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Company: Nihon Kohten
Company: Nihon Kohden (6849.T-JP)
Business: Nihon Kohden is a Japan-based company engaged in the research, development, manufacture and sale of medical electronic devices, as well as the provision of maintenance and repair services. The Company offers a wide range of devices to support medical diagnosis, including electroencephalographs, evoked potential testing devices, electrocardiographs, cardiac catheterization devices, diagnostic information systems and related consumables. The company is also engaged in the promotion of its products as well as general business activities and personnel scheduling.
Market value: $2.6 billion ($31.02 per share)
Activist: ValueAct Capital
Percentage ownership: 5.01%
Average cost: n/a
Comment from activists: ValueAct has been a leading corporate governance investor for over 20 years. ValueAct's directors generally serve on the boards of half of the company's core portfolio positions and have held 56 directorships at listed companies over 23 years. ValueAct was a pioneer of US-led international activism, particularly in Japan. ValueAct's co-CEOs Rob Hale and Mason Morfit are also co-portfolio managers of the firm's Japan fund. A significant portion of the portfolio is invested internationally. Hale sits on the boards of Japanese companies, an unprecedented and industry-leading move for U.S. activist funds. ValueAct previously had 26 international activist investments and delivered an average return of 36.19% versus an average of 4.04% for the MSCI EAFE index over the same period. Additionally, two of their best international investments were two Japanese companies where Hale is on the board – Olympus (109.48% vs. 7.68% for MSCI EAFE) and JSR (116.86% vs. 38.57% for MSCI EAFE) .
What happens
It is December. 25, ValueAct said it held 5.01% of Nihon Kohden.
Behind the scenes
ValueAct was a pioneer of US-led activism in Japan. A significant portion of the company's portfolio is invested internationally. Two of his best international investments were two Japanese companies where ValueAct co-CEO Rob Hale sits on the board: Olympus and JSR. Nihon Kohden is a Japanese medical device manufacturer and distributor with a dominant domestic market presence and an excellent international reputation for on-time delivery, service and product quality.
This is the third Japanese medical technology company ValueAct has invested in. Notably, the company invested in Olympus in 2017, gained a board seat in 2019, and remains on the board to this day. Both Olympus and Nihon Kohden are global medical device companies. However, Olympus generates 80% of its sales outside Japan, while Nihon Kohden generates about 40% of its sales outside Japan. However, both companies have great products and the ambition to be global, and Nihon Kohden could take a path to globalization similar to Olympus's.
At Nihon Kohden, there are three main levers for value creation: increasing operating margin, optimizing the mix of equipment and consumables and services revenue, and disciplined capital allocation. First, despite a gross profit margin of 51%, Nihon Kohden's operating margin is only 10%, while its competitors in Japan and abroad are in the mid-to-high teens. With a market share of approximately 60% in Japan, where a portion of sales come from the distribution of third-party products, and a market share of 10% in the United States, where the company offers its own products, the growth and margin potential in the United States is at Nihon Kohden larger can use its reputation strength to benefit from the US market. The company has the opportunity to quickly achieve an operating margin of 15% within a few years and can see gradual improvements in the following years.
Second, Nihon Kohden has historically focused on hardware sales, and its revenue is divided roughly equally between hardware and consumables and services. However, there is an opportunity for value creation if the company follows a strategy to increase its revenue from consumables and services, as this type of revenue is recurring and generates higher margins. With these two strategies alone, Nihon Kohden can achieve 20% earnings growth over the next three years.
Third, the company currently has net cash equivalent to approximately 15% of its market capitalization. Like many Japanese companies, Nihon Kohden could create value through a capital deployment strategy that includes returning capital to shareholders or disciplined mergers and acquisitions. Historically, stock buybacks have not been a popular tactic in Japan, but share buybacks have increased in recent years. The Tokyo Stock Exchange has encouraged them as part of a process to get companies to trade above simple book value.
ValueAct has a reputation as a cooperative and friendly activist, and there is no reason why the situation should be any different. Before building such a position, ValueAct likely got to know management over the past year and spent a lot of time with CEO Hirokazu Ogino. Furthermore, ValueAct would not have made this investment if the company had not shown a high level of respect for Ogino and the rest of the management team. We believe that ValueAct and management are aligned in their views, particularly with regard to margin improvement and capital allocation.
ValueAct conquers board seats not through fear or violence, but organically through dialogue and harmony. Accordingly, we expect the Company to continue to support management as an active shareholder and only take a seat on the Board if both ValueAct and management believe the investor could add value. At Olympus it took two years. For JSR it took over a year. Both companies have been incredibly successful exposures for them: they returned 109.48% for Olympus versus 7.68% for the MSCI EAFE and 116.86% for JSR versus 38.57% for the MSCI EAFE. ValueAct remains on the board of both companies. A similar result here can lead to an almost doubling of the population in two to three years.
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, an investment fund that invests in a portfolio of 13D activist investments.