportunity.
Along with his partners, David Baran (pictured), co-chief executive and co-founder of SFP, has reinvented the concept of an event driven strategy to fit the peculiar Japanese situation.
“We are the event creation fund,” explains Baran. The SFP Value Realization Master Fund exploits market inefficiencies by investing in undervalued listed Japanese companies and “constructively engaging management” to implement changes leading to share price appreciation. The goal is to realise gains over a two to four-year period.
With more than 20 years of experience investing in Japanese equities, Baran, together with co-CEO Kazuhiko Shibataand managing director Jason Schwartz, first began looking at the Japanese market in the late 1990s/early 2000. “At that time there was a lot of private equity money being raised for Japan. Our close contact with those investors led us to realise that while the money was there to buy, the offers were not there to sell,” says Baran. “We realised there was a space in the marketplace that was not being appropriately exploited.”
This is where SFP stepped in. Private equity investors usually require control while equity investors tend to be passive. “We found in the Japanese equity market an abundance of very cheaply priced equities where nobody seemed to be in control. The companies were operating somewhat on autopilot. Doing very well, but there was no engagement with shareholders.”
Changes in Japanese corporate law and culture were creating a pool of what Baran calls “orphans”: companies where there was nothing really wrong but no-one seemed to care about them.
“We decided these were the companies we were going to care about. We were going to make a substantial investment in these companies through the listed equity. We would become the number one, two, three shareholder in the company.”
This meant owning large stakes in companies, ranging from around 10% to 49% in one case. Using this significant holding, SFP then works with management to “cause the shares to be properly priced”. The intention, notes Baran, is not to disrupt or reorganise management but rather to help management realise value for the company and for shareholders.
|Full name of fund
|| SFP Value Realization Master Fund
|| David Baran, Kazuhiko Shibata, Jason Schwartz
|| Symphony Financial Partners
|| the new Otani Garden Court 9F, 4-1 Kioi-cho, Chiyoda-ku, Tokyo 102-0094, Japan (+81 3 45000 9250; fax +81 3 3222 1312
|| September 2003
|Assets under management
|| $200 million (at May 1, 2012)
|Net cumulative performance since inception
|| 52.66% (at 29 February 29, 2012)
|Annualised standard deviation
||Citi, Goldman Sachs
||Schulte, Roth and Zabel; Maples and Calder; Oebashi
|| event driven, activist
|| A, B, C
|| 2% (A and B); 1.5% (C)
||20% with high water mark (A); 20% with high water mark (B); for shares acquired during 2011, 10% until end of 2012 and 15% thereafter with high water mark (C); for shares acquired after 2011, 15% with high water mark (C)
|| None but possible penalty for redemption within one year (class A); two years (B); redeemable up to 5% on first and second anniversaries of acquisition and up to 50% on third anniversary of acquisition (C)
|| quarterly with 90 days’ notice (A and B); quarterly with 90 days’ notice
“The equity markets [in Japan] are not the same as other equity markets where being listed confers on the equity owner, the shareholder, certain rights that they will exercise. That’s not really the mechanism for Japanese equities. There is no market for corporate control, no clearing price at which an entire enterprise can be priced,” he explains.
“Instead of taking the ‘my wallet’s bigger than your wallet route’, we want to work with management.”
Big in Japan
All the ingredients for the strategy were present in Japan. First, there was a large target universe because of prolonged market weakness. The status quo clearly was not working. Companies needed to address strategic issues, financial performance, shareholder discontent and governance, something management was not necessarily equipped to do.
“They’re good guys, just never had this type of external bombardment of demands from shareholders causing them to rethink the way they do their day-to-day business,” says Baran. “Generally there’s nothing wrong with the way they do day-to-day business. The problem is with the share price.”
In addition corporate management stagnation had created mispricing as well as opportunity. Drastic improvements in corporate governance norms meant management was accountable to shareholders while domestic investors were agitating for change. SFP saw an opening to step in and avoid value traps by working with management to enhance share price performance,
Baran says SFP spotted the opportunity and moved in. “You don’t need control. You need influence. You need to be able to sit down with management and come up with up viable ideas which they can implement and will lead the share price to higher and higher ground,” he explains.
