Wednesday, March 22, 2023

Hedge funds are having a hard time running this business

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When the important shares of the hedge fund Elliott Management Corp. at Toshiba Corp. went public in 2021, the company was in the midst of a strategic review. More than 18 months later, the storied Japanese conglomerate’s earnings have turned to losses, private equity firms are bidding for it at a discount and a top executive has resigned over spending misdeeds.

For all the hedge fund talk of “fundamental value” and the need for change, it’s hard to see what gains have been made so far.

This month, Toshiba posted dismal earnings: operating income fell 87.5% for the quarter ended in December, as every segment – from power systems to printing and infrastructure – struggled. The situation is bad by almost any standard, but the company singled out factors for the decline. They included product warranty issues, reputational damage charges and a “drastic change” in the hard drive market.

Supply chain problems, including raw material and logistics costs, were also hit hard, but much later than most other industrial companies had felt the brunt of the rumblings. Toshiba lowered its full-year profit forecast. To add to the ongoing turmoil, its chief operating officer resigned over allegations of inappropriate entertainment expenses while a manager at Toshiba Energy Systems in 2019. That doesn’t say much about its internal controls.

Meanwhile, after months of speculation, a consortium led by Japan Industrial Partners, or JIP, backed by more than $9 billion in loans from major Japanese banks and investments from 20 companies, submitted an offer this month to buy Toshiba — at a discount to to. market value, no less. Shareholders were disappointed. A leveraged buyout was seen as one of the most likely options to revive the electronics giant and had attracted foreign heavyweights such as Bain Capital and CVC Capital Partners.

It is unclear why management was effectively waiting for deep-pocketed investors to come forward with offers while the business units’ performance declined. Surely the board had some knowledge of what was going on with the company’s operations? The revenue decline was much larger than consensus estimates. Meanwhile, in June last year, analysts had already started saying that Toshiba’s segments were “weakened beyond repair”. Little was done to stop the bleeding or heed the warning.

Executives have tried to allay concerns about deteriorating performance. At the recent earnings conference, Masayoshi Hirata, Toshiba’s chief financial officer, said that the current results will not divert the company from its strategic plans, which are concerned with the future value of the corporation.

While activists and other foreign investors were quick to rescue the firm with a lucrative $5.4 billion bailout in 2017, they have done little to make surgical operational changes. Much of the increase in Toshiba’s market capitalization came from optimism about the presence of foreign hedge funds and what they could potentially do, not so much in creating real value.

The thing is, Toshiba has real businesses on offer. From energy systems, including nuclear to power semiconductors, many industrial products are in high demand right now. If it is restructured and invested, there will be real returns. Hedge funds and foreign investors have focused on so-called long-term value – for the better part of a decade. Taking board seats and working through strategic solutions on paper for a large company is not the same as running an industrial conglomerate. In theory, operational experts, focused on the sector, could have been brought in to dig deeper into performance and find out where to trim the fat.

The only option now is the JIP offer. Shareholders did not like the discounted takeover offer – the share price fell. Still, it’s worth considering what the potential deal means for Toshiba. If it passes, the company will again be caught up in a network of domestic firms such as Chubu Electric Power Co. and Orix Corp. operating in several sectors. This looks more like the stock-mixing mess that has long plagued the country’s corporations. It is difficult to say who will bring about the operative repair that is so necessary. Many gamers may leave Toshiba right where it is right now.

At one point, Toshiba had all the makings of a turnaround: With Paul Singer’s Elliott on board, it got good marks for good governance, while much talk of corporate and shareholder value, spin-offs and restructuring made it to sound progressive. The company looked like it was about to make a comeback. It was beset by a series of crises, including accounting issues, an escape from bankruptcy and a report that exposed Toshiba’s efforts to block shareholders from exercising their rights.

In a letter to shareholders after the JIP offer, Akihiro Watanabe, chairman of the board of directors, blamed the difficult macro environment for the problems, saying “we feel strongly that there is an urgent need to transform” Toshiba. He added that they needed to reach a final conclusion soon to start moving forward.

More from Bloomberg Opinion:

• The barbarians are at the gate. Don’t Resist: Anjani Trivedi

• Elliott’s Spreadsheets Against Market Whims: Chris Hughes

• Paul Singer got the right virus, but could still lose: Chris Bryant

This column does not necessarily reflect the opinion of the editorial board or of Bloomberg LP and its owners.

Anjani Trivedi is a columnist for Bloomberg Opinion. It covers industries including policies and firms in the machinery, automotive, electric vehicle and battery sectors across Asia Pacific. Previously, she was a columnist for the Wall Street Journal’s Heard on the Street and a finance and markets reporter for the paper. Before that, she was an investment banker in New York and London

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