“Those strategies may be share buybacks, maybe having an investor relations department, may be increasing dividends. But most effective we have found is some sort of corporate action, whether it’s a merger or an acquisition of something else or a management buyout. Something a bit more binary as opposed to something that is a bit more creative. Raising dividends is nice, but it’s a governance thing. Share prices may react to it in the short term but it’s usually not enough,” Baran adds.
Baran is proud of the fact SFP executed the first hedge fund-led management buyout in Japan, creating alpha for his investors by exiting to a strategic buyer at a substantial premium.
In fact the premiums almost appear too good to be true. The catch is that it does not take six to 12 months but more likely two to four years to cause enough of a sea change in management activities to realise the investment.
In the first quarter of 2012, there were 19 tender offers in Japan with an average bid premium of 51%. “That’s a lot of deals and a big premium,” comments Baran. “It’s indicative of exactly what we’re saying: there is so much optionality in Japanese equities that you ignore them at your own peril, performance-wise.”
He admits SFP is probably alone in completing multiple MBOs in Japan as well as M&A executed and implemented. “Because we take such large stakes in our target companies, we’re much more able to influence the pricing of any of these corporate actions. So whereas the average premium bid for the first quarter this year was 51%, the last deal we did in December 2011 was 135%.”
SFP can command such returns because it is setting the price. “We own enough of the company, if you want to do the deal, this is the price it’s going to happen at. Of course there was some horse-trading going on, too. We actually see the biggest risk for investors in Japanese equities in allowing Japanese management or other strategic buyers to buy Japanese companies too cheaply,” says Baran.
According to Baran the average equity shareholder is “so thrilled to be getting a premium for what they paid for it that they’ll sell at any reasonable price”. The problem is the reasonable price is not actually a fair market price.
“You’ve got companies trading one times Ebitda and management is buying them at two or three times Ebitda when a real buyer would pay five or six. You look at it and say ‘wait a minute. Just because you’re getting premium of 50% doesn’t mean it’s a fair price, just a higher price’.”
With all this potential value in the offering, SFP seems at present to be the only organisation seizing the chance to make money. Modestly Baran says he puts it down to stubbornness and a lack of ability by anyone else to do it.
However, he admits the real problem is that it is a difficult trick to pull off. “If you’re a hedge fund manager you almost by definition don’t have the skillset to engage with management to do this. We came at this from a completely different perspective. We came at it from a private equity arbitrage perspective,” explains Baran,
Seeing an arbitrage opportunity, the next question was how to get at it. If the company is trading at a discount to net cash on its balance sheet, the problem for SFP was how to close that value gap. “Can you take over the company, do a levered recap and distribute all the cash? Probably not in Japan. That’s why the opportunity exists.”
SFP usually has 10-15 core portfolio holdings limiting positions to 10% of assets under management at the time of investment. Industry concentration limits are set at 15% of AUM. The strategy uses no leverage and usually has cash holdings of 5% to 10%.
Finding the companies, admits Baran, is about “shoe leather”. “You can do all the work you want in your office, pulling together annual reports and 10Ks and other types of information about the company’s business prospects, but you’ve got to go and visit with management, see the factories, see the competitors, see the clients and put together a mosaic.”
Finding underpriced companies is not difficult, he says. “Figuring out what is going to make them fairly priced is a lot more complicated. Implementing what you figured out is a Herculean task.”
With only around $200 million AUM, the fund has no capacity problem. While SFP has not been actively marketing the fund, Baran thinks attitudes towards investing in Japan may be changing. He is confident the fund will attract more investors this year, mainly from outside Japan although domestic investors are also becoming interested in what they term ‘concentrated portfolios’.
Baran maintains the fund offers a compelling investment opportunity. With his own background at Lehman Brothers, Goldman Sachs and Barclays Capital, coupled with Shibata’s experience also gained at Lehman and Goldman Sachs, Baran is confident their expertise in the Japanese market and the fund’s performance will attract more investors in future